Tradable Quotas Taxation and Market Power

Abstract

We show how corrective taxation can improve the efficiency properties of tradable quotas systems affected by market power. Indeed, when only a subset of firms are price takers while the remaining firms enjoy market power, we show that, if the regulator sets an ad hoc taxation on firms' traded quotas, cost effectiveness can be restored without necessarily driving dominant firm(s) net demand to zero. Cost effectiveness with market power and quotas taxation implies some cost in terms of tax revenue that, however, can be justified from a social welfare perspective. Moreover, all firms may result to be better off when the corrective taxation is implemented.