Cap and Dividend: How to Curb Global Warming while Protecting the Incomes of American Families

This essay examines the distributional effects of a “cap-and-dividend" policy for reducing carbon emission in the United States: a policy that auctions carbon permits and distributes the revenue to the public on an equal per capita basis. The aim of the policy is to reduce U.S. emissions of carbon dioxide, the main pollutant causing global warming, while at the same time protecting the real incomes of middle-income and lower-income American families. The number of permits is set by a statutory cap on carbon emissions that gradually diminishes over time. The sale of carbon permits will generate very large revenues, posing the critical question of who will get the money. The introduction of carbon permits – or, for that matter, any policy to curb emissions – will raise prices of fossil fuels and have a regressive impact on income distribution, since fuel expenditures represent a larger fraction of income for lower-income households than for upper-income households. The net effect of carbon emission-reduction policies depends on who gets the money that households pay in higher prices. We find that a cap-and-dividend policy would have a strongly progressive net effect. Moreover, the majority of U.S. households would be net winners in purely monetary terms: that is, their real incomes, after paying higher fuel prices and receiving their dividends, would rise. From the standpoints of both distributional equity and political feasibility, a cap-and-dividend policy is therefore an attractive way to curb carbon emissions.