The (ir)relevance of transaction costs in climate policy instrument choice: an analysis of the EU and the US

Abstract

This article assesses the relevance of ex post transaction costs in the choice of climate policy instruments in the EU (focusing mainly on the example of Germany) and the US. It reviews all publicly available empirical ex post transaction cost studies of climate policy instruments broken down by the main private and public sector cost factors and offers hypotheses on how these factors may scale depending on instrument design and other contextual factors. The key finding from the evaluated schemes is that it is possible to reject the hypothesis that asymmetries in ex post transaction costs across instruments are large and, thus, play a pivotal role in climate policy instrument choice. Both total and relative ex post transaction costs can be considered low. This conjecture differs from the experience in other areas of environmental policy instruments where high total transaction costs are considered to be important factors in the overall assessment of optimal environmental policy choice. Against this background, the main claim of this article is that in climate policy instrument choice, ex post transaction cost considerations play a minor role in large countries that feature similar institutional characteristics as the EU and the US. Rather, the focus should be on the efficiency properties of instruments for incentivizing abatement, as well as equity and political economy considerations (and other societally relevant objectives). In order to inform transaction cost considerations in climate policy instrument choice in countries that adopt new climate policies, more data would be desirable in order to enable more robust estimates of design- and context-specific transaction-cost scaling factors.

Policy relevance

The findings of this study can help inform policy makers who plan to set up novel climate policy instruments. The results indicate that ex post transaction costs play a minor role for large countries that feature similar institutional characteristics as the EU and the US. For instrument design the focus should rather be on efficiency properties of instruments in incentivizing abatement, as well as equity and political economy considerations (and other societally relevant objectives).

Keywords:

• carbon tax
• climate policy instruments
• emissions trading schemes
• EU Emissions Trading Scheme
• OECD
• transaction costs

Notes

1. Throughout this article, all € values have been adjusted for inflation to the year 2011.

2. This calculation is based on firms' MRV cost data, provided by Löschel et al. (2011). The high cost estimates (used in Figure 2) could not be used because no differentiation was made between the small and large firms in the studies by VBW (2011) and Destatis (2011).

3. In the first trading period, 806 appeals were lodged against 1600 allocation decisions and 604 appeals against cost decisions in Germany (UBA, 2009). There were 373 appeals against allocation decisions in the second trading period (UBA, 2009).

4. It has been stated that the enthusiasm for legal disputes is a special German phenomenon (Seidel, personal communication, April 20, 2011 Berlin, DEHSt; VBW, 2011). Litigation costs in Spain and France were substantially lower at only €960 and €60 per installation or €0.9 million and €60,000 total p.a., respectively (VBW, 2011). No data are available for other instruments and other countries.

5. Firms' MRV costs are substantially higher for the US SO₂ scheme than for the EU ETS. In 2001 there were 2100 regulated entities with average MRV costs of €47,000 (or $50,000) (EPA, 2001). Initial capital costs were also large. Ellerman (2000) estimated them to be approximately $700,000 per generating unit (at 371 MWe per unit).

6. We assume that, due to political economy considerations (i.e. the rent distribution interests of firms), the taxing scheme would also be designed in a downstream manner.

7. In this context, ‘large entities' refers to the producers and importers of fossil fuels.

8. There are 900 large installations (>25,000 tCO₂) and 1100 small installations (<25,000 tCO₂) in Germany that make up almost 99% of emissions (Community Independent Transaction Log (CITL), 2013).

9. The numbers of regulated emissions and entities are assumed to be identical in both scenarios.