China’s Emissions Trading System and an ETS-Carbon Tax Hybrid

Abstract China is introducing a national carbon emission trading system (ETS), with details yet to be finalized. The ETS is expected to cover only the major emitters but it is often argued that a more comprehensive system will achieve the emission goals at lower cost. We first examine an ETS that covers both electricity and cement sectors and consider an ambitious cap starting in 2017 that will meet the official objective to reduce the carbon-GDP intensity by 60-65% by 2030 compared to 2005 levels. The two ETS-covered industries are compensated with an output-based subsidy to represent the intention to give free permits to the covered enterprises. We then consider a hybrid system where the non-ETS sectors pay a carbon tax and share in the CO 2 reduction burden. Our simulations indicate that hybrid systems will achieve the same CO 2 goals with lower permit prices and GDP losses. We also show how auctioning of the permits improves the efficiency of the ETS and the hybrid systems. Finally, we find that these CO 2 control policies are progressive in that higher incomes households bear a bigger burden.