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Climate Economics Seminar: Strategic Climate Policy with Offsets and Incomplete Abatement: Carbon Taxes versus Cap-and-Trade

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Date(s): October 9, 2012, 1 - 2:30 PM

Location: Room 4128, EPA West Building, 1301 Constitution Ave., NW, Washington, DC

Contact: Carl Pasurka, 202-566-2275

Presenter: Jon Strand (Development Research Group, Environment and Energy Team, The World Bank and Department of Economics, University of Oslo)

Description: This paper provides a first analysis of a “policy bloc” of fossil fuel importers which implements an optimal coordinated climate policy, faces a (non-policy) fringe of other fuel importers, and a bloc of exporters, and purchases offset from the fringe. We compare a carbon tax and a cap-and-trade scheme for the policy bloc, which in either case is accompanied by an efficient offset mechanism for reducing emissions in the fringe. The policy bloc is then shown to prefer a tax over a cap, since only a tax reduces the fuel export price, and by more when the policy bloc is large; and offsets are more favorable to the policy bloc under a tax than under a cap. The optimal offset price under a carbon tax is below the tax rate, while under a cap and free quota trading the offset price must equal the quota price. The domestic carbon and offset prices are both higher under a tax than under a cap when the policy bloc is small. When it is larger the offset price can be higher under a cap. Fringe countries gain by mitigation in the policy bloc, more under a carbon tax since the fuel import price is lower.

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