Intertemporal permit trading for the control of greenhouse gas emissions

This paper integrates two themes in the intertemporal permit literature thr ough the construction of an intertemporal banking system for a pollutant th at creates both stock and flow damages. A permit banking system for the spe cial case of a pollutant that only causes stock damages is also developed. This latter, simpler case corresponds roughly to the greenhouse gas emissio n reduction regime proposed by the U.S. Department of State as a means of f ulfilling the U.S. commitment to the Framework Convention on Climate Change . This paper shows that environmental regulators can achieve the socially o ptimal level of emissions and output through time by setting the correct to tal sum of allowable emissions, and specifying the correct intertemporal tr ading ratio for banking and borrowing. For the case of greenhouse gases, we show that the optimal growth rate of permit prices, and therefore the opti mal intertemporal trading rate, has the closed-form solution equal to the r atio of current marginal stock damages to the discounted future value of ma rginal stock damages less the decay rate of emissions in the atmosphere. Gi ven a non-optimal negotiated emission path we then derive a permit banking system that has the potential to lower net social costs by adjusting the in tertemporal trading ratio taking into account the behavior of private agent s. We use a simple numerical simulation model to illustrate the potential g ains from various possible banking systems.