Optimal Noncompliance In Emissions Trading Programs

This paper characterizes optimal noncompliance for an emissions trading policy that seeks to achieve a given aggregate emissions target at least cost. The total costs of achieving the target consist of aggregate abatement costs, monitoring costs, and the expected costs of collecting penalties from noncompliant firms. Optimal noncompliance depends in large measure on whether the marginal penalty for individual violations is increasing or constant. The primary result of this work is that any policy that achieves an aggregate emissions target with a linearly increasing marginal penalty, regardless of whether it involves perfect or imperfect compliance, is more costly than an alternative policy that induces perfect compliance with a constant marginal penalty.