Designing climate policy mixes: Analytical and energy system modeling approaches

Abstract

A matter of debate in climate policy is whether lawmakers should rely on carbon pricing or regulations, such as low-carbon standards, to reach emission reduction goals. Past research showed that pricing is more cost-effective. However, previous work studied the two policies when implemented separately, in effect comparing two policy extremes. In contrast, we explore the full spectrum of climate policy mixes that include both types of policies but vary in how much they rely on each. We do this both analytically by extending previous theory and numerically with two energy system models. In line with past work, increasing reliance on pricing increases the cost-effectiveness of the policy mix. However, we show that this benefit exhibits diminishing marginal returns. Thus the gain in cost-effectiveness from complementing stringent standards with modest pricing is relatively large. Our results show that relying on pricing for 20% of emission reductions (and on a standard for 80%) reduces costs by 32%–57% compared to a standard-only approach. Importantly, trading off more of the standard for pricing delivers smaller and smaller gains in cost-effectiveness. For example, a policy mix that relies on each policy for 50% of emission reductions decreases costs by 60%–81%, which is already 71%–88% as cost-effective as the theoretically most cost-effective pricing-only policy.