Tax, kill or bill: An analysis of unilateral CO2 price floor options in multilateral emissions trading systems

As more governments consider minimum domestic CO2 prices, we investigate three unilateral options for jurisdictions operating within a multilateral emissions trading system (ETS): 1) an additional CO2 TAX; 2) an auction reserve policy to KILL (invalidate) allowances; and 3) an overcompliance requirement to BILL domestic emitters for extra allowances per ton of emissions. We assess three main economic incentives for unilateral action: environmental benefits, fiscal benefits, and terms-of-trade gains. We derive theoretically optimal unilateral price floors and, based on numerical simulations for the EU ETS, illustrate how a national government's preferred strategy depends on how it values fiscal versus environmental benefits.

Automated summary

As more governments consider implementing minimum domestic CO2 prices, this study explores three unilateral options for jurisdictions operating in a multilateral emissions trading system (ETS): an additional CO2 tax, an auction reserve policy to invalidate allowances, and an overcompliance requirement to charge domestic emitters for extra allowances. The study evaluates the economic incentives for unilateral action, including environmental benefits, fiscal benefits, and gains in terms of trade. The authors derive theoretically optimal unilateral price floors and provide numerical simulations for the EU ETS to demonstrate how a national government's preferred strategy depends on its valuation of fiscal benefits versus environmental benefits.