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Efficiency and Distributional Consequences of the Allocation of Tradable Emission Allowances and Tradable Performance Standards

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Objectives/Hypothesis:
As emission trading policies begin to encompass more diverse actors and extend over greater time frames, decision makers are looking beyond "grandfathering" toward new allocation methods, particularly ones that adjust over time. We will analyze three approaches to allocating permits: (1) grandfathering permits based on historic emissions or production; (2) auctioning, with revenues retained by government; and (3) updating allocations based on a recent-year activity, in particular "output-based" allocations and tradable performance standards. The investigators will evaluate these approaches according to three criteria: cost-effectiveness, environmental performance, and distributional impacts.

Approach:
The investigators will investigate these questions using analytical and pre-existing simulation models. The simulations will involve a detailed electricity sector model coupled to an integrated assessment for environmental assessment. It also will involve two computable general equilibrium models, one of the U.S. and another international model that includes trade. A methodological contribution will be to integrate detailed results of the sector models with welfare measures obtained through general equilibrium analysis.

Expected Results:
The results will inform decision-makers and interested parties at the state and federal level. State decision-makers will be interested in understanding the cost and distributional consequences of their decisions, as well as understanding more generally their possible choices with respect to permit allocation. The results of this research will help state decision-makers to engage in efforts at regional coordination in the design and implementation of trading programs. We also anticipate this research providing information about the actual performance of programs that have been implemented. Environmental advocates and industry will benefit from this research by obtaining a more complete understanding of the attributes of various approaches to environmental regulation and how those attributes affect the issues of greatest concern to them. As firms are already considering control strategies for greater NOX and possibly SO2 control this research will help them identify salient considerations important to their abatement decisions in the face of varying uncertainty. In addition, the research offers a contribution to scholarship through analytical and methodological advances. In addition, agency and congressional staff should be interested in the immediate policy-relevant nature of the research. A fuller understanding by all of these parties of the cost-effectiveness, distributional and environmental aspects of these policy instruments should lead to more efficient and more equitable outcomes.

Supplemental Key Words: air, atmosphere, public policy, cost benefit, northeast, central, Atlantic coast, Chesapeake Bay, Great Lakes, Midwest, mid-Atlantic

Metadata

EPA/NSF ID:
R828628
Principal Investigators:
Burtraw, Dallas
Fischer, Carolyn
Palmer, Karen
Pizer, Billy
Technical Liaison:
Research Organization:
Resources for the Future
Funding Agency/Program:
EPA/ORD/Incentives
Grant Year:
2000
Project Period:
October 1, 2000 to September 30, 2002
Cost to Funding Agency:
$251,000
Project Status Reports:
For the Year 2001

Objective:
This research project is organized around three questions:
    (1) What effect does the mechanism for allocating emission permits have on cost, distributional consequences, and environmental performance of the environmental regulation? We will investigate this question in a numerical framework using a detailed model of the electricity industry to simulate NOx emission allowance trading in the eastern U.S. We also will use a general equilibrium model with international trade to study the effects of domestic, multi-sector trading of CO2 pollution permits.
    (2) Do strategic incentives stemming from inter-jurisdictional relations affect the choice of allocation mechanisms? Inter-jurisdictional competition can be an important factor in the determination of a variety of state policies, and we expect the same to be true with respect to allocations. We will consider the patchwork of state-level environmental and electricity regulation within the simulation model to study the allocation of NOx emission allowances in the United States. We will search for optimal strategies from the perspective of individual states and compare these with the federal perspective.
    (3) How does the performance of tradable permit allocations change in a dynamic context? Time can play an important role that is omitted in static analysis. Over time, regulatory standards may evolve, leading to unanticipated changes in programs. Also, firms have incentives to innovate, enter, and exit an industry. These dynamic actions will affect the relative performance of different allocation mechanisms.

Progress Summary:

In the first year of this research project, the principal investigators have worked separately on two major initiatives. One is an analytical investigation of the efficiency of output-based allocations of emission allowances. This work has been tested in general computable equilibrium models with international trade, and has led to several presentations and two manuscripts; a third manuscript is in preparation.

The second initiative focuses on the efficiency and equity implications in the context of a U.S. domestic permit trading program. An example would be to control NOx or CO2 with special study of the electricity sector. This work has led to two manuscripts and one shorter educational piece, and has been the focus of approximately 40 presentations and briefings for the advocacy community, industry, agencies, legislative staff, and academics. It also has generated interest at both the state and federal levels.

Viewed together, this research establishes a seminal body of literature to guide policymakers on approaches to the allocation of emission allowances. The research findings are of unusual magnitude, suggesting tremendous efficiency and equity consequences. Furthermore, normative guidance that has attracted the interest of a diverse community of interest groups has been achieved.

Future Activities:

The second year of the project will extend the ambitious accomplishments of the first year, and also initiate a second effort dedicated to combining analytical results with empirical and simulation modeling exercises to examine strategic issues in the allocation of permits. We expect to complete the development of analytical models by preparing the following paper: Fischer, Carolyn. Output-Based Rebating of Environmental Policy Revenues and Imperfect Competition (2002).

The following two papers also will be completed: (1) Approaches to the Distribution of NOx Allowances: Efficiency and Fairness, and (2) Formulas for Fairness: Compensation Through Allowance Allocations. In addition, we plan to write a paper on strategic issues. That manuscript is not yet in preparation.

Publications:

Burtraw D. Carbon emission trading costs and allowance allocations: evaluating the options. Resources 2001;145(Fall):13-16.

Bernard A, Fischer C, Vielle M. Is there a rationale for rebating environmental levies? Resources for the Future Discussion Paper 01-31. Washington, DC: Resources for the Future. Journal of Public Economics.

Palmer K, Paul A, Bharvirkar R. The effect on asset values of the allocation of carbon dioxide emission allowances. The Electricity Journal Volume 15, Issue 5, June 2002, Pages 51-62.

Papers:

Fischer C, Fox A. Output-based allocations of emissions permits: efficiency and distributional effects in a general equilibrium setting. U.S. International Trade Commission.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Resources for the Future Discussion Paper 01-30, July 2001.

Presentations:

Fischer C, Fox A. Output-based allocations of emissions permits: efficiency and distributional effects in a general equilibrium setting. Presented at the IIASA/IEW/EMF Joint Workshop, Laxenburg, Austria, June 2001.

Fischer C, Fox A. Output-based allocations of emissions permits: efficiency and distributional effects in a general equilibrium setting. Presented at the 57th Congress, The Role of Political Economy in the Theory and Practice of Public Finance, Linz, Austria, August 2001.

Fischer C, Fox A. Output-based allocations of emissions permits: efficiency and distributional effects in a general equilibrium setting. Presented at the Canadian Federal/Provincial Working Group on Emissions Trading, Toronto, Canada, October 2001.

Fischer C, Fox A. Output-based allocations of emissions permits: efficiency and distributional effects in a general equilibrium setting. Presented at the French Council of Economic Advisors, Paris, France, December 2001.

Fischer C, Fox A. Output-based allocations of emissions permits: efficiency and distributional effects in a general equilibrium setting. Presented at the 5th Conference on Global Economic Analysis, Taipei, June 2002.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented at the Environmental Policy Conference, Ohio State University, Columbus, OH, April 2000.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented at the Resources for the Future Council Meeting, San Antonio, TX, April 2000.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to the National Resource Defense Council, April 2000.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to Cynergy, House Committee Staff, May 2000.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to Americans for Equitable Climate Solutions, Clean Air Markets Division, U.S. Environmental Protection Agency, May 2000.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to Minnesota Power and Alette Power, House Energy and Commerce Staff, May 2000.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented at Clear the Air, Washington, DC, June 2000.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to the Clean Energy Group, June 2000.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to Exelon, Senate Legislative Staff, June 2000.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to Entergy and Mirant. Capitol Briefing organized by the Environment and Energy Study Institute, July 2001.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to Duke Energy, August 2001.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented at the Executive Enterprises Training Institute, Pacific Gas and Electric Company, September 2001.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to Foundation Roundtable hosted by the Surdna Foundation, Senate Environmental and Public Works Committee, Stakeholders Meeting on Multi-Pollutant Legislation, Resources for the Future, October 2001.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented at the Redefining Progress Conference, November 2001.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented at the Resources for the Future Workshop on The Distributional Impacts of Carbon Mitigation Policies: Various Lenses on the Issue, October 2001.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented at the Electric Utilities Environmental Conference, February 2002.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented at the Center for Clean Air Policy Policy Briefing, Senate Dirksen Building, January 2002.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to Texaco, March 2002.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented at the Electric Power Research Institute's 7th Annual Global Climate Change Research Seminar, June 2002.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented at Meetings and Consultation With Senate Staff, June 2002.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to the Natural Resources Defense Council, June 2002.

Palmer K, Bharvirkar R, Paul A. The effect of allowance allocation on the cost of carbon emission trading. Presented to the Americans for Equitable Climate Solutions, June 2002.

Supplemental Keywords: air, global climate, nitrogen oxides, sulfates, acid rain, public policy, decision making, cost benefit, public good, compensation, conservation, modeling, analytical, northeast, electricity sector.

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