Joint design of Emission Tax and Trading Systems∗

This paper analyzes the joint design of fiscal and cap-and-trade instruments in climate policies under uncertainty. Whether the optimal mechanism is a mixed pol-icy (with some firms subject to a tax and others to a cap-and-trade) or a uniform one (with all firms subject to the same instrument) depends on parameters reflect-ing preferences, production, and, most importantly, the stochastic structure of the shocks affecting the economy. This framework is then used to address the issue of the non-cooperative design of ETS in various areas worldwide and to character-ize the resulting inefficiency and excess in emission. We provide a strong Pareto argument in favor of merging ETS of different regions in the world