In the case of countries in the process of structural reform, it is important to understand the new policy context to develop reasonable assessments of the feasibility of implementing GHG mitigation policies. Recent measures taken to liberalize energy markets have been inspired for the most part by desires to increase competition in energy and power markets, but they also can have significant emission implications, through their impact on the production and technology pattern of energy or power supply. In the long run, the consumption pattern change might be more important than the sole implementation of climate change mitigation measures.

Market-based instruments – principally domestic taxes and domestic tradable permit systems – will be attractive to governments in many cases because they are efficient. They will frequently be introduced in concert with conventional regulatory measures. When implementing a domestic emissions tax, policymakers must consider the collection point, the tax base, the variation among sectors, the association with trade, employment, revenue, and the exact form of the mechanism. Each of these can influence the appropriate design of a domestic emissions tax, and political or other concerns are likely to play a role as well. For example, a tax levied on the energy content of fuels could be much more costly than a carbon tax for equivalent emissions reduction, because an energy tax raises the price of all forms of energy, regardless of their contribution to CO₂ emissions. Yet, many nations may choose to use energy taxes for reasons other than cost effectiveness, and much of the analysis in this section applies to energy taxes, as well as carbon taxes.

A country committed to a limit on its GHG emissions also can meet this limit by implementing a tradable permit system that directly or indirectly limits emissions of domestic sources. Like a tax, a tradable permit system poses a number of design issues, including type of permit, ways to allocate permits, sources included, point of compliance, and use of banking. To be able to cover all sources with a single domestic permit regime is unlikely. The certainty provided by a tradable permit system of achieving a given emissions level for participating sources comes at the cost of the uncertainty of permit prices (and hence compliance costs). To address this concern, a hybrid policy that caps compliance costs could be adopted, but the level of emissions would no longer be guaranteed.

For a variety of reasons, in most countries the management of GHG emissions will not be addressed with a single policy instrument, but with a portfolio of instruments. In addition to one or more market-based policies, a portfolio might include standards and other regulations, voluntary agreements, and information programmes:

• Energy efficiency standards have been effective in reducing energy use in a growing number of countries. They may be especially effective in many countries where the capacity to administer market instruments is relatively limited, thereby helping to develop this administrative infrastructure. They need updating to remain effective. The main disadvantage of standards is that they can be inefficient, but efficiency can be improved if the standard focuses on the desired results and leaves as much flexibility as possible in the choice of how to achieve the results.
  
  
• Voluntary agreements (VAs) may take a variety of forms. Proponents of VAs point to low transaction costs and consensus elements, while sceptics emphasize the risk of “free riding”, and the risk that the private sector will not pursue real emissions reduction in the absence of monitoring and enforcement. Voluntary agreements sometimes precede the introduction of more stringent measures.
  
  
• Imperfect information is widely recognized as a key market failure that can have significant effects on improved energy efficiency, and hence emissions. Information instruments include environmental labelling, energy audits, and industrial reporting requirements, and information campaigns are marketing elements in many energy-efficiency programmes.

A growing literature has demonstrated theoretically, and with numerical simulation models, that the economics of addressing GHG reduction targets with domestic policy instruments depend strongly on the choice of those instruments. Price-based policies tend to lead to positive marginal and positive total mitigation costs. In each case, the interaction of these abatement costs with the existing tax structure and, more generally, with existing factor prices is important. Price-based policies that generate revenues can be coupled with measures to improve market efficiency. However, the role of non-price policies, which affect the sign of the change in the unit price of energy services, often remains decisive.

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