1. Do taxes or auction mechanisms affect efficiency of natural resource utilization? Fridrik Mar Baldursson and Jon Thor Sturluson University of Iceland

2. Why appropriation of scarcity rents may matter... Allocative efficiency: Positive transaction costs  grandfathering may lead to an inefficient situation where potentially efficient trades are not made. Auctions make it more likely that the most efficient firms end up with the quotas (Stavins, 1995). Dynamic efficiency: It is argued that auctions provide stronger incentives for firms to develop substitutes and seek new solutions for improved resource utilisation (Hahn and McGartland, 1989). Uncertainty: Uncertainty about future quota prices may affect investment incentives and lead to inefficient market outcomes both with full grandfathering and full auctioning. The regulator can auction quotas partially to offset this effect (Baldursson and von der Fehr, 2004). Public Finance: Revenues raised by auctions can be used to finance reductions in distortionary taxes (the “double dividend” argument, Goulder et al, 1996).

3. Spoiled rotten on Smog and Cod Two prime examples: Air pollution permits in the US ITQ’s in Iceland Proposition: Collecting a resource fee through auctioning quotas and/or imposing a tax will help increase efficiency and put pressure on inefficient firms to exit the industry; see e.g. Gylfason and Matthiasson on the Icelandic ITQ system. Caveat: Requires large transactions costs, non-profit motives or bounded rationality. In a neoclassical model a tax/auction does not matter for allocative efficiency. Real costs and opportunity costs are valued alike. Question: Does a tax/auction matter in the lab (here, without explicit transaction costs)

4. Setup 15 periods Production conditional on permit ownership Market with permits (Double auction with assets, Smith, Suchanek and Williams (1988) Fixed supply of permits: 15 in total 6 different players 3 cost structures 2 initial endowments Non-contextual setup Computer run, using Z-tree Unit of productionAllocation Role1.2.3.4.5.Init.Eff. 135 455504-5 235 455554-5 335455565 02-3 435455565 52-3 55565 75 00-1 65565 75 50-1 Cost and endowment Output price = 75 Cost parameters are private information, and fixed throughout the session No exogenous uncertainty

5. Treatments A: Benchmark –The scarcity rent goes to the firm B: Tax scenario –¾ of supra marginal rents appropriated by a fixed tax per permit (e$ 15) C: Auction scenario –20% of permits are revoked each period and reallocated by a Vickrey auction The value of rents appropriated in B and C are almost equal, given prices based on fundamentals Neo-classical predictions Permit holdings should converge to the efficient allocation in all treatments Price equal to discounted future rents (net of tax)

6. Examples

11. Permit holdings, sessions 1-9

12. Permit holdings, sessions 10-18

13. To sum up...

14. Result 1 : Fees and efficiency H0: Aggregate cost equal in all treatments H1: Aggregate cost higher in treatment A than in treatment B/C No significant difference between A and C –Auctioning off permits does not help Significant difference between A/C and B –A tax on permit holdings seems to improve allocative efficiency (marginally significant) A tax scheme performs better than a auction scheme Periods 1-5 Periods 6-10 Periods 11-15 A vs. B0.020.100.09 A vs. C0.470.440.26 B vs. C0.050.04 Wilcoxon-Mann-Whitney Nonparametric test of equal medians: Significance level for rejecting the H0

15. Result 2: The effect of roles H0: For each role in turn, the number of permits held is the same in each treatment (last 5 periods) H1: One sided (depends on role) No role seems to contribute to the difference of A and B in particular The difference in C (auction) is significant for roles 1 and marginally for 5 and 6 A simple regression model indicates: –With taxes, high cost firms hold too many permits –With auction, low cost firms hold too few permits Test RoleA vs. BA vs. CB vs. C 10.430.010.00 20.420.470.42 30.330.440.23 40.270.410.24 50.480.070.17 60.290.220.06 Wilcoxon-Mann-Whitney Nonparametric test of equal medians: Significance level for rejecting the H0

16. Observations Slow and often no increase in efficiency over time Great variation in outcomes across sessions within the same treatment Compounding mistakes –One player holds too many permits  other players hold too few permits

17. Conclusions (preliminary) Even in the absence of transaction costs, a fee on resource utilization permits matters for allocative efficiency – A tax marginally increases efficiency (high cost firms keep fewer permits) – A tax scheme performs significantly better than an auction scheme (fewer permits in low cost firms with auction) Further considerations –Elaborate on behavior in different roles –Compare different behavioral explanations, i.e. the anchor effect –Correct for price bubbles and other subjects’ mistakes –Ordered probit model with random effects Comments and suggestions welcome