Common Tragedies

Thoughts on Environmental Economics

Yet another reason to oppose free allocation of carbon permits

Posted by Rich Sweeney on March 27, 2008

If permits are given away for free to industry, it is essentially a transfer of wealth to equity holders. As many people, such as Gilbert Metcalf and Terry Dinan have pointed out, this exacerbates the regressivity of a carbon cap, because equities are disproportionately held by richer Americans. But clearly that’s not enough to make politicians abandon the idea of free allocation, as all the major Congressional bills still have some permits being given away for free [right Daniel?].

So maybe this will work: According to the Treasury Department, as of June 30, 2006, foreign investors held 10.2% of US equities. Assuming foreign holdings are diversified, that means that up to 1/10 of America’s carbon revenue, which will be tens of billions of dollars, will be effectively given to foreigners. And then the rest will be transferred to rich people. Politically, how is this even still an option?

3 Responses to “Yet another reason to oppose free allocation of carbon permits”

  1. Dan said

    Where allowances are freely allocated, the idea is that there will be a reduction in emissions among the participants. The market value of the credits fundamentally reflects the cost of achieving that reduction (if the allocation does not require any reduction, the credits will have no market value – as we saw in phase 1 of the EU ETS). Free allocation of credits (I think) does not mean any net transfer of wealth, because the participants can only (finally) trade between themselves (at the end of the round, the allowances are not worth anything to anyone else). Any asset value of the allowances is matched by a liability that is the requirement to meet the reduction.

  2. Rich Sweeney said

    Not sure what you mean. By capping carbon and requiring people to hold permits to emit (assuming the cap is binding), we’re creating a very large asset, equivalent to the value of our country’s carbon emissions. Now this value is the same whether we auction permits or give them away for free, because what firms care about is the opportunity costs of the permits, not the accounting cost. The allocation scheme does, however, have distributional implications. And since, no one currently owns our nation’s carbon emissions, apportioning this asset, which will be funded by all of us through price increases, amounts to a transfer of wealth.

    Now many people (such as the two authors I mentioned above) have looked at the possible forms this transfer could take. If permits are auctioned, the government can divvy up the revenue any way it likes. In a perfect world, one could imagine a scheme that would reapportion auction revenues to citizens so as to completely offset their price increases. Another idea is to simultaneously reduce other taxes (such as the payroll tax) so as to have zero net effect on the societal tax burden. If permits are given away for free, however, companies will distribute their value to shareholders. Remember, carbon permits still have the same value, and consumers still bear the same costs. Yet since the wealthy own a disproportionate share of America’s equity, this distribution scheme can be seen as a transfer to the rich. And since foreigners own 10% of US equities, I’d say this can also be viewed as a transfer to foreigners.

  3. TJR said

    I am not aware of the debate in the US but in Australia the allocation of free permits to industry is much more nuanced. The argument in Australia is that permits should be allocated to two categories of industry, domestic industries that will be significantly adversely affected and trade exposed emission intensive industries.

    The significantly adversely affected industries include the electricity generation sector which is primarily coal-fired in Australia. The permit allocation to this sector is not to compensate them completely but to provide compensation only to the level of the average impact on the economy. As a hypothetical example if there is an overall loss of value of five per cent across all industries and the electricity generation sector has a 15% loss in value then they would be eligible for compensation of the difference which would be 10%. This is to compensate for the sovereign risk from governments changing the rules and ensuring that additional risk factors are not built in to future investments with the consequent loss of welfare for all consumers of the production of these industries. There is no intention to provide windfall gains but only partial compensation to the investors and it does not matter if they are foreigners or the mums and dads with equity in these assets or even indirect stakes through ownership of lending institutions which may be adversely affected if the companies are severely damaged. Pursuing equity considerations amongst taxpayers should be targeted directly through the appropriate instruments of the income tax system which recognizes the individual circumstances of taxpayers. Equity considerations should not be seen as a function of where their retirement incomes are to be derived from or their choice of asset mix for their incomes.

    For the trade exposed emissions intensive industries the intention is to ensure that industries competing on world markets are not severely disadvantaged by competitors in countries with no carbon pricing with the potential for carbon leakage as one of the major issues. These permits are being debated as being for limited time periods and re-assessable as competitor nations change their carbon policy framework.

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