Revenue and efficiency in pollution permit allocation mechanisms

Highlights: • We propose a mechanism that can improve on existing pollution auctions. • We allow the regulator to determine the supply once all bids have been submitted. • This incites truthful revelation of firms' private abatement costs. • This maximizes revenue, and allocates permits efficiently. A contentious design issue within pollution markets is the choice of initial allocation mechanism. Within this debate, auctions have become the predominant method of allocation. Although auctions provide potential gains—such as revenue generation, efficiency, and price discovery—these benefits are rarely realized due to firms submitting non-truthful bids. We propose a mechanism that can improve on existing auctions. We allow the regulator to determine the supply once all bids have been submitted. This incites truthful revelation of firms' private abatement costs, maximizes revenue, and allocates permits efficiently. This is relevant to existing permit auctions in the US and Europe.