Impacts of Alternative Emissions Allowance Allocation Methods Under a Federal Cap-and-Trade Program

44 Pages Posted: 20 Aug 2009

See all articles by Lawrence H. Goulder

Lawrence H. Goulder

Stanford University - Department of Economics; National Bureau of Economic Research (NBER); Resources for the Future

Marc A. C. Hafstead

Stanford University

Michael Dworsky

Stanford University

Multiple version iconThere are 2 versions of this paper

Date Written: August 18, 2009


There has been intense focus on the issue of how emissions allowances might be allocated under a potential federal cap-and-trade program. What fraction of the allowances should be auctioned out, as opposed to given out free? How much free allocation would be sufficient to preserve profits in various industries? What are the economy-wide implications of alternative uses of whatever auction revenues are collected?

This paper employs a dynamic general equilibrium model of the U.S. economy to address these issues. The model’s unique treatment of capital dynamics permits close attention to the impacts of alternative policies on industry profits.

We find that freely allocating a relatively small fraction of the emissions allowances generally suffices to prevent profit losses among the eight industries that, without free allowances or other compensation, would suffer the largest percentage losses of profit. Under a wide range of cap-and-trade designs, freely allocating less than 15 percent of the total allowances prevents profit losses to these most vulnerable industries. Allocating 100 percent of the allowances substantially overcompensates these industries, in many cases causing more than a doubling of profits.

These results indicate that profit preservation is consistent with substantial use of auctioning and the generation of considerable auction revenue. GDP costs of cap and trade depend critically on how such revenues are used. When these revenues are employed to finance cuts in marginal income tax rates, the resulting GDP costs are about 33 percent lower than in the case where all allowances are freely allocated and no auction revenue is generated. On the other hand, when the auction proceeds are returned to the economy in lump-sum fashion (for example, as rebate checks to households), the potential cost-advantages of auctioning are not realized.

Our results are robust to cap-and-trade policies that differ according to the presence or absence of provisions for offsets or intertemporal banking of allowances, or in terms of policy stringency.

Keywords: cap and trade, emissions allowance allocation, industry impacts, general equilibrium modeling, climate change policy

JEL Classification: D58, H23, Q52, Q54, Q58

Suggested Citation

Goulder, Lawrence H. and Hafstead, Marc A. C. and Dworsky, Michael, Impacts of Alternative Emissions Allowance Allocation Methods Under a Federal Cap-and-Trade Program (August 18, 2009). Available at SSRN: or

Lawrence H. Goulder (Contact Author)

Stanford University - Department of Economics ( email )

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Resources for the Future

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Marc A. C. Hafstead

Stanford University ( email )

Stanford, CA 94305
United States

Michael Dworsky

Stanford University ( email )

Stanford, CA 94305
United States

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