Climate Policy’s Uncertain Outcomes for Households: The Role of Complex Allocation Schemes in Cap-and-Trade

Uncertainty is a fundamental characteristic of climate change. This paper focuses on uncertainty that is introduced in the implementation of policy, especially as it affects the level and distribution of theburden on households that results from the allocation of emissions allowances. We examine the Waxman–Markey bill (H.R. 2454), with bookend scenarios labeled optimistic and pessimistic. The scenarios vary outcomes associated with allocations to local distribution companies, investments in electricity energy efficiency and technology development. We introduce a third scenario that allocates asubstantial portion of allowance value directly to households. We find the average consumer surplus loss per household in 2016 in the optimistic scenario to be $136 and the allowance price is as low as $13.20 per ton. In the pessimistic scenario, the consumer surplus loss rises to $413, with an allowance price of $23.43 per ton. Allocation of allowance value directly back to households provides an intermediate, but more certain, result.

The allocation of emissions allowances in a cap-and-trade program will play a key role in the level and distribution of the financial burden on American households. In “Climate Policy’s Uncertain Outcomes for Households: The Role of Complex Allocation Schemes in Cap-and-
Trade,” Research Assistant Joshua Blonz and Senior Fellows Dallas Burtraw and Margaret A. Walls analyze these impacts, finding a great deal of cost uncertainty depending on the effectiveness of various bill provisions at reducing emissions and saving money for households.  This uncertainty in how the policy will be implemented and its cost to households amplifies a fundamental characteristic of the climate problem—its underlying uncertainty—and may make the adoption of climate policy more difficult to achieve.

Blonz, Burtraw, and Walls examine provisions of the Waxman–Markey bill (H.R. 2454), with bookend scenarios labeled “optimistic” and “pessimistic.” The scenarios vary outcomes associated with allocations to local electricity providers, energy efficiency measures for electricity, and investments in technology development.

Under the pessimistic assumptions, the average household incurs a net loss of $420; under optimistic assumptions, the loss is only $136. The allowance price for carbon dioxide in the optimistic scenario is $13.20 per ton, while it is $23.43 per ton in the pessimistic scenario.

For the sake of comparison, the authors introduce a third scenario that allocates a substantial portion of allowance value directly to households, an approach called cap-and-dividend. In this case, the average household loss and allowance price fall between the optimistic and pessimistic scenarios at $206 and $17.37 per ton, respectively. The authors argue this option is characterized by greater certainty in outcomes than the complex provisions in H.R. 2454.

The results suggest that the allocation of allowances to energy efficiency programs for electricity is responsible for 69 percent of the difference in net loss between the pessimistic and optimistic scenarios. The authors also find that, compared to the other two scenarios, the cap-and-dividend approach is more predictable in outcome and more progressive across income distributions.