Interferences – interaction with other political instruments

(2) Emission trading vs. subsidies

The coexistence of emission trading and subsidisation also results in inefficient achievement of the reduction target. The efficiency inherent in emission trading is lost as soon as subsidisation leads to emission reductions at higher marginal avoidance costs. If, for example, electricity generation from photovoltaic is subsidised at 500 EUR/MWh¹, the marginal CO2

avoidance costs for the society are about 1,000 EUR/ton CO22. At the same time, the price of emission allowances is about 20-25 EUR/ton CO2. Even if the price of emission allowances increased by 100 or 200% and if all other climate political instruments were fully replaced by emission trading, which would result in a tighter allocation of emission allowances, there is still a factor of 10-20 in between both marginal avoidance costs. While this spread in marginal avoidance costs is a strong sign of economic inefficiency with regard to current reduction of CO2 emissions, the high subsidisation may be justified by the expectancy of a significant decrease in marginal avoidance costs due to a learning curve. As scientific estimates on the learning curve and with it the future marginal avoidance costs of photovoltaic versus other emission reduction opportunities are very difficult to make, the degree of subsidisation is finally a political question.

(3) Emission trading vs. emission taxes and energy taxes

As pointed out in the previous sections, emission trading and emission taxes each achieve emission reduction at equal marginal avoidance costs and emission reductions are achieved cost efficiently. The major difference is that emission trading determines the final emission level ex-ante, while emission taxes do this ex-post. If emission taxation is introduced in addition to an existing emission trading scheme, the price of emission allowances and the traded emission volume decrease, whereas the overall CO2 costs increase. While the supply function for emission allowances remains constant, the demand function has a negative offset equal to the tax rate, as it reflects the price willingness for CO2 costs. With the introduction of the tax in addition to emission trading, both instruments have to share this price willingness (see Fig. 14).

1 Feed-in tariffs for electricity from certain photovoltaic installations according to the German Renewable Energy Act are currently EUR/MWh 574, while the actual electricity price is about EUR/MWh 40.

2 500 kg CO2/MWh can be assumed for the average CO2-intensity of European power generation. The numbers do not include the initial CO2 emission of producing the equipment.

Fig. 14: Interaction between emission trading and emission taxes

As long as the supply curve does not have the same offset too – which would not be reasonable – the decrease in the certificate price does not equal the tax rate. Thus, the overall CO2 costs are higher than before, unless the allocation of emission allowances is expanded to compensate for the effect. Anyway, there is no good reason to believe that the efficiency of an efficient quantity instrument or an efficient price instrument increases with the combination of both instruments.¹ The caveat above does not imply differences in the boundaries. If, for example, the price for emission allowances is set internationally, while only some sectors in some countries are subject to taxation, the effect of the tax on the certificate price is even lower. This can result in a double burden for these sectors. Other aspects are energy taxes instead of emission taxes and the use of the funding from taxation.

Due to the interference of emission trading and emission taxation, some economists as e.g.

(e.g., Wackerbauer, 2003) suggest exemption of sectors subject to emission trading from energy taxation, as is largely the case in Germany and the United Kingdom. However, others such as Rehbinder and Schmalholz (2002) raise the issue of disturbed competition, due to unjust subsidisation in the form of exemption from energy taxation.

(4) Emission trading vs. Clean Development Mechanism and Joint Implementation

Emission trading and both other mechanisms for reductions of greenhouse gas emissions take their legal foundation from the Kyoto Protocol. CDM and JI are designed as complements to

1 The argumentation of Philibert and Pershing (2002) referring to an investigation by Roberts and Spence (1976) that hybrid instruments have advantages over pure quantity or price instruments (emission trading respectively emission taxation) is not conclusive as both instruments themselves are efficient. A gain in efficiency through a combination is not feasible.

Price, Tax

Volume t CO₂ EUR/t CO₂

P₁

V₁

Supply function

Demand function without tax P₂

V₂ Tax rate

Demand function with tax

CO₂costs without tax CO₂costs with tax Price, Tax

Volume t CO₂ EUR/t CO₂

P₁

V₁

Supply function

Demand function without tax P₂

V₂ Tax rate

Demand function with tax

CO₂costs without tax CO₂costs with tax

the instrument of emission trading. Thus, there is no (negative) interference in economic efficiency. Solely the conversion of CERs, ERUs, and emission allowances may cause difficulties due to the above-mentioned uncertainties in crediting specific emission reductions (versus absolute reduction targets) and potentially temporal limitation of the duration of the reduction in CDM and JI projects.

(5) Emission trading vs. labelling

There is no obvious interference between emission trading and labelling. As pointed out in chapter 2.1.1.2, emission trading provides a cost-minimal achievement of a defined emission level, whereas it does not determine the optimal level itself. A labelling scheme can just be supportive. If the consumers have understood the ecological implications with all the associated costs and benefits, they can act accordingly. Those who have not understood the implications or are conscious free-riders do not diminish the efficiency of emission trading.

The transaction costs of labelling are the only restriction.

(6) Emission trading vs. voluntary commitments

Although voluntary commitments of industry to reduce emissions cannot be regarded as an instrument of environmental politics (see chapter 2.1.1.1), they may come into conflict with the instrument of emission trading. In the case of the commitment of German industry, the commitment was adopted under two conditions: (1) participating industry sectors received significant provisions from energy taxation and funding of subsidies for the generation of electricity from renewable energy sources and cogeneration and (2) the government agreed not to take further regulatory actions as long as the commitment is met. Thus, Bode (2002) assesses that in the case of mandatory participation of these industrial sectors, both instruments are nominally incompatible. Wackerbauer (2003) regards the specific reduction targets for an entire sector in the commitment versus installation-specific and absolute reduction targets in the emission trading scheme as the practical problem. To solve it, economists call for a smooth introduction with a sufficient initial allocation. Boie (2002) suggests a solution using the opting-out clause and Wackerbauer (2003) is in favour of two routes of participation with a certain gateway to transfer emission allowances from one to the other.