Greenhouse Gas Auctions and Taxes: Some Practical Considerations

Abstract

Many scholars assert that "cap and trade" is an appropriate strategy for addressing climate change. Some economists have argued that auctions of greenhouse gases should be an integral part of any cap-and-trade mechanism. These economists suggest that auctions can efficiently distribute emissions allowances among firms, and potentially offset some of the dead weight costs with raising government revenues. Many environmentalists argue that revenue from auctions should be used by the government to promote reductions in greenhouse gas emissions. Similar arguments are made for greenhouse gas taxes.

This paper evaluates various arguments for auctions and taxes in light of political realities. I argue that economists are likely to be overly optimistic in their support for auctions and taxes, and that many potential uses of these revenues are unlikely to result in economic benefits. I then offer some general guidance for governments on the role of auctions in a cap-and-trade mechanism and offer recommendations for participating firms. Specifically, I urge the government to compare a realistic set of policy options, while recognizing that the feasibility of different types of mechanisms can change over time. To illustrate one such comparison, I examine auctions and taxes as ways of raising revenue, and find that neither is likely to do particularly well in terms of efficiency based on history. Furthermore, I suggest that the introduction of political economy considerations may lead to an optimal level of pollution control that is lower than that suggested by conventional economic analysis.

Keywords: Auctions, Environmental Economics, Climate Change, Benefit-Cost Analysis, Regulation, Political Economy