Non-technical summary

Research Question

In this paper, we analyze how two distinct carbon pricing policies, namely the European Cap and Trade (CaT) regime and the Chinese Tradable Performance Standard (TPS), compare in terms of their economic and welfare implications. The CaT system imposes a cap on total emissions and allows for trading of emissions allowances, while the TPS sets an emissions intensity target and enables firms to trade allowances based on their relative performance against this target.

Contribution

The paper contributes to the existing literature by providing a dynamic general equilibrium analysis of the two carbon pricing systems in a multi-sector framework. It demonstrates that the CaT can be equivalent to TPS when carbon pricing revenues are redistributed to firms proportional to their output. The study also compares the performance of these systems when CaT revenues are used to reduce consumption or labor taxes, offering insights into the most effective use of carbon pricing revenues.

Results

The results indicate that TPS outperforms the CaT regime that redistributes carbon revenues to households in a lump-sum manner resulting from higher output gains and welfare due to relatively lower production costs. When revenues from CaT are used to subsidize output similarly to TPS, the differences in performance between the two systems disappear. However, the CaT system with labor tax reduction is found to increase welfare most because it alleviates distortions on the production side and improves the income situation for all households. Our study suggests that the most promising redistribution schemes of carbon price revenues are those that reduce distortions on the production side and distribute welfare gains or burdens evenly across household types.