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Trade-Offs in Allocating Allowances for CO2 Emissions 1 (April 2007)

handle is hein.congrec/cbo8860 and id is 1 raw text is: A series ofissue summaries from the Congressional Budget Office APRIL 25, 2007 Trade-Offs in Allocating Allowances for CO2 Emissions Overview In light of scientific evidence about the potential damages from climate change, the Congress is considering legisla- tion that would impose a cap-and-trade program to reduce U.S. emissions of greenhouse gases, including carbon dioxide (CO2) from the burning of coal, oil, and natural gas. The merit of a cap-and-trade program is that, like a tax on CO2 emissions, it could motivate businesses and households to reduce emissions in the least costly way. Such programs have been used successfully in the United States to limit the cost of reducing emissions of other air pollutants, such as lead in gasoline and nitrogen oxides and sulfur dioxide from electricity generators. Under a cap-and-trade program for carbon dioxide emis- sions, policymakers would set a limit on the total amount of CO2 that could be emitted in a given period-the cap-and would issue rights, or allowances, corre- sponding to that level of emissions. Entities that were subject to the cap (such as coal mines, oil importers, refineries, or electric utilities, depending on the proposal) would be required to hold allowances for their CO2 emis- sions. After the allowances were initially distributed, enti- ties would be free to buy and sell them-the trade part of the program-and the price of allowances would adjust to reflect the cost of meeting the emission cap. This brief examines how policymakers' decisions about allocating the allowances would affect the total cost of the policy to the U.S. economy, as well as the distribution of that cost among households in their various roles as workers, consumers, and investors. Although cap-and- trade programs could cover all greenhouse gases, this brief focuses on a program for CO2 emissions. By capping those emissions, policymakers would create a new commodity: the right to emit carbon dioxide. The emission allowances (each of which would represent the right to emit, say, 1 ton of CO2) would have substantial value-perhaps totaling tens of billions or even hundreds of billions of dollars per year. Who received that value would depend on how the allowances were allocated. One option would be to have the government capture their value by selling the emission allowances, as it does for licenses to use the electromagnetic spectrum. Another possibility would be to give the allowances to energy pro- ducers or some energy users at no charge-the approach that the U.S. government adopted in the sulfur dioxide program and that the European Union has used since 2005 in its cap-and-trade program for CO2 emissions. Regardless of how the allowances were distributed, most of the cost of meeting a cap on CO2 emissions would be borne by consumers, who would face persistently higher prices for products such as electricity and gasoline. Those price increases would be regressive in that poorer house- holds would bear a larger burden relative to their income than wealthier households would. In addition, workers and investors in parts of the energy sector-such as the coal industry-and in various energy-intensive industries would be likely to experience losses as the economy adjusted to the emission cap and production of those industries' goods declined. Such losses would probably be limited to current workers and investors. Job losses in those industries would be likely to impose a fairly large burden on a relatively small number of households; This brief was prepared by Terry Dinan and is based on various CBO publications, including Shifting the Cost Burden of a Carbon Cap-and- Trade Program (July 2003), An Evaluation of Cap-and-Trade Pro- gramsfor Reducing U.S. Carbon Emissions (June 2001), and Who Gains and Who Pays Under Carbon- Allowance Trading? The Distributional Effects ofAlter- native Policy Designs (June 2000). Those and other reports about policy choices associated with climate change are available on CBO's Web site at www.cbo. gov/publications/collections/climatechange.cfm. Peter R. Orszag Director

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