Tradable Permit Tariffs: How Local Air Pollution Affects Carbon Emissions Permit Trading

Abstract

Recent literature on greenhouse gas controls shows the costs of climate protection can be offset by the ancillary benefits generated from lower local air pollution. We show here that such ancillary benefits imply the unfettered price of carbon emissions permits observed in tradable permit markets might significantly exceed the incremental social cost of controlling carbon emissions. This difference can help to justify market interventions such as an import tariff on permits traded internationally. Uncertainty about the nature of local air pollution regulation and the variability and magnitude of ancillary benefits may complicate substantially the design of cost-effective carbon policies. (JEL Q21)