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Windfalls

Posted by Eric de Place

03/25/2008 08:00 AM

Why consumer protection means selling carbon permits.

cash money One of the thorniest problems in cap and trade programs is deciding how to distribute the carbon permits. Should the public sell pollution privileges or give them away for free?

Some folks worry that if we make polluters pay for carbon permits, they'll just raise prices for consumers. That's a perfectly legitimate concern. But unfortunately, it turns out to be true whether or not we sell the permits or give them away for free. Prices rise by the same amount in either scenario. (The only difference is whether polluters reap windfall profits or whether the public earns revenue from selling the permits.) It may be counterintuitive, but it's true.

It's also very hard to explain why this is the case without resorting to a lecture on economics. So in an attempt to clear things up, we've put together this easy-on-the-eyes summary. It comes in four parts:

A simple explanation
A bit more detailed explanation
A look at Europe's carbon trading market
A review of the (basically unanimous) economic literature

Take a look and let us know what you think.

Economy

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Comments

Posted by Milan 03/28/2008 10:48 AM

That is a very clear and helpful explanation. Thanks a lot for providing it.

It will help to make clear just what the cost associated with grandfathering is. Often, cap-and-trade is favoured over a carbon tax because it is deemed more politically acceptable. If a lot of those permits are freely allocated within the industries meant to be subject to the regulation, it is not hard to see why that would be so.

Posted by bill mckibben 03/28/2008 01:15 PM

This is remarkably concise and useful--thanks.

bill mckibben, 350.org

Posted by michael mcginn 03/31/2008 10:04 PM

I expected a citation to the Coase Theorem.

Another example worth looking at is how the U.S. allocated spectrum to cellular phone companies -- first it was a lottery then the government moved to an auction system. The lottery system granted tremendous value to the lucky winners as spectrum was ultimately purchased at a premium by the big players. The auction generated that benefit to the taxpayers. The choice of allocation system probably made little difference to the ultimate allocation, but it did make a difference to taxpayers.