Climate Change Policy: Preliminary Observations on Options for Distributing Emissions Allowances and Revenue Under a Cap-and-Trade Program

This testimony by the Government Accountability Office (GAO-09-950T) dated August 4, 2009 states that the method for allocating allowances in a cap-and-trade program can have significant economic implications for the government, regulated entities, and households.

The government could allocate these allowances to regulated entities in three main ways. First, it could auction all of the allowances and collect a significant amount of revenue that it could use, for example, to compensate households affected by the cap-and-trade program. Second, it could give away the allowances to entities affected by the program and thereby transfer the value of the allowances to those entities. Third, the government could give away some allowances and auction the rest.

According to the economic literature and economists we interviewed, regardless of the mechanism for distributing allowances, consumers will bear most of the costs of a cap-and-trade system because most regulated entities will pass along their increased costs in the form of increased prices; however, these costs could be largely offset depending on how revenues are used.

Available literature and economists we interviewed point to five main options for distributing a program’s allowance revenues, although numerous other options exist. First, the government could lower the overall cost of the cap-and-trade program to the economy through accompanying reductions in taxes on income, labor, or investment. Second, auction revenues could be distributed to households through lump-sum payments, which could offset the higher consumer prices resulting from a cap-and-trade program and mitigate any disproportionate impacts on low-income households. Third, the government could expand the scope of the Earned Income Tax Credit to further benefit low-income working families. Fourth, the government could compensate regulated entities and their shareholders for lost profits by allocating them free allowances. Finally, revenues might be used to fund climate-related programs, such as research on low-carbon technologies, or used to support climate change mitigation activities in developing nations.