How to Regulate Carbon Emissions with Climate-conscious Consumers

Abstract

Carbon prices are the most cost-effective instrument to reduce CO2 emissions, but there is strong political opposition to raising them to the efficient level. Therefore, additional efforts of consumers, firms, and local governments are required. We study how different regulatory regimes affect moral behaviour and show that a carbon tax complements voluntary efforts to reduce emissions, while cap-and-trade discourages them. The opportunity to invest in offsets increases welfare, while the option to buy and delete emission rights induces more emissions and reduces welfare. Furthermore, cap-and-trade shifts the burden of adjustment to poor consumers and has dysfunctional incentive effects.