Free allocation of allowance value to electricity local distribution companies (LDCs) could offset the lion’s share of the increase in electricity prices that would otherwise arise under a cap-and-trade program. However, the ultimate effect on households is uncertain: Does free distribution to LDCs make households better or worse off compared to other approaches to compensation?

To consider this question we examined three compensation options using detailed electricity market modeling coupled with a distributional analysis of impacts across regions and income groups.  Analysis accounted for changes in supply and demand side investment and behavior in the electricity sector that could be expected by 2015.

Our models included:

Assuming conventional electricity pricing and behavior for all customer classes.

Separating fixed and variable charges and assume rational behavior by industrial and commercial customers.

Returning value that would be given to LDCs to households as a per capita, nontaxable dividend.

Our simulation modeling indicates that the assignment of 30 percent of allowance value to LDCs raises the costs of climate policy by $157 per household compared to providing a dividend of the same magnitude directly to households. If there is widespread reform of electricity pricing by separating fixed and variable charges, and if industrial and commercial customers respond rationally, the cost per household (as compared to providing a dividend of the same magnitude) falls to $66. There is significant redistribution of income from lower income to upper income households because of the allocation to LDCs when compared to providing dividends.

Read a detailed report of our latest modeling here.

Rich Sweeney and Josh Blonz are a research assistants at Resources for the Future and regular contributors to Common Tragedies.