Tradable quota taxation and market power*

- We focus on a tradable quota market featuring a dominant firm that can exert market power.
- We propose a corrective taxation scheme that can restore the cost effectiveness property of tradable quotas.
- Achieving cost effectiveness with market power and quota taxation implies some costs in terms of tax revenue.
- We identify a case where all firms result to be better off after the implementation of corrective taxation.

We investigate how corrective taxation can improve the efficiency properties of tradable quota systems affected by market power. Indeed, we show that, when there is a dominant firm in the tradable quota market, the regulator can set an ad hoc taxation on firms' traded quotas that restores cost effectiveness without driving the dominant firm's net demand to zero. Achieving cost effectiveness with market power and quota taxation implies some costs in terms of tax revenue that, however, can be justified by the corresponding reduction of compliance costs. Moreover, we see that there may be cases where all firms result to be better off after the implementation of corrective taxation.