Offsetting distributional effects of a cap-and-trade program

June 17, 2008

CBO issued a letter today reviewing options to offset price increases experienced by low- and moderate-income households under a cap-and-trade program for carbon dioxide emissions.

  • Under a cap-and-trade program for CO2 emissions, the government would set gradually tightening limits on emissions, issue rights (or allowances) corresponding to those limits, and then allow firms to trade the allowances among themselves. The net financial impact of such a program on low- and moderate-income households would depend in large part on how the value of emission allowances was allocated. By itself, a cap-and-trade program would lead to higher prices for energy and energy-intensive goods. Those price increases would impose a larger burden, relative to either income or household consumption, on low- and moderate-income households than on higher-income households.
  • Lawmakers could choose to offset the price increases experienced by low- and moderate-income households by providing for the sale of some or all of the CO2 emission allowances and using the revenues to compensate such households.
  • For example, if all allowances were sold and the proceeds used for an equal lump-sum rebate to each household, the rebate would be greater than the average increase in low-income households' spending on energy-intensive goods. CBO's letter discusses that and other options, including broad or targeted reductions in income tax rates, payroll or income tax rebates, an increase in the Earned Income Tax Credit, a supplement to Food Stamp benefits, increased funding for the Low Income Home Energy Assistance Program, and increased incentives for energy-saving investments by households. In addition, automatic cost-of-living increases for Social Security and Supplemental Security Income would provide partial protection for some households.
  • Choosing among such options often involves a trade-off between providing targeted assistance to low- and moderate-income households and offsetting some of the adverse effects on overall economic activity from reducing carbon emissions.