Emissions Taxes Versus Tradeable Permits With Many Countries

Abstract

Tradeable permits and emissions taxes are compared in a multi‐country global emissions game with perfectly competitive firms and a trans‐boundary production externality. In a one‐shot game, comparing welfare under the Nash equilibria, it is shown that tradeable permits are superior to emissions taxes. In an infinitely‐repeated game, comparing the discount factors required to sustain a global International Environmental Agreement (IEA), it is shown that it is easier to sustain cooperation with tradeable permits than with emissions taxes when the number of countries is sufficiently large. In a coalition‐formation game, the number of countries in a stable IEA is two with tradeable permits, but may be all countries in the world with emissions taxes.