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In a recent paper for E3 Network, Elizabeth A. Stanton and Frank Ackerman present the seven key questions that the public should ask about any proposed climate legislation. The answers to these questions will determine whether the proposed legislation will be successful in reducing emissions and how it will impact households. 

Today we address questions three and four from this paper. Question three asks: will a significant share of revenues be rebated to households? Question four tackles the related question: are emission permits given away?

Both are important questions that have been raised by other economists on Real Climate Economics. Here is what Stanton and Ackerman have to say:

Will a significant share of revenues be rebated to households?

If businesses pass on the costs to their customers, a carbon tax or a system of carbon permits will mean “carbon costs” for every household. At a $75 per metric ton CO₂ carbon price in 2020, we estimate these costs would range from an average of 6.3 percent of income for the poorest tenth of U.S. households, to 2.4 percent of income for the richest tenth. This would be an important increase to many families’ budgets, and the impact would be felt most strongly by those with lower incomes and by residents of states that rely primarily on coal for their electricity generation.

To assure that half of all households receive a net benefit from carbon policy, at least 65 percent of all carbon revenues must be returned to households. If 85 percent of the revenues are returned to households, 80 percent of all U.S. households would receive a net dividend, i.e. a rebate greater than their carbon costs (Stanton and Ackerman 2010). Alternatively, part or all of revenues could be returned to households as a reduction to payroll taxes or an increase to the Earned Income Tax Credit or Social Security payments, while still giving a net gain to all working- and middle-class households (Burtraw et al. 2009).

Are emission permits given away?

Under a cap-and-trade policy, funds are available for significant rebates to households only if permits are sold rather than given away. This choice – whether to sell permits or give them away – makes little or no difference in how effective legislation is at reducing emissions, but it makes all the difference to whose pocket the carbon revenues end up in. Carbon prices work by increasing prices on carbon-intensive goods, thereby giving customers an incentive to buy something else instead. When carbon permits are given away, businesses will “pass along” the cost of the permits – even though they didn’t pay for them! If permits are sold (or a carbon tax is adopted) and the revenues are rebated to households, the money ends up with households. If the revenues are collected and used for green investments, the money ends up creating new green jobs. But if permits are given away, the revenue goes to private companies in the form of higher profits: Prices paid by customers go up, while costs of production are unchanged.

So, how well did the recent Congressional proposals to cap carbon emissions answer each of these two questions?

In terms of giveaways, the Cantwell-Collins bill is the only bill that proposed auctioning 100% of the permits. Waxman-Markey would have given away 80% of permits to industry to start, before reducing the share of giveaways to 30% percent by 2030. Kerry-Lieberman would have given away 77-81% percent of permits from 2013 to 2026, and 25% percent after 2030. 

In terms of whether the revenues from permit sales are refunded, the Cantwell-Collins proposal returns 75% of all revenues to households on an equal per capita basis. Starting in 2025, the Waxman-Markey bill would have rebated revenues to some households on an equal per capita basis – about 28% in 2030, rising to 55% in 2050. Another share of revenue is targeted to households as a rebate on electricity bills – a policy that could tend to negate the incentive effect of a carbon price. Kerry-Lieberman would have established a fund by 2026 to give rebates to households, up to a maximum of 58% of total permit revenues in 2035-2050. In addition, it would have provided 10-12% of revenues to  support energy refunds for the poor and a “working families” credit.