Abstract
A distinguishing feature of China's recently launched emissions trading system (ETS) is its rate-based structure. This structure governs the way emissions allowances are allocated and the conditions for compliance, and it has important implications for system performance. We show that the rate-based structure implies a wedge between the marginal costs of emissions abatement as perceived by firms and society's marginal costs of abatement. Moving to a mass-based system would eliminate this wedge and thereby yield significant gains in terms of cost-effectiveness and efficiency (aggregate net benefits). We indicate that these gains could be realized while addressing concerns about distributional equity.
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