Regulating Greenhouse Gases: Emissions Intensity Limits, A Hybrid Policy, and Offsets

Emissions intensity caps, which have gained popularity for regulating greenhouse gas emissions, limit emissions as a proportion of output. The objective is to index allowed emissions to output, avoiding a higher than expected marginal abatement cost when output is expanding. In aggregate, it is possible to set an emissions intensity cap and translate it into an absolute cap for the purpose of emissions trading. However, individual intensity limits are also used, and are part of some emission trading programs. Without the restrictive assumption that output is unresponsive to changes in price or cost, it is not possible to set individual intensity limits that will achieve economic efficiency. This inefficiency also compromises the welfare gains achievable through true cost saving abatement options, such as cheap offsets. A hybrid price-quantity regulation can better promote economic efficiency, while preserving the political appeal of a permit system with gratis initial allocation. It can also avoid a high marginal abatement cost without conceding the gains achievable through cheaper abatement technologies. Nevertheless, individual intensity caps can be part of a piecemeal approach to economic efficiency. If conditionally efficient intensity caps are already in place, the transition to a hybrid system is relatively straightforward.