Working Paper: NBER ID: w15293
Authors: 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.\n\nWe 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.\n\nThese 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.\n\nOur 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.
Keywords: Cap-and-trade; Emissions allowances; Economic output; Industry profits
JEL Codes: D58; H23; Q52; Q54; Q58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| freely allocating fewer than 15% of emissions allowances (D45) | prevent profit losses among the eight industries most vulnerable to the cap-and-trade program (Q52) |
| freely allocating 100% of allowances (D61) | profit increases exceeding 100% for these industries (L16) |
| use of auction revenues to finance cuts in marginal income tax rates (H29) | GDP costs approximately 33% lower (E20) |
| all allowances are freely allocated without generating auction revenue (D44) | higher GDP costs (E20) |
| policy stringency and availability of offsets (Q58) | impacts differ (F69) |