DISTRIBUTIONAL IMPACTS OF GREENHOUSE GAS EMISSIONS TRADING: ALTERNATIVE ALLOCATION AND RECYCLING STRATEGIES IN CALIFORNIA

I. INTRODUCTION Thirty U.S. states have completed or are in the process of drafting climate action plans. Emissions trading, or "cap and trade," features are integrated into most of these plans, including collaboration among states in regional greenhouse gas (GHG) trading consortia (Regional Greenhouse Gas Initiative--RGGI 2007). Forward movement has been slowed by the current recession, but cap and trade remains attractive to many state governments because it provides a much-needed source of additional revenue when GHG emission allowances are auctioned to the highest bidder. Revenues can be used for a variety of purposes such as cutting state budget deficits, offsetting existing distorting or burdensome taxes, investment in research and development of clean technologies, and compensating key groups adversely affected by the policy. The distributional impacts of policy alternatives are important for two reasons. First is the normative goal of equity, or fairness. Of special concern is the impact of GHG mitigation on low-income households because they tend to be more vulnerable to economic losses. Lower income groups spend a higher proportion of their income on necessities, such as electricity and gasoline, and these goods are among those most likely to have their prices affected by climate policy (Parry and Williams 2010). Revenue recycling can help overcome negative income impacts. Second, distributional impacts are important for reasons of positive economics of predicting the outcome of the policymaking process (Parry and Williams 2010; Rose, Stevens, and Davis 1988). This perspective typically shifts many policy makers' attention to powerful special interest groups. It has led to greater willingness to consider the free granting of GHG emission allowances to emitters, mostly businesses. A fairness aspect arises here as well in that many emitters see free granting as a way of compensating them for potential economic losses from undertaking GHG mitigation. The distributional impacts are complicated by the workings of climate action plans. GHG mitigation polices will have a major effect at the site of their implementation. Some of the options, such as energy efficiency, can result in cost savings directly to businesses, households, non-profit institutions, and government operations that implement them, and they can also provide gains to business and household customers if the savings are passed on in the form of lower prices. It is likely that other options will incur costs to businesses or households, thereby affecting their competitiveness or purchasing power. Many entities will try to recoup these cost increases by raising their prices and passing the burden on to their customers. Net impacts will be affected by various types of indirect effects stemming from economic interdependence. Increases in demand ripple through the economy generating a set of successive rounds of positive multiplier effects on suppliers. Cost savings are passed along to several rounds of customers to add further to the stimulus. Cost increases and decreases in demand in other sectors will have their own ripple effects on different sets of suppliers and customers. The interactive sum of all of these price and quantity effects for the entire economy represents a set of macroeconomic effects whose outcome cannot easily be predicted a priori. In this study, we analyze four GHG emission allowance allocation/recycling alternatives for the California Global Warming Solutions Act for the target Year 2020. We adapt the Regional Economic Models, Inc. (REMI) Policy Insight Plus (PI+) model (REMI 2010), and supplement it with a Multisector Income Distribution Matrix (MSIDM) to update and heighten the resolution of income distribution considerations. First, we examine the recycling of revenues through proportional income tax relief and a per capita dividend (lump sum transfer). Then we examine the distributional impacts of free allocation under conditions where the opportunity costs of free allowances can and cannot be passed on to purchasers of products generating the emissions. …