Does Banking of Permits Improve Welfare?∗

The paper investigates the welfare effects of banking permits. The possibility that permits can be saved for use in a later period is an important part of the 1990 CAAA in the US. Banking of permits is also under consideration for a sulphor permit trading program in Europe. It is not obvious, however, whether a system like this is welfare improving. If under certainty a regulator issues the optimal number of permits in each period, welfare cannot be improved in comparison to a regime without banking if banking is allowed. This can be different under uncertainty. The paper shows that under uncertainty on the abatement costs there will always be positive welfare effects of banking if the natural clean–up rate of an accumulating pollutant is sufficiently small. For the case of pure flow pollution, however, i.e. no accumulation of pollutants, we show that banking has negative welfare effects if the damage function is sufficiently steep. As an alternative to banking we suggest that the regulator buys back excessive permits at the end of each period.