SO2 Emission Permits Tradable Under Exchange Rates: U.S. Case

This study evaluates a novel scheme to trade sulfur dioxide emission permits subject to non-uniform rates. These rates are based on generators’ marginal costs of compliance with environmental policy in a hypothesized least social-cost solution. This scheme is compared against the existing trading program used by the U.S. Environmental Protection Agency, featuring permits tradable one for one. Both policies are modeled to yield identical aggregate emissions. A numerical partial-equilibrium model of the U.S. energy industry is used to infer sulfur dioxide concentrations and health damages, as well as producer and consumer surplus, under the two policies. Regional pollution levels are found to vary across the two policies significantly. The system of exchange rates is estimated to outperform the uniform-trading scheme by $2.2 billion in industry profits and $2.1 billion in health damages, but to reduce consumer surplus by $6.7 billion. Paradoxically, exchange rates are thus estimated to lower total welfare by $2.5 billion. This is due to conceptual mechanism-design problems, as well as empirical issues.