The Incidence of U.S. Climate Policy: Where You Stand Depends on Where You Sit

Federal policies aimed to slow global warming would impose potentially significant costs on households that vary depending on the policy approach that is used. This paper evaluates the effects of a carbon dioxide cap-and-trade program on households in each of 11 regions of the country and sorted into annual income deciles. We find tremendous variation in the incidence (the distribution of cost) of the policy. The most important feature that affects households is how the policy distributes the value created by placing a price on CO2 emissions. We evaluate 10 policy alternatives that yield results that range from moderately progressive (expansion of the Earned Income Tax Credit, investments in efficiency and capand-dividend) to severely regressive (reduce income taxes, free distribution to incumbent emitters and reduction of the payroll tax). To varying degrees the allocation of the value of emissions allowances amplifies or potentially resolves the tradeoff between equity and efficiency.

A detailed and comprehensive analysis by scholars at Resources for the Future indicates that a national climate policy could have significant distributional effects across regions and income groups, but policymakers have a number of tools at their disposal to address those impacts. Many of the options currently up for debate raise government revenues, and the decision about how to use that money plays the dominant role in determining how the costs of climate policy are shared.

In The Incidence of U.S. Climate Policy: Where You Stand Depends on Where You Sit, Senior Fellows Dallas Burtraw and Margaret Walls and Research Assistant Richard Sweeney examine the distributional implications of 10 policies that could accompany a national cap-and-trade system. These policies fall into four categories:

• cap-and-dividend options,
• adjustments to preexisting distortionary taxes,
• energy and fuel sector remedies, and
• free allocation of allowances to shareholders of incumbent emitting facilities (grandfathering), the approach used in most previous emissions trading programs.

The analysis indicates distributional consequences of CO2-pricing policies vary widely. Households in the lowest two income deciles could incur welfare losses as high as 10 percent of their income or welfare gains up to 6 percent of their income, depending on how revenues are distributed. While several of the policy cases look sharply regressive before the distribution of revenues, most are approximately proportional or progressive after revenues are disbursed.

Only three scenarios remain regressive after the return of revenue: grandfathering, a reduction of the income tax, and a reduction of the payroll tax. The latter two may have important efficiency advantages, however, implying a potentially significant equity-efficiency tradeoff.

Geographically, the range of impacts on average households across regions can be as high as about $550. For example, under a cap-and-dividend policy (with dividends that are taxable) the average household in the Northeast experiences a consumer surplus loss of $1,150 per year while the average household in the Northwest loses only $625 per year. However, when expressed as a fraction of income, these differences are quite small.

But significant differences across regions exist for poorer households in terms of a percentage of income. Again using cap-and-dividend as an example, average households in the lowest two deciles may enjoy a consumer surplus gain of as much as 3.8 percent of income (in Texas) or incur a consumer surplus loss equal to 1.2 percent of income (in the Northeast).

The research was funded by the U.S. Environmental Protection Agency (Contract EP-D-04-006) and Mistra’s Climate Policy Research Program. It does not necessarily reflect the views of the Agency and no official endorsement should be inferred.