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Cap-and-Trade Climate Policy, Free Allowances, and Price-Regulated Firms

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Abstract

Firms subject to cost-of-service regulation cannot withhold windfall profits associated with free emissions allowances. This paper examines the efficiency and distributional impacts of two approaches to transfer free allowances to consumers: output subsidies and lump-sum payments. We employ an empirically calibrated model of the U.S. economy that features regulated monopolies in the electricity sector and many heterogeneous households. Under a carbon dioxide cap-and-trade policy, we find that using free allowances to subsidize regulated electricity prices increases aggregate welfare costs by 40-80 percent relative to lump-sum transfers. These inefficiencies are disproportionately borne by households in the tails of the income distribution.

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  • Bruno Lanz & Sebastian Rausch, 2013. "Cap-and-Trade Climate Policy, Free Allowances, and Price-Regulated Firms," CER-ETH Economics working paper series 13/178, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
    • Handle: RePEc:eth:wpswif:13-178
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    2. Niu, Xiaoyan & Zhang, Yuwen & Li, Baoqi & Chen, Zhenling & Ni, Guohua & Lyu, Ning, 2024. "How does carbon emission trading scheme affect enterprise market value? A roadmap towards natural resources sustainability," Resources Policy, Elsevier, vol. 88(C).
    3. Gordon, Hal & Burtraw, Dallas & Williams, Roberton, 2015. "A Microsimulation Model of the Distributional Impacts of Climate Policies," RFF Working Paper Series dp-14-40, Resources for the Future.
    4. Rubio-Varas, Mar & Muñoz-Delgado, Beatriz, 2019. "Long-term diversification paths and energy transitions in Europe," Ecological Economics, Elsevier, vol. 163(C), pages 158-168.
    5. Kim, Yong-Gun & Lim, Jong-Soo, 2014. "An emissions trading scheme design for power industries facing price regulation," Energy Policy, Elsevier, vol. 75(C), pages 84-90.

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    More about this item

    Keywords

    Climate policy; Cap-and-trade; Allowance allocation; Cost-of-service regulation; Electricity Generation.;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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