Carbon emissions reduction potential of carbon pricing policies in China

The carbon tax and the carbon emissions trading scheme (ETS) are two widely adopted carbon pricing mechanisms for reducing carbon emissions. While China has prioritized the implementation of a national ETS, it remains an open and important empirical question whether a carbon tax or a hybrid policy could offer superior performance in terms of carbon emissions reduction potential and efficiency. This policy comparison constitutes a counterfactual that cannot be directly observed under the current policy pathway. To enable a controlled counterfactual comparison, we model the ETS as an idealized, mass-based system with allowances ex-post equal to actual emissions and treat carbon tax payments as input costs. Using data envelopment analysis (DEA) on China’s electric and thermal power industry, we evaluate the performance of these two policies. Our counterfactual simulations indicate that, under this specific theoretical setup, both policies offer substantial abatement potential. Notably, the relative abatement potential of the ETS is larger, as it allows for reallocating abatement efforts among firms, while the relative technical efficiency of decision-making units (DMUs) is higher under the carbon tax, which imposes a uniform price signal on all emitters. Given these complementary strengths, we suggest China retain the national ETS and develop hybrid carbon pricing to advance carbon neutrality.