Early Emission Reduction Programs: An Application to CO2 Policy

Abstract

In the wake of the December 1997 Kyoto Protocol, which if implemented would oblige the United States and other industrialized countries to reduce greenhouse gases (GHGs) by 2008-2012, a number of proposals have been offered to increase the incentives for emissions reductions over the nearer term. The existence of an interim period between setting and implementing environmental goals is ubiquitous in environmental policymaking. The existence of this interim period gives rise to several potential rationales for early reductions. In this paper we use a series of simple models and numerical illustrations to analyze some aspects of the performance of early reduction programs in the case of GHGs. We show that there is a compelling economic case for allowing early GHG reduction credits if the Kyoto Protocol were to be amended to allow countries (not just individual firms) to bank early credits to offset future emissions. The annualized cost savings to the United States from spreading out abatement over time could easily amount to several billion dollars. But without the aggregate banking provision, early reduction credits could easily generate an excessive amount of abatement, and produce net economic losses. We analyze a number of other issues that affect the economic efficiency of early reduction credits, including asymmetric information, learning-by-doing, and fiscal impacts, and we compare their performance with that of an early cap-and-trade program. This latter approach, if properly scaled, can avoid many of the problems associated with early credits.