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Auction or Allocate

The great debate over emissions allowance distribution.

Fortnightly Magazine - February 2009

although a great deal has been written on the subject, particularly in the context of a potential GHG program. 6,7 Regardless of the auction format or percentage of total allowances, there will be a secondary market where allowances will be available for purchase or sale.

As previously mentioned, when allowances are sold at auction, the government captures the value of the allowances in the form of revenue raised. The government then faces the task of deciding how that revenue is to be used: Whether it will be returned to businesses or consumers or spent on government programs. The Congressional Budget Office looked at the effects of a 15 percent cut in CO 2 emissions on various segments of the population under three different revenue recycling schemes. 8 While the CBO analysis is informative, there are some limitations to the findings. Notably, the report is not specific to the power sector and does not address important differences in traditionally regulated and restructured states. Looking economy-wide, the study found that a lump-sum rebate given out directly to households was the most progressive policy in that it made lower-income families better off (because the size of the rebate was greater than the increased energy cost). However, this approach also had a high overall cost to the economy and less effect on incentives to invest in emissions reductions. Using revenues from auctions to cut payroll taxes was found to be regressive because it favored higher wage earners. Finally, if allowances were given out freely to regulated entities, it would result in the same cost to the economy as lump-sum rebates, but be the most regressive because the scheme largely benefits corporate shareholders while still increasing energy costs for consumers (with the exception of electricity costs inside cost-of-service areas). Other uses for revenue include funding R&D in new low-emitting energy technologies, providing aid to low income households for energy efficiency improvements, and reducing the federal deficit.

Allocation-Auction Hybrid

It also is possible to allocate freely a static or dynamic share of the allowances while auctioning the remainder. This hybrid approach permits policymakers to meet various objectives as they shift over time ( e.g., near vs. long term). Most proposals that end up adopting this approach tend to allocate a decreasing share of allowances over time while auctioning an increasing share. The main advantage of this type of approach is the comparatively more measured impact on electricity consumers in cost-of-service states (which EPA believes is more than two-thirds of electricity customers) when a cap-and-trade program goes into effect. On the downside, there is no assurance of optimized compliance actions achieving reductions at the lowest cost.

In the short term, emitting generators may need to adjust their investment decisions to comply with new regulations. During this time period, free allocations to generators might assist with this transition. In the long term, the majority of the burden likely will shift to consumers who can be compensated through the use of auction revenue—suggesting the benefit of an increasing share of auctioned allowances over time. Alternatively, allocations or auction revenue could