would instantly shift up the trajectory of current and expected future permit prices, before
any adjustment to the future cap is actually made. In contrast, under a carbon tax, it might
take some time to enact a legislative change in the tax rate in response to new scientific
information, which would leave emission control suboptimal during the period of policy
stickiness.
Distributional Impacts
The distributional impacts of alternative environmental policies can be considered across
numerous dimensions, such as regions, ethnic groups, or generations. Here we focus on two
dimensions that have received especially great attention in policy discussions: the distribution
between owners of polluting or energy-intensive industries and other members of society
(consumers, taxpayers, workers), and the distribution across households of different incomes.
These distributional impacts have important implications not only for fairness or distributive
justice but also for political feasibility.
Distribution Between Owners of Polluting Enterprises and Other Economic Actors
Since the combustion of fuels is a major contributor to pollution, an important issue is the
burden that pollution control policies might impose on industries supplying these fuels as
well as industries (such as electricity and metals production) that use these fuels intensively.
Depending on specific design features, different instruments can have very different impacts
on capital owners in these industries.
Consider first the impacts of a cap-and-trade system. As discussed in Section 2, for a given
quantity of allowances, free allocation leads to the same allowance prices and output price
increases as does auctioning of allowances. However, the nature of the initial allocation can
have a significant effect on the distributional burden from regulation.
An emissions allowance system causes firms to restrict the level of production, thereby
causing an increase in the equilibrium output price. Higher output prices potentially generate
rents to firms, in much the same way that a cartel enjoys rents by reducing output.
With free allowance allocation, firms enjoy these rents. In contrast, if allowances are
introduced through a competitive auction, the rents are bid away as firms compete to obtain
the valuable allowances. In this case, what would be firms’ rents under free allocation become
government revenue instead. This benefits the general taxpaying public to the extent that it
reduces the government’s need to rely on various existing taxes for revenue; alternatively, the
public could benefit from additional government-provided goods or services financed by the
auction revenue.
In fact, when allowances are initially given away for free, regulated firms might even
enjoy higher profits than in the case of no regulation: the rents might more than fully
compensate firms for the costs of complying with the program. Whether this occurs depends
on two factors. The first is the elasticity of supply relative to the elasticity of demand for the
industry’s output. The greater the relative elasticity of supply, the greater the price increase
associated with a given free allocation of allowances, and the larger the rents generated to
firms. The second is the extent of required abatement: at low levels of abatement, allowance
rents are large relative to compliance costs, which implies a greater potential for an overall
increase in profit.
Downloaded from http://reep.oxfordjournals.org/ at Instructional Resources Ctr Khon Kaen University on April 6, 2015