CBO's director on Cap-and-Trade

Douglas Elmendorf :

A cap-and-trade program would lead to higher prices for energy and energy-intensive goods, which would provide incentives for households and businesses to use less energy and to develop energy sources that emit less carbon dioxide. Higher relative prices for energy would also shift income among households at different points in the income distribution and across industries and regions of the country. Policymakers could counteract those income shifts by using the revenues from selling emission allowances to compensate certain households or businesses, or by giving allowances away.
 
In distributing the value of the allowances, policymakers have a wide range of options but face trade-offs. For example:

• If allowances were auctioned, some of the revenue could be used to fund climate-related research and development. This approach might reduce the cost of transitioning from a high carbon emissions economy, but it would not provide any immediate help to affected industries or households.
• Instead, auction revenue could be used to reduce existing taxes on capital or labor. This could lessen the overall economic cost of restricting emissions but would do little to offset the burden that higher prices would impose on certain industries or households.
• A different approach is to use the revenue to give rebates to low-income households, perhaps using the tax system. This would lessen the burden on these households but not trim economy-wide costs.

Alternatively, allowances could be given away for free to certain industries. Giving away allowances is generally equivalent to auctioning the allowances and giving the proceeds to the same firms. Giving allowances to energy-intensive manufacturers would not, by itself, hold down the price of their output, which would rise to reflect the private market value of the allowances. The result could be windfall profits for these firms, which would tend to benefit higher-income households who own most stocks. However, if receipt of free allowances was tied to future production or employment, then prices would not rise as much as otherwise. At the same time, because these firms would not reduce emissions as much as they would have without free allowances, other sectors of the economy would have to reduce emissions by a larger amount to meet the overall cap.

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