From the look of things, the president’s cap-and-trade bill is dying a slow death. The bill’s introduction in the Senate has been postponed by another month, a clear indicator that it remains well short of the 60 votes needed to pass.
A key problem seems to be that politicians care mainly about their regional constituencies and the impact of cap-and-trade on their state. Article after article discusses the concerns of the Midwestern states relying on coal-fired power and heavy manufacturing. When fuel prices rise as they will under cap-and-trade, the impact on these states will likely be worst. But what of the East Coast Democrats? Are they any better off? Can the party count on their votes?
Ironically, analysis of such regional burdens is relatively scant. The definitive CBO analysis of the Waxman-Markey completely ignored the regional distribution of the burden and focused only on the regressivity of the tax on low-income households. The same is true for the EPA analysis and a recent NBER working paper by Grainger and Kolstad. All these studies confirm our earlier finding that the carbon tax is regressive, but stop short of any analysis of the geographic distribution of the burden.
Our paper (Hassett, Mathur, and Metcalf, 2009), published in the Energy Journal earlier this year, addresses this gap in the literature. Subsequent to its publication, the CBO used our paper as the basis for discussing the regional burden of cap-and-trade. Contrary to conventional wisdom, the paper finds that the imposition of cap-and-trade with 100 percent auctioning would lead to modest differences in average tax burdens across regions. Costs on households would rise, but would be fairly evenly distributed. In particular, the increase in household spending associated with a $15 permit price would range from 1.9 percent of annual income in the East South Central Region to 1.47 percent in the New England region. So yes, the New England senators are better off than others, but not by a whole lot.
However, things are even more complicated than they appear at first glance. The Waxman-Markey bill assumes that in the initial years, permits will be given away free. Over time, however, these free allocations would be phased out, so that by 2035 roughly 70 percent of the permits will be auctioned by the government. In our calculations, we show that the type of initial allocation is critical to determining the distribution of costs across regions. For instance, in most competitive markets, firms are assumed to pass on the higher costs associated with cap-and-trade to consumers in the form of higher prices. This happens whether permits are allocated freely or auctioned to producers, since even free permits have an implicit opportunity cost equal to the price at which they can be traded in the market. However, certain markets, such as the electricity market, are not competitive, but instead operate under cost-of-service regulation. Under regulated electricity pricing, it is unclear how much emitters would be able to increase their prices if they receive freely allocated permits. In this case, producers in regulated regions would be expected to allow their customers to receive the benefit of free allocation, but producers in competitive regions would not.
The consequence is that an asymmetry emerges across regions, which is not tied to the amount of carbon emissions but rather is tied to the nature of electricity-sector regulation. Our results suggest that the impact of freely allocated permits and regulators who don’t pass forward the price of permits is to shift the regional burden from coal-intensive (regulated) states to those states that have moved ahead with electricity deregulation. We can see this by looking at the difference in the total burden with and without free allocation (see chart). The burden with free allocation falls by much more in regions such as the South Atlantic, East North Central, East South Central, and West North Central regions, and much less in the Mid-Atlantic and Pacific regions. In fact, it punishes consumers in those regions of the country that have moved to deregulation.
So under Waxman-Markey, in the initial period of free allocation, the coal-intensive states may be marginally better off than the others. In the long run, however, as auctioning replaces free allocation, that advantage will dissipate.
