PERI Working Paper No. 150, November 2007
EXECUTIVE SUMMARY
Policies to curb emissions of carbon dioxide—the main cause of global warming—will inevitably raise the prices of fossil fuels: coal, oil, and natural gas. The resulting price increases will reduce the real incomes of American families, striking hardest at those who can afford it least: lower-income households for whom fuel costs represent a higher fraction of their expenditures. The political feasibility of U.S. efforts to curb carbon emissions may hinge on whether policies are designed to protect middle-class and poor families from these adverse income effects.
A "cap-and-dividend" policy offers a simple and practical way to do this. The policy would auction carbon permits—rather than giving them free-of-charge to historic polluters—and then return all or most of the revenue to American families on an equal per person basis. Families who consume lower-than-average amounts of fossil fuels come out ahead, receiving more in dividends than they pay in higher prices. Those who consume more-than-average amounts pay more.
The policy has three basic steps:
- First, U.S. carbon emissions are capped at a level that gradually declines over time. One widely discussed target is to reduce emissions 80% below their current level by the year 2050.
- Second, based on the cap in a given year, permits are auctioned to firms that bring fossil carbon into the economy (whether through domestic extraction or imports). The supply of permits in a given year is fixed by the cap; their price depends on the demand for them.
- Third, revenue from the sale of permits is deposited into a trust fund and paid out equally to every woman, man, and child in the country. In addition, some fraction of the revenue initially may be earmarked for other uses, such as transitional adjustment assistance.
This paper calculates the net effects of a cap-and-dividend policy on income distribution in the United States. We estimate that a permit price of $200 per ton of carbon would reduce U.S. emissions by approximately seven percent. The resulting increases in the prices of fossil fuels, and in the prices of goods and services produced with them, would raise the cost of living of the median American family by $1,570 per year. The price increases would represent a larger percentage of family income in poor households than in more affluent households (see Figure A).
The revenue from the sale of carbon permits would amount to roughly $200 billion per year. If this revenue is recycled to the public equally, the majority of households receive more in dividends than they pay as a result of higher fossil fuel prices. The net impact ranges from a 14.8% income gain for the poorest 20% of families (and a 24% gain for the poorest 10%) to a 2.4% loss for richest 20% (see Figure B).
Initially earmarking a modest fraction of the carbon revenues for other uses, such as transitional adjustment assistance, could further enhance the appeal of the cap-and-dividend policy. Up to 10% of the carbon revenues can be dedicated to other uses while maintaining positive net benefits for roughly 50% of households. Withholding carbon revenues beyond this threshold would push the net beneficiary share of the population below half.
A cap-and-dividend policy will assert the principle of common ownership of nature's wealth: the right to benefit from our share of the Earth's capacity to absorb carbon emissions is allocated equally to all Americans. It will protect the real incomes of the majority of Americans while curbing global warming and hastening the U.S. economy's transition towards the energy sources of the future. From the standpoints of both distributional equity and political feasibility, a cap-and-dividend policy is therefore an attractive way to curb carbon emissions.
