Distributional Effects of Carbon Allowance Trading: How Government Decisions Determine Winners and Losers

Abstract

If the U.S. should limit carbon dioxide emissions, an allowance trading policy may offer one method of achieving that goal in a cost-effective manner. The distributional effects of such a program could be large, far in excess of the actual cost to the economy. This paper examines how two key decisions that the government would need to make in designing a carbon trading program would determine those distributional effects. Those decisions are how to allocate the allowances and how to use the revenue that the government would receive under alternative allocation strategies. Distributional effects are estimated for both domestic and international trading programs. We distribute deadweight losses due to policy-induced declines in both carbon consumption and factor supplies. Further, we separate the distributional effects associated with government carbon consumption from private sector carbon consumption. Finally, we highlight the problems in measuring distributional effects that are caused by poor data on households' consumption and income.