Greenhouse Gas Auctions and Taxes: Some Political Economy Considerations

Many economists suggest that a cap-and-trade program and a carbon tax represent promising mechanisms for addressing climate change. A potentially attractive feature of both policies is that they have the potential to recycle revenues in an efficient manner. In the case of cap and trade, this would involve using auction revenues; in the case of a tax, it would involve using tax revenues. This article evaluates various arguments for auctions and taxes in light of political realities and finds that the enthusiasm for auctions and taxes has not been accompanied by sober assessments of whether and how the revenues would actually be used. Most of the evidence suggests that at least some of the revenues would not be spent wisely. Specifically, the article urges the government to compare a realistic set of policy options, while recognizing that the feasibility of different types of mechanisms can change over time. Furthermore, it is suggested that the introduction of political economy considerations may lead to an optimal level of pollution control that is less stringent than conventional economic analysis would suggest. Copyright 2009, Oxford University Press.