Carbon Pricing in the EU: Evaluation of Different EU ETS Reform Options

This paper studies various options to support allowance prices in the EU Emissions Trading System (ETS), such as adjusting the cap, an auction reserve price, and fixed and variable carbon taxes in addition to EU ETS. We use a dynamic computable general equilibrium model that explicitly allows for allowance banking and for a detailed cost-effectiveness analysis at the EU Member State level. We find that both a variable carbon tax and an auction reserve price support effective carbon prices at least cost in times of negative demand shocks for emission allowances. Moreover, these price-based policies still benefit from the intertemporal flexibility through the banking provision in the EU ETS by re-allocating emissions over time with stronger emission reductions in early years and emission increases in later years. Compliance costs of the various options differ over time and between Member States. New Member States face larger welfare gains than the EU as a whole with a variable tax, while they are worse off than other Member States under an auction reserve price.