Rate-Based Emissions Trading with Overlapping Policies: Insights from Theory and an Application to China

Jurisdictions employing emissions trading systems (ETSs) to control emissions often utilize other environmental or energy policies as well, including policies to support renewable energy and reduce energy consumption. Interactions with these other policies lead to different outcomes from what might be predicted by examining the policies separately. The prior literature considering policy interactions has focused mainly on the case where the ETS is cap and trade. This paper extends the literature by examining the outcomes under a wide range of ETSs (including several forms of tradable performance standards) and overlapping policies (including various renewable subsidies and electricity consumption taxes). An analytical model demonstrates that the impacts of overlapping policies on allowance prices, emissions, and electricity output depend critically on the nature of the ETS. A numerical general equilibrium model tailored to China’s economy explores the implications for the cost-effectiveness of emissions reductions. Results indicate that overlapping policies that reduce cost-effectiveness under cap and trade can significantly enhance cost-effectiveness under tradable performance standards. The model predicts that under the current and planned designs for China’s ETS, which sets differentiated tradable performance standards for emitters, implementing renewable portfolio standards and accounting for indirect emissions from electricity consumption are both beneficial. Together they can reduce the cost of achieving the national emissions target by 20-30 percent over the interval 2020-2035. Transitioning to uniform benchmarks for emitting power generators could save another 10-15 percent. The findings highlight the importance of coordinating the designs of emissions trading systems with the overlapping policies.