Again, the ultimate impacts of revenue-raising policies such as emissions taxes and auctioned
emissions allowances depend critically on how the revenues are used. Dinan and
Rogers (2002) and Metcalf (2007) examine recycling revenues from carbon taxes or auctioned
carbon allowances via tax reductions favoring low-income groups (e.g., payroll tax
rebates, higher income tax thresholds, lump-sum transfers).These recycling schemes can help
achieve a fairer distributional burden, for example by imposing a more equitable pattern of
burden-to-income ratios across different income groups. However, they might not help
some elderly or other nonworking households, who may require targeted energy assistance
programs.
The choice between free allocation and auctioning of allowances also has distributional
implications across household income groups. In particular, free allocation tends to increase
the disparity in the burden-to-income ratios between low- and high-income groups, since
firms’ equity values will rise with the increase in producer surplus, and upper-income groups
own a disproportionate share of such equity (Dinan and Rogers 2002). In this regard, direct
regulatory policies may have some appeal since they avoid transferring rents from households
(through large price increases) to firms.
Conclusions
From the above discussion it should be clear that numerous dimensions are relevant to
instrument choice, and that no single instrument is best along all dimensions. For example,
as shown in Table 1, tradable allowance systems with free allocationmight perform relatively
well in terms of political feasibility (column 4) but relatively poorly in terms of minimizing
general equilibrium costs or achieving household equity (columns 3 and 5). The opposite
applies for (revenue-neutral) emissions taxes or auctioned allowances. Direct regulatory
policies have some appeal in terms of distribution (columns 4 and 5) but are generally less
cost-effective along the lines indicated by columns 1–3.
Details matter, and the general type of instrument doesn’t always indicate the overall implications
for cost, fairness, or political feasibility. Emissions taxes and auctioned allowances
may lose some of their key attractive properties if accompanying legislation does not require
offsetting reductions in other taxes. On the other hand, the political obstacles to these policies
might be tempered by providing tax exemptions for some of the infra-marginal emissions,
or by reserving a portion of allowances for free allocation. And the differences between
emissions taxes and emission permits in the presence of abatement cost uncertainty can be
blurred through provisions, such as banking and borrowing, that reduce allowance price
volatility.