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Impacts of Alternative Emissions Allowance Allocation Methods under a Federal Cap-and-Trade Program

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  • Lawrence H. Goulder
  • Marc A. C. Hafstead
  • Michael S. Dworsky

Abstract

This paper examines the implications of alternative allowance allocation designs under a federal cap-and-trade program to reduce emissions of greenhouse gases. We focus on the impacts on industry profits and overall economic output, employing a dynamic general equilibrium model of the U.S. economy. The model's unique treatment of capital dynamics permits close attention to profit impacts. We find that the effects on profits depend critically on the method of allowance allocation. Freely allocating fewer than 15 percent of the emissions allowances generally suffices to prevent profit losses among the eight industries that, without free allowances or other compensation, would suffer the largest percentage losses of profit. Freely allocating 100 percent of the allowances substantially overcompensates these industries, in many cases causing more than a doubling of profits. These results indicate that profit preservation is consistent with substantial use of auctioning and the generation of considerable auction revenue. GDP costs of cap and trade depend critically on how such revenues are used. When these revenues are employed to finance cuts in marginal income tax rates, the resulting GDP costs are about 33 percent lower than when all allowances are freely allocated and no auction revenue is generated. On the other hand, when auction proceeds are returned to the economy in lump-sum fashion (for example, as rebate checks to households), the potential cost-advantages of auctioning are not realized. Our results are robust to cap-and-trade policies that differ according to policy stringency, the availability of offsets, and the extent of opportunities for intertemporal trading of allowances.

Suggested Citation

  • Lawrence H. Goulder & Marc A. C. Hafstead & Michael S. Dworsky, 2009. "Impacts of Alternative Emissions Allowance Allocation Methods under a Federal Cap-and-Trade Program," NBER Working Papers 15293, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:15293
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    References listed on IDEAS

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    1. Fair, Ray C & Taylor, John B, 1983. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 51(4), pages 1169-1185, July.
    2. Ian W. H. Parry, 2003. "Fiscal Interactions and the Case for Carbon Taxes Over Grandfathered Carbon Permits," Oxford Review of Economic Policy, Oxford University Press, vol. 19(3), pages 385-399.
    3. James M. Poterba & Lawrence H. Summers, 1984. "The Economic Effects of Dividend Taxation," Working papers 343, Massachusetts Institute of Technology (MIT), Department of Economics.
    4. Kling, Catherine & Rubin, Jonathan, 1997. "Bankable permits for the control of environmental pollution," Journal of Public Economics, Elsevier, vol. 64(1), pages 101-115, April.
    5. Stavins, Robert, 2007. "A U.S. Cap-and-Trade System to Address Global Climate Change," Working Paper Series rwp07-052, Harvard University, John F. Kennedy School of Government.
    6. Paul Leiby & Jonathan Rubin, 2001. "Intertemporal Permit Trading for the Control of Greenhouse Gas Emissions," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 19(3), pages 229-256, July.
    7. Lawrance, Emily C, 1991. "Poverty and the Rate of Time Preference: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 99(1), pages 54-77, February.
    8. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 67-140.
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    Cited by:

    1. James B. Bushnell & Howard Chong & Erin T. Mansur, 2009. "Profiting from Regulation: An Event Study of the EU Carbon Market," NBER Working Papers 15572, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • Q52 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Pollution Control Adoption and Costs; Distributional Effects; Employment Effects
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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