Alternate solutions in mixing energy tax/subsidy and emission control policies

In this article, we look at the combination of several market-based climate and energy policies and compare them with first best solution, i.e., a perfectly designed emission tax or emission cap level. It is shown that in the case an emission control policy is imperfect designed or implemented, its performance can be improved by an energy (output) tax/subsidy scheme, where the subsidy is given only to renewable generators or for energy efficiency improvements. This combination can bring the production levels and energy price to the optimum level. The emission level is also decreased by this combination, but not to the optimum level. Thus it may be considered as a second-best policy set. However, other targets on renewables share or energy efficiency level are improved instead, although they are bounded by an optimum level. The policy combination needs to be applied globally to have its best effect and heterogeneous implementation (i.e. different levels of tax/subsidy for various regions) makes welfare loss, but still adding a global emission control policy to a set of existing different local output tax/subsidy policies may be beneficial.