Designing Emission Permits Regulation for Multiple Compliance Periods

Problem definition: This paper investigates the effectiveness of emission permits policies with varying levels of temporal flexibility, including different compliance periods and the allowance/prohibition of intertemporal banking and borrowing. We also explore advanced policy designs aimed at improving social welfare. Methodology/results: Our analysis reveals that extreme policies, such as fully flexible or fully nonflexible permits, are generally suboptimal from a welfare perspective. Restricting temporal flexibility can be beneficial, particularly when pollution damage is severe or production costs are highly volatile. This finding arises from the tradeoff between the positive industrial impacts and the negative environmental consequences of temporal flexibility. We further demonstrate that partially flexible permits—such as transfer cap/discount and permits-tax hybrid—can achieve a better balance between industrial efficiency and environmental protection, even surpassing the classic welfare bound associated with fully flexible permits. Additionally, we find that temporal flexibility may reduce overall industrial profits by intensifying market competition, and allocating additional permits can widen profit gaps among firms. Managerial implications: This study provides actionable insights for regulators aiming to enhance emission permits policies and offers a deeper understanding of their impacts on firms’ profitability and operations.