Voluntary opt-in provision and instrument choice in environmental regulation

Abstract

We study market-based instruments under incomplete participation. Incomplete participation means that the regulation does not cover all emitters that contribute to harmful damages. Our results show that a voluntary opt-in provision should always be incorporated into regulation under incomplete participation as the provision unambiguously increases expected social welfare. Incomplete participation also affects the choice between market-based instruments, tradable permits and environmental taxes, under uncertainty. The impact will depend on whether the voluntary provision is used or not. The voluntary participation does not unambiguously favor one of the instruments, but the advantage is case-specific.