Cap and Dividend: Cap and of American Families of American Families

RESEARCH INSTITUTE POLITICAL ECONOMY Cap and Dividend: How to Curb Global Warming While Protecting the Incomes Of American Families James K. Boyce & Matthew Riddle November 2007 Gordon Hall 418 North Pleasant Street Amherst, MA 01002 Phone: 413.545.6355 Fax: 413.577.0261 [email protected] www.peri.umass.edu WORKINGPAPER SERIES Number 150 CAP AND DIVIDEND: HOW TO CURB GLOBAL WARMING WHILE PROTECTING THE INCOMES OF AMERICAN FAMILIES James K. Boyce & Matthew Riddle Political Economy Research Institute University of Massachusetts, Amherst November 2007 ABSTRACT This essay examines the distributional effects of and have a regressive impact on income distri- a “cap-and-dividend” policy for reducing carbon bution, since fuel expenditures represent a lar- emission in the United States: a policy that auc- ger fraction of income for lower-income tions carbon permits and rebates the revenue households than for upper-income households. to the public on an equal per capita basis. The The net effect of carbon emission-reduction aim of the policy is to reduce U.S. emissions of policies depends on who gets the money that carbon dioxide, the main pollutant causing households pay in higher prices. We find that a global warming, while at the same time protect- cap-and-dividend policy would have a strongly ing the real incomes of middle-income and progressive net effect. Moreover, the majority of lower-income American families. The number of U.S. households would be net winners in purely permits is set by a statutory cap on carbon monetary terms: that is, their real incomes, af- emissions that gradually diminishes over time. ter paying higher fuel prices and receiving their The sale of carbon permits will generate very dividends, would rise. From the standpoints of large revenues, posing the critical question of both distributional equity and political feasibil- who will get the money. The introduction of car- ity, a cap-and-dividend policy is therefore an bon permits – or, for that matter, any policy to attractive way to curb carbon emissions. s curb emissions – will raise prices of fossil fuels, s Key words: Global warming; fossil fuels; climate JEL codes: H22, H23, Q48, Q52, Q54, Q58 change; carbon permits; cap-and-dividend; cap-and-auction; cap-and-trade. EXECUTIVE SUMMARY FIGURE A: IMPACT ON FAMILY INCOMES OF A $200/TON CARBON CHARGE Policies to curb emissions of carbon dioxide – 0.0% the main cause of global warming – will inevita- bly raise the prices of fossil fuels: coal, oil, and -2.0% natural gas. The resulting price increases will reduce the real incomes of American families, -4.0% striking hardest at those who can afford it least: lower-income households for whom fuel costs -6.0% -5.3% represent a higher fraction of their expenditures. -6.6% Lowest Quntile The political feasibility of U.S. efforts to curb car- -8.0% -7.6% bon emissions may hinge on whether policies Second Quintile -8.8% Third Quintile are designed to protect middle-class and poor -10.0% Fourth Quintile families from these adverse income effects. -10.2% Highest Quintile -12.0% A “cap-and-dividend” policy offers a simple and Source: Calculated from Table 7. 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 This paper calculates the net effects of a cap- or most of the revenue to American families on and-dividend policy on income distribution in the an equal per person basis. Families who con- United States. We estimate that a permit price of sume lower-than-average amounts of fossil fuels $200 per ton of carbon would reduce U.S. emis- come out ahead, receiving more in dividends sions by approximately seven percent. The re- than they pay in higher prices. Those who con- sulting increases in the prices of fossil fuels, and sume more-than-average amounts pay more. in the prices of goods and services produced with them, would raise the cost of living of the The policy has three basic steps: median American family by $1,570 per year. The • First, U.S. carbon emissions are capped at a price increases would represent a larger per- level that gradually declines over time. One centage of family income in poor households widely discussed target is to reduce emis- than in more affluent households (see Figure A). sions 80% below their current level by the FIGURE B: NET IMPACT ON FAMILY year 2050. INCOMES OF A CAP-AND-DIVIDEND POLICY • Second, based on the cap in a given year, 16.0% permits are auctioned to firms that bring 14.0% 14.8% Lowest Quintile fossil carbon into the economy (whether Second Quintile 12.0% through domestic extraction or imports). The Third Quintile 10.0% supply of permits in a given year is fixed by Fourth Quintile 8.0% the cap; their price depends on the demand Highest Qunitile for them. 6.0% 3.9% • Third, revenue from the sale of permits is 4.0% deposited into a trust fund and paid out 2.0% 0.8% equally to every woman, man, and child in 0.0% the country. In addition, some fraction of -2.0% -0.9% -2.4% the revenue initially may be earmarked for -4.0% other uses, such as transitional adjustment Source: Calculated from Table 9. assistance. CAP & DIVIDEND / EXECUTIVE SUMMARY / PAGE II The revenue from the sale of carbon permits Withholding carbon revenues beyond this would amount to roughly $200 billion per year. threshold would push the net beneficiary share If this revenue is recycled to the public equally, of the population below half. the majority of households receive more in divi- A cap-and-dividend policy will assert the princi- dends than they pay as a result of higher fossil ple of common ownership of nature’s wealth: fuel prices. The net impact ranges from a 14.8% the right to benefit from our share of the Earth’s income gain for the poorest 20% of families capacity to absorb carbon emissions is allo- (and a 24% gain for the poorest 10%) to a 2.4% cated equally to all Americans. It will protect the loss for richest 20% (see Figure B). real incomes of the majority of Americans while Initially earmarking a modest fraction of the curbing global warming and hastening the U.S. carbon revenues for other uses, such as transi- economy’s transition towards the energy tional adjustment assistance, could further en- sources of the future. From the standpoints of hance the appeal of the cap-and-dividend policy. both distributional equity and political feasibility, Up to 10% of the carbon revenues can be dedi- a cap-and-dividend policy is therefore an attrac- cated to other uses while maintaining positive tive way to curb carbon emissions. s net benefits for roughly 50% of households. I. INTRODUCTION FIGURE 1A: CARBON EMISSIONS OF THE U.S, CHINA, AND EU-15, 1987-20051 The time is coming when the United States ( MILLION METRIC TONS) government will enact policies to curb emissions 1800 of carbon dioxide and other greenhouse gases, 1600 joining the efforts of other nations to confront the 1400 historic challenge of global warming. When this happens, a key question – from the standpoints 1200 of both fairness and political feasibility – will be 1000 how to protect the incomes of American families. 800 600 The Clinton administration signed the 1997 400 EU Kyoto Protocol, which envisioned a 7% cut in China 200 U.S. carbon emissions from their 1990 level by US the year 2012. But the Senate refused to ratify 0 7 3 98 989 991 99 995 997 001 003 005 the agreement, and when the government of 1 1 1 1 1 1 1999 2 2 2 George W. Bush came to power it announced it Source: U.S. Energy Information Administration (2007, Table H.1). had “no interest” in the accord. Political winds in the country are now shifting. At FIGURE 1B: CARBON EMISSIONS PER CAPITA OF THE U.S, CHINA, AND EU-15, 1987-2005 the Group of Eight summit meeting in Germany ( MILLION METRIC TONS) in June 2007, the Bush administration agreed to 6.0 re-enter international climate negotiations and to “seriously consider” a European plan to cut 5.0 greenhouse gas emissions in half by 2050. A US legislative proposal unveiled in August 2007 by 4.0 China U.S. Senators Joseph Lieberman and John War- EU 3.0 ner goes further, calling for a 70% reduction by 2050. It now seems possible, even likely, that 2.0 the U.S. will adopt a serious emissions-reduction policy early in the post-Bush administration. 1.0 Any policy to curb carbon emissions will raise 0.0 8 0 2 4 prices of fossil fuels – coal, oil, and natural gas – 99 00 00 00 1997 1 1999 2 2001 2 2003 2 2005 and the prices of other goods and services in Source: U.S. Energy Information Administration (2007, Table H.1). proportion to the use of fossil fuels in supplying them. These price increases will reduce the real incomes of Americans in general, and low-income II. THE CARBON ECONOMY and middle-class American households in par- ticular. But for every dollar paid by consumers in The United States is the world’s top emitter higher prices, someone else receives a dollar in of carbon dioxide (CO2), the most important additional income. Recycling this money to the greenhouse gas. The burning of fossil fuels in public would protect real incomes of the majority the U.S.

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