This paper builds a simple economy-wide model to study how carbon offsets change emissions and welfare. Carbon offsets are payments meant to fund projects that reduce pollution elsewhere. The authors show that raising the price paid for offsets does not always reduce total emissions or increase welfare. The effects depend on how markets and prices shift across the whole economy.

The researchers construct an analytical general equilibrium model with two inputs: a “clean” input (like renewable energy) and a “dirty” input (like fossil fuel energy). In the model, clean inputs can be subsidized by selling offsets. Consumers value final goods but also suffer from an emissions damage. The authors solve the model in closed form and then run numerical examples using parameter values they describe as plausible for the U.S. economy.

They compare two ways to count offset impacts. Conventional carbon accounting credits offsets with the direct emissions reductions of a project. Aggregate carbon accounting measures the change in total, economy-wide emissions that happen because of the project, including indirect effects. The paper finds conventional accounting often over-credits offsets relative to the aggregate change. In other words, market spillovers can erase some or all of the claimed emissions benefits. But the opposite can also happen: conventional accounting can under-credit offsets in some cases.

One reason for the mixed results is that offsets change many margins in the economy. The model identifies four margins by which offset payments can affect supply and demand, and it highlights one new margin not previously emphasized. As an example, projects that look “non-additional” by traditional project screens (they would have been built anyway) can still respond to higher offset prices by increasing output. That additional response can reduce emissions elsewhere, but conventional accounting may not credit that effect, producing under-crediting. Conversely, offsets can raise clean input production, reduce final-good output, and — through price changes — even increase dirty input production, so aggregate emissions can go up or down.