Conference Agenda

We explore the theoretical effects of carbon sequestration credits embodied in U.S. federal tax code §45Q to show the extent to which they induce firms to choose less than optimal investments. We model a single, representative firm producing a single output with two inputs of differing carbon intensity. Firms also have the ability to sequester a portion of their total carbon emissions, but this carries a large fixed cost. We show that firms that are induced to sequester under a carbon tax would also be induced to sequester under an equal-sized sequestration subsidy. In practice, we corroborate our theoretical results through numerical simulations and show that the carbon tax inducing sequestration is much, much larger than the sequestration credit required to induce sequestration. This reflects the fact that the firm is earning revenue under the credit that can be used to offset high fixed costs. We also show that under a carbon tax, firms will utilize far less costly abatement options in response to the policy long before adopting sequestration. We show this likely points to substantial inefficiencies associated with sequestration subsidies even relative to a carbon reduction rebate that would act like a carbon tax supplemented with a lump-sum transfer. Lastly we compare the effects of these policies to alternatives such as a net emissions standard.