Construction and demolition waste reduction (C&DWR) is an important measure to protect the environment and promote sustainable development in the construction sector. The present policy in China remains a lack of emphasis on carbon tax and penalty for reducing construction waste. This paper proposes a construction and demolition waste (C&DW) management model to identify the waste reduction effects of various policies in China. It simulates the effects of single policies and combined policies on waste reduction and carbon emission by using the approach of integrating system dynamics and grey model theory. The results reveal that: (1) Penalties can effectively reduce the amount of illegal dump waste and carbon emissions from illegal dump waste, with an appropriate penalty value (in Chinese CNY) suggested as ∈160,320. (2) Subsidies can vastly increase the amount of waste recycled and a carbon tax can reduce carbon emissions; the recommended values are suggested as subsidies ∈30,45 and carbon tax ∈40,70. (3) Compared to other policies, the combined policy of penalty–waste disposal charging fee–subsidy–carbon tax (160, 60, 45, 70) achieves the greatest environmental benefits in terms of reducing waste and carbon emission. (4) Governments should improve waste minimization incentive policies and gradually introduce trials for a carbon tax policy, encourage the use of digital governance combined with blockchain technology to regulate C&DW. These findings provide valuable insights for policymakers to develop effective waste reduction strategies and promote sustainability through the implementation of C&DWR theories.