Offset credits in Cap-and-Trade and Firm Size Distribution

This paper examines the macroeconomic effects of integrating Offset Credits (OCs) into traditional emissions pricing systems, allowing covered firms to negotiate OC prices with non-covered entities. Using data from California’s Cap-and-Trade program, I find that: (1) OC usage increases with firm emissions, reducing effective carbon costs for larger emitters; (2) established firms rely more on OCs than new or exiting firms; and (3) OC retirement rates decline over time. Extending an industry dynamics model to include cap-and-trade with OCs priced via Nash bargaining, results suggest OCs can enhance environmental outcomes with welfare gain (0.021%) and slight productivity trade-off (0.002%). Findings are compared across permit allocation methods: auction, grandfathering, and output-based rebate.