Distributional Impacts of Greenhouse Gas Emissions Trading: Alternative Allocation and Recycling Strategies in California

Abstract

Cap and trade remains attractive to many state governments because it provides a much‐needed source of additional revenue when greenhouse gas emission allowances are auctioned to the highest bidder. We analyze the income distribution impacts of the California Global Warming Solutions Act under alternative policy designs. These include the free allocation of emission allowances versus recycling of auction revenues through proportional income tax relief and a per capita dividend. The analysis is undertaken under conditions where significant economic gains, rather than losses, are projected for the policy, and in the context of the new electricity pricing regulatory environment in which passing along the opportunity costs of using free allowances may not be approved. We adapt and enhance the Regional Economic Models, Inc. Policy Insight Plus Model and apply it for the first time to estimate the income distribution impacts of cap and trade. The analysis illustrates the importance of considering macroeconomic impacts and identifies important efficiency‐equity tradeoffs. The method and results are generalizable to the dozens of states and regions still formulating or revising climate action plans in the United States and to many regions and nations around the world.

JEL Classification: D31, R11, Q54