Size-Dependent Exemptions in Cap-and-Trade and Aggregate Productivity

This paper examines the long-term effects of size-dependent exemptions in cap-and-trade systems, which allow firms below a specific emissions threshold to avoid regulation. Using data from California’s Cap-and-Trade program, I provide evidence of firms clustering near the threshold confirmed a discontinuity test in emissions distribution post-regulation. This pattern suggests that firms strategically adjust emissions to avoid regulatory costs. By extending an industry dynamics framework with heterogeneous firms, I quantify the policy’s impact on aggregate productivity, finding that removing exemptions raises productivity by 0.2% as resources shift to more productive firms. Additionally, I show that the policy causes misallocation, as intermediate-productivity firms near the threshold exhibit higher average Total Factor Productivity (TFPR) than larger, more productive firms subject to emissions costs. Download