March 6, 2011

Options for Returning the Value of CO2 Emissions Allowances to Households

by Dallas Burtraw and Ian W.H. Parry

- This paper examines alternative ways that the value of CO2 emissions allowances created under cap-and-trade policy could be returned to households. One approach (based on principles of economic efficiency) is effectively a “tax shift” that would use revenues from an auction of CO2 emissions allowances to reduce preexisting distortionary taxes. A second approach (based on principles of property rights for common-pool resources), known as cap-and-dividend, would refund allowance value as equal lump-sum cash transfers to households. Economic theory suggests (with some caveats) that a tax shift would be considerably less costly to the overall economy. In contrast, cap-and-dividend provides ample compensation for low-income households, though it appears to be more costly than other approaches, including perhaps well-designed regulatory policies. A dividend approach might be combined with other policies to provide incentives for households to invest in energy-efficient technologies and thereby lower the costs of the carbon policy.

Burtraw, D. and I.W.H. Parry (2011). "Options for Returning the Value of CO2 Emissions Allowances to Households." RFF Discussion Paper 11-03, Feb 2011.