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

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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Paper provided by CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich in its series CER-ETH Economics working paper series with number 13/178.

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Length: 52 pages
Date of creation: Apr 2013
Date of revision:
Handle: RePEc:eth:wpswif:13-178
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