The Consumer Burden of a Cap-and-Trade System with Freely Allocated Permits

In discussions over how best to implement mandatory restrictions on carbon, the most commonly discussed option is a cap-and-trade system. One critical economic question surrounding cap-and-trade is how to distribute the permits. The two main competing mechanisms are free allocations to polluters (usually based on past emissions levels, output levels, or carbon intensity) and the auction of permits.

In this paper, we explore the differential economic impact of the two approaches. Our results show that the consumer price effects across regions of auctioning and free allocation are quite different. These differences arise due to the nature of electricity regulation. If permits are auctioned, regulators are likely to allow utilities to pass forward to consumers the electricity price increase due to the cost of permits. However, if permits are freely allocated, this forward shifting may not be allowed to take place.

These results suggest that giving the permits away in a world where state regulators don't allow utilities to pass forward the "cost" of free permits simply punishes consumers in those regions of the country that have moved to deregulation.

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Kevin A. Hassett is a senior fellow and the director of economic policy studies at AEI. Aparna Mathur is a research fellow at AEI. Gilbert E. Metcalf is a professor of economics at Tufts University and a research associate at the National Bureau of Economic Research.

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About the Author

 

Kevin A.
Hassett
  • Kevin A. Hassett is the State Farm James Q. Wilson Chair in American Politics and Culture at the American Enterprise Institute (AEI). He is also a resident scholar and AEI's director of economic policy studies.



    Before joining AEI, Hassett was a senior economist at the Board of Governors of the Federal Reserve System and an associate professor of economics and finance at Columbia (University) Business School. He served as a policy consultant to the US Department of the Treasury during the George H. W. Bush and Bill Clinton administrations.

    Hassett has also been an economic adviser to presidential candidates since 2000, when he became the chief economic adviser to Senator John McCain during that year's presidential primaries. He served as an economic adviser to the George W. Bush 2004 presidential campaign, a senior economic adviser to the McCain 2008 presidential campaign, and an economic adviser to the Mitt Romney 2012 presidential campaign.

    Hassett is the author or editor of many books, among them "Rethinking Competitiveness" (2012), "Toward Fundamental Tax Reform" (2005), "Bubbleology: The New Science of Stock Market Winners and Losers" (2002), and "Inequality and Tax Policy" (2001). He is also a columnist for National Review and has written for Bloomberg.

    Hassett frequently appears on Bloomberg radio and TV, CNBC, CNN, Fox News Channel, NPR, and "PBS NewsHour," among others. He is also often quoted by, and his opinion pieces have been published in, the Los Angeles Times, The New York Times, The Wall Street Journal, and The Washington Post.

    Hassett has a Ph.D. in economics from the University of Pennsylvania and a B.A. in economics from Swarthmore College.

  • Phone: 202-862-7157
    Email: khassett@aei.org
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    Name: Emma Bennett
    Phone: 202-862-5862
    Email: emma.bennett@aei.org

 

Aparna
Mathur
  • Aparna Mathur is an economist who writes about taxes and wages. She has been a consultant to the World Bank and has taught economics at the University of Maryland. Her work ranges from research on carbon taxes and the impact of state health insurance mandates on small firms to labor market outcomes. Her research on corporate taxation includes the widely discussed coauthored 2006 "Wages and Taxes" paper, which explored the link between corporate taxes and manufacturing wages.
  • Phone: 202-828-6026
    Email: amathur@aei.org
  • Assistant Info

    Name: Hao Fu
    Phone: 202-862-5214
    Email: hao.fu@aei.org

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