Cap, Auction and Trade: Auction and Revenue Recycling under Carbon Cap and Trade
(Washington, January 23, 2008)
A majority of economists favor the use of auctions over the free allocation of emissions allowances. One reason is that an auction satisfies the principle of simplicity and transparency. It is administratively simple and precludes regulated parties from seeking a more generous future allocation. The second and equally forceful reason is that it makes available funds that can be used to achieve related goals.
Depending on how these revenues are used, they can help reduce the cost of policy significantly. The harm to industry in the aggregate represents no more than 30 percent of the value of emissions allowances. Special attention is often focused on the electricity sector because it holds the potential for the largest emissions reductions in the first decades of climate policy. The harm in that sector in the aggregate is equal to only 6 percent of total allowance value. However, this statistic masks the fact that many firms are winners. Compensating firms is problematic because the delivery of compensation will be imprecise.
Depending on the approach used and the compensation target, the opportunity cost of delivering compensation may be several times the amount of deserved compensation because much of the compensation will accrue to undeserving firms.
Meanwhile, the harm to consumers in the electricity sector is eight times greater than that to producers. The best way to deliver compensation to consumers would be through broad-based approaches that preserve and enhance the efficiency advantages of an auction. Some leading possibilities would be revenue recycling to achieve broad-based reductions in preexisting taxes, investments in energy efficiency and research, and direct rebates of revenue to individuals.
by Dallas Burtraw
Resources for the Future, an independent and nonpartisan Washington, D.C., think-tank, seeks to improve environmental and natural resource policymaking worldwide through objective social science research of the highest caliber.