Markets for tradable emission permits with fiscal competition

We model a non-cooperative energy tax setting game amongst countries who join an international market in which firms trade emission permits. Countries can auction a share of their permit endowment and issue the remainder for free to a representative firm. Each country's regulator has a double mandate consisting of obtaining tax and auction revenue without increasing firm's costs too much. Energy may be subsidized or taxed depending on the relative weight of the two objectives. We show how equilibrium taxes depend on the proportion of permits which is auctioned, on the total amount of permits in the market, on the allocation of permits across countries and on the number of participating countries. We also show how the creation of the market in a previously unregulated world changes energy taxation. Finally, we highlight that, despite the permit market being perfectly competitive, it does not achieve emission abatement in a cost-efficient way.