Introduction
Traditional instruments for environmental regulation are emission standards and taxes. An emission standard, also referred to as ‘command and control’, defines the maximum amount of emissions of a certain pollutant or the maximum amount of emissions per unit of output or energy.
An emission tax sets a tax rate on emissions to achieve a predefined emission level. Although both types of legal instruments to control environmental pollution are still being used in various - but certainly not all - areas of environmental policy, they have also met with increasing opposition from policy makers, managers and scholars, with economists at the fore. Taxes and energy efficiency standards, for instance, have been criticized for being not only too costly and rigid for firms, but also too ineffective for governments, because it is not clear how high the tax or energy efficiency rate must be set to achieve the national emission target. Moreover, high costs and low effectiveness endanger the compliance of governments with internationally agreed emission levels. To facilitate cost savings, increase flexibility and strengthen compliance, a relatively new instrument is beginning to find its way into environmental law: tradable emission rights.Emissions trading, as it is also referred to, originates from the United States (US), but the instrument is now also implemented in other parts of the world such as the European Union (EU). The idea is, simply, that it is cheaper for one polluter to reduce its emissions as required by some environmental standard than for another, and that it is profitable for both if the former reduces its emissions below the standard and sells its surplus to the latter which is then allowed to emit more than the standard prescribes. The latter is allowed to emit more, but the former must emit less. This implies that the overall emission ceiling is met, with or without trading. Trading makes it cheaper, though, making compliance easier.
In this chapter, a law and economics approach will be taken to analyse tradable emission rights as a relatively new instrument in environmental law. The aim is, first, to analyse this legal instrument in terms of effectiveness and efficiency, and second, to analyse what role efficiency plays in a number of legal issues associated with it. To that end, different emissions trading design variants will be discussed against the background of the path-dependence approach, according to which a suboptimal design might eventually lock-in institutionally rather than evolve into an optimal one. Moreover, the legal relevance will be demonstrated of the (often overlooked) economic concept of opportunity costs when allocating tradable emission rights, in particular with respect to state aid regulation and the polluter-pays principle in European law. The issues of harmonization and competitive distortion will be fully addressed.