Enforcing Transferable Permit Systems in the Presence of Transaction Costs

In this paper we examine the impacts of transaction costs on enforcing a transferable emissions permit system. We derive an enforcement strategy with a self-reporting requirement that achieves complete compliance in a cost-effective manner. In the absence of transaction costs targeted enforcement—the practice of monitoring some firms more closely than others—is neither necessary nor desirable. In the presence of constant marginal transaction costs, buyers of permits should be monitored more closely than sellers, but within groups of buyers and sellers monitoring should be uniform. When marginal transaction costs are not constant, effective monitoring will depend on whether a firm is a buyer or seller, its demand for permits relative to its initial allocation, and whether marginal transaction costs are increasing or decreasing. We also show that the initial distribution of permits can have an impact on total enforcement costs in the presence of transaction costs, but only if marginal transaction costs are not constant. However, firm conclusions about the impact of the initial distribution of permits on enforcement costs will, in general, be situation-specific.