The Allocation of Emission Allowances Free of Charge: Legal and Economic Considerations

Emissions trading schemes (ETSs) are policy tools designed to cut greenhouse gas emissions where this can be done in the most cost effective way. Existing and proposed schemes generally take the form of cap-and-trade systems, meaning that there is a political commitment to limit overall emissions by putting in place a cap, and that the emissions quotas allowed are distributed as permits between covered entities in the scheme, permits that can be traded freely. It has become common practice to allocate the majority or all of the emission allowances to firms free of charge. There are a number of reasons for this. One is political. The other primary reasons are related to concerns of carbon leakage and distortions in competitiveness. In the light of these claims, the question investigated in this paper, from both an economic and a legal perspective, is whether the practice of allocating emission allowances free of charge may constitute a subsidy and thereby distort international trade. A subsidy can have world-wide effects, potentially undermining the competitive position of any firm competing in any market with the subsidized entities. Distortions in trade may negatively impact growth and economic development. Moreover, subsidies entail government spending that should be brought into the daylight and assessed so that taxpayers and constituencies can evaluate whether it is money well spent.