SSE Working Paper Series in Economics,
Stockholm School of Economics

Abstract: There are conflicting views on how to handle permits for greenhouse gases in cost-benefit analysis. This paper aims at clarifying within a simple general equilibrium model how to treat different kinds of tradable permits in economic evaluations of projects. Within a framework that reminds of the EU Emissions Trading System (EU ETS), the paper looks at cost-benefit rules for a small project providing a public good, interpreted as a shortcut for infrastructure, using a fossil fuel and a renewable as inputs. In addition, it illustrates the Samuelson condition for the optimal provision of the public good, discusses briefly how to assess the EU permit system for sectors not covered under the EU ETS, as well as taxes and permits used to combat acid rain, and provides an illustration of the magnitude of the bias incurred if permits are valued at the marginal damage cost. The paper also introduces electricity (“green”) certificates, a cousin to tradable permits, as well as well as energy savings (“white”) certificates. Finally, a cap on the output of a commodity is considered.

Keywords: Cost-benefit analysis; greenhouse gases; emissions trading; tradable permits; general equilibrium; Samuelson condition; EU ETS; non-ETS; acid rain; electricity certificates; renewable portfolio standards; energy savings certificates; output cap

JEL-codes: H21; H23; H41; H43; I30; L13

25 pages, June 1, 2016

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