Regulating greenhouse gas emissions by an inter‐temporal policy mix: an experimental investigation*

Abstract

Emissions taxes impose a fixed price on emissions, whereas under tradable permit schemes prices emerge in the secondary permit market. The delayed price discovery under tradable permits creates uncertainty about the future cost of compliance that liable emitters face. To mitigate this uncertainty, some jurisdictions have designed policies to regulate GHG with an emissions tax that is in force for several years, subsequently transforming into a tradable permit scheme. This paper examines the effects that this staged transition – from no regulation to a regulation by a tax, to a regulation by tradable permits – has on abatement investment, quantity of emissions, permit prices and overall regulation efficiency. The effects of the inter‐temporal mix of policy instruments are compared to the effects of single policy instrument: a tax‐only, and a tradable permit‐only regulation. Our investigation relied on laboratory economics methods to test economic behaviour under these three policy regimes. We find that a staged transition from a tax to a tradable permit scheme results in more socially desirable outcomes on a range of criteria when compared to a regulation based solely on tradable permits, and specifically, it improves ability to make better abatement investment decisions.