BANKABLE PERMITS FOR THE CONTROL OF ENVIRONMENTAL-POLLUTION

Intertemporal trading of emission permits (banking) is often identifie d as one of three promising market mechanisms for controlling pollutio n (along with averaging and trading). Surprisingly, the efficiency pro perties of permit banking systems have not been investigated. Using a simple optimal control model, this paper investigates firms' incentive s for banking or borrowing emission permits and compares the emission and output streams firms would choose with the socially optimal soluti on. We find that in many cases firms will suboptimally choose excessiv e damage and output levels in early periods and correspondingly too fe w in later periods if given the opportunity to freely move emissions b etween time periods. We propose a simple alternative trading scheme we term modified banking that counters this problem and should be no mor e difficult for an environmental authority to implement than a straigh t banking system.