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When a National Cap-and-Trade Policy with Carve-out Provision May Be Preferable to a National CO2 Tax

We analyze the effect of various combinations of state and national emissions policies on national emissions of a global pollutant, specifically, greenhouse gas emissions. We highlight the effect of unintended increases in out-of-state emissions on the efficacy of overlapping state policies. We show that emission taxes do not necessarily prevent a completely offsetting increase in out-of-state emissions when states add a state-level emissions tax to the national emissions tax. In particular, states small relative to their market will be unable to reduce national emissions with a state-level CO2 tax or a system of tradable permits. However, under a national cap-and-trade regime that allows states to be carved out, a state of any size can reduce national emissions by setting a tighter state cap. This combination yields a lower total cost than the equivalent combination of national and state CO2 taxes (if one exists) but increases the cost to consumers outside the market.

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Keywords: Electricity, Tax, Tradable permits, Nested regulations, Renewable energy, Emissions, Climate change

DOI: 10.5547/01956574.36.3.macc

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Published in Volume 36, Number 3 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.