The introduction of a cap-and-trade program for carbon dioxide emissions could have important effects on households. Changes in the electricity sector are especially important because nearly 40 percent of emissions come from this sector and a majority of emissions reductions are expected to come from this sector in the early decades of a program.

But the changes in the electricity sector may affect households in different regions and income groups in different ways, as electricity is derived from different sources and transmitted by distinct means. To reduce possible adverse effects on electricity prices, various proposals call for free allocation of emissions allowances to local electricity distribution companies.

 

These companies are regulated throughout the nation and could be expected to act as trustees on behalf of consumers, using allowance value to offset the lion’s share of the increase in electricity prices that would otherwise occur under a cap-and-trade program. Free allocation to electricity consumers will mitigate the change in electricity bills; however the ultimate effect on households is uncertain.

 

The lower electricity prices that result lead to increased electricity consumption and associated emissions in the electricity sector. Achieving the same level of emissions reduction from the overall economy would require greater emission reductions in other sectors such as personal transportation, industry, etc. In turn, this raises the costs of goods and services from these sectors. Second, the allocation of free allowances to electricity consumption erodes the allowance value that otherwise might be returned to households or firms or directed to other purposes.

 

We model the household impacts of an allowance auction and free allocation in this technical paper, considering the differing impacts through the nation’s various regions. We found that with the exceptions of the Ohio Valley region and households with the highest income deciles, consumers would see smaller cost increases with an auctioning system than they would if allocations were given gratis to local electricity distributors ($139 annually per household with an auction as opposed to $175 a year with allowances).

A table of our results can be found here.