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Neutralizing the Adverse Industry Impacts of CO2 Abatement Policies: What Does It Cost?

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Goulder, Lawrence
Bovenberg, A. Lans

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Abstract

The most cost-effective policies for achieving CO2 abatement (e.g., carbon taxes) are considered politically unacceptable because of distributional consequences. This paper explores policies designed to address distributional concerns. Using an intertemporal, numerical general equilibrium model of the United States, we examine how efficiency costs change when CO2 abatement policies include elements that neutralize adverse impacts on energy industries. We find that desirable distributional outcomes can be achieved at relatively low cost in terms of efficiency. Without substantial added cost to the overall economy, the government can implement carbon abatement policies that protect profits and equity values in fossil-fuel industries. The key to this conclusion is that CO2 abatement policies have the potential to generate rents that are very large in relation to the potential loss of profit. By enabling firms to retain only a very small fraction of these potential rents, the government can protect firms’ profits and equity values. Consequently, the government needs to grandfather only a small percentage of CO2 emissions permits or, similarly, must exempt only a small fraction of emissions from the base of a carbon tax. Each of these government policies involves only a small sacrifice of potential government revenue. Such revenue has an efficiency value because it can be used to finance cuts in pre-existing distortionary taxes. Because these policies give up little of this potential revenue, they involve only a small sacrifice in terms of efficiency. We also find that there is a very large difference between preserving firms’ profits and preserving their tax payments. Allowing firms to enjoy a dollar-for-dollar offset to their payments of carbon taxes—for example, through industry-specific cuts in corporate tax rates—substantially overcompensates firms, raising profits and equity values significantly relative to the unregulated situation. This reflects the fact that producers can shift onto consumers most of the burden from a carbon tax. The efficiency costs of such policies are far greater than the costs of policies that do not overcompensate firms.

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Paper provided by Resources For the Future in its series Discussion Papers with number dp-00-27.

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Date of creation: 01 Jul 2000
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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  6. Buchanan, James M & Tullock, Gordon, 1975. "Polluters' Profits and Political Response: Direct Controls Versus Taxes," American Economic Review, American Economic Association, vol. 65(1), pages 139-47, March. [Downloadable!] (restricted)
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  11. Don Fullerton & Gilbert Metcalf, 1997. "Environmental Controls, Scarcity Rents, and Pre-Existing Distortions," NBER Working Papers 6091, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  19. A. Lans Bovenberg & Lawrence H. Goulder, 2001. "Environmental Taxation and Regulation," NBER Working Papers 8458, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  20. Lawrence H. Goulder & Ian W. H. Parry & Dallas Burtraw, 1996. "Revenue-Raising vs. Other Approaches to Environmental Protection: The Critical Significance of Pre-Existing Tax Distortions," NBER Working Papers 5641, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  23. Parry, Ian W. H. & Williams, Roberton III & Goulder, Lawrence H., 1999. "When Can Carbon Abatement Policies Increase Welfare? The Fundamental Role of Distorted Factor Markets," Journal of Environmental Economics and Management, Elsevier, vol. 37(1), pages 52-84, January. [Downloadable!] (restricted)
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  24. Parry, Ian W. H., 1997. "Environmental taxes and quotas in the presence of distorting taxes in factor markets," Resource and Energy Economics, Elsevier, vol. 19(3), pages 203-220, August. [Downloadable!] (restricted)
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  1. Burtraw, Dallas & Kruger, Joseph & Zetterberg, Lars & Åhman, Markus, 2005. "The Ten-Year Rule: Allocation of Emission Allowances in the EU Emission Trading System," Discussion Papers dp-05-30, Resources For the Future. [Downloadable!]
  2. Parry, Ian, 2003. "Fiscal Interactions and the Case for Carbon Taxes over Grandfathered Carbon Permits," Discussion Papers dp-03-46, Resources For the Future. [Downloadable!]
    Other versions:
  3. Lawrence H. Goulder & William A. Pizer, 2006. "The Economics of Climate Change," NBER Working Papers 11923, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Herman Vollebergh, 2004. "Lessons from the Polder: Is Dutch CO2-Taxation Optimal?," Working Papers 2004.6, Fondazione Eni Enrico Mattei. [Downloadable!]
  5. Don Fullerton & Gilbert E. Metcalf, 2002. "Cap and Trade Policies in the Presence of Monopoly and Distortionary Taxation," NBER Working Papers 8901, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. Burtraw, Dallas & Palmer, Karen & Bharvirkar, Ranjit & Paul, Anthony, 2002. "The Effect on Asset Values of the Allocation of Carbon Dioxide Emission Allowances," Discussion Papers dp-02-15-, Resources For the Future. [Downloadable!]
  7. John C. V. Pezzey, 2002. "EmissionTaxes and Tradable Permits: A Comparison of views on Long Run Efficiency," Economics and Environment Network Working Papers 0210, Australian National University, Economics and Environment Network. [Downloadable!]
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  9. Gilbert E. Metcalf, 2003. "Pollution Taxes in a Second-Best World," Discussion Papers Series, Department of Economics, Tufts University 0316, Department of Economics, Tufts University. [Downloadable!]
  10. Goulder, Lawrence, 2002. "Mitigating the Adverse Impacts of CO2 Abatement Policies on Energy-Intensive Industries," Discussion Papers dp-02-22, Resources For the Future. [Downloadable!]
  11. Bovenberg, A.L. & Goulder, L.H. & Gurney, D.J., 2003. "Efficiency costs of meeting industry-distributional constraints under environmental permits and taxes," Discussion Paper 86, Tilburg University, Center for Economic Research. [Downloadable!]
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  12. Fischer, Carolyn & Fox, Alan, 2004. "Output-Based Allocations of Emissions Permits: Efficiency and Distributional Effects in a General Equilibrium Setting with Taxes and Trade," Discussion Papers dp-04-37, Resources For the Future. [Downloadable!]
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  14. Geir H. Bjertnæs, 2005. "Avoiding Adverse Employment Effects from Energy Taxation: What does it cost?," Discussion Papers 432, Research Department of Statistics Norway. [Downloadable!]
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