The combined use of taxation and voluntary agreements for energy policy

The paper models the combined use of taxation and voluntary agreements when there is asymmetric information between the regulator and industry on the firms' actual emissions. The model incorporates the following features: 1) the regulator does not know the firm's special production characteristics and actual emissions; 2) the regulator offers a policy into which firms self-select according to type; 3) energy audits are costly; 4) systematic factors determine whether a firm choose to sign a voluntary agreement or not. The analysis offers a characterisation of voluntary agreements as a trade-off between incurring audit costs and other transaction costs for a voluntary agreement and obtaining detailed information on emissions allowing better targeting of policy. This brings a new argument into the existing literature, where it sometimes is claimed that voluntary agreements lower transaction costs compared to other policy. Conditions are obtained that determine the characteristics of firms that opt to sign a voluntary agreement. In particular, it is shown that the efficiency of the scheme depends on the transaction costs related to the agreements, the environmental damage cost, and the responsiveness in the firm's emissions to the proposed measures following the energy audit. The model cautions that it is feasible that the firms signing voluntary agreements are energy-efficient firms, benefiting from an implicit subsidy for energy efficiency investments that would have been undertaken anyway.