Joint Design of Emission Tax and Trading Systems

This paper analyzes the joint design of fiscal and cap-and-trade instruments in climate policies under uncertainty. Whether the optimal mechanism is a mixed policy (with some firms subject to a tax and others to a cap-and-trade) or a uniform one (with all firms subject to the same instrument) depends on parameters reflecting preferences, production, and, most importantly, the stochastic structure of the shocks affecting the economy. This framework is then used to address the issue of the non-cooperative design of ETS in various areas worldwide and to characterize the resulting inefficiency and excess in emission. We provide a strong Pareto argument in favor of merging ETS of different regions in the world and evaluate the welfare gains in each region.