We use economic analysis to evaluate grandfathering, auctioning, and benchmarking approaches for allocation of emissions allowances and then discuss practical experience from European and American schemes. In principle, auctions are superior from the viewpoints of efficiency, fairness, transparency, and simplicity. In practice, auctions have been opposed by important sectors of industry, which argue that carbon pricing without compensation would harm international competitiveness. In the European Union's Emissions Trading System, this concern led to grandfathering that is updated at various intervals. Unfortunately, updating gives industry an incentive to change behavior to influence future allocation. Furthermore, the wealth transferred to incumbent firms can be significantly larger than the extra costs incurred, leading to windfall profits. Meanwhile, potential auction revenues are not available to reduce other taxes. By circumscribing free allocation, benchmarking can target competitiveness concerns, incur less wealth transfer, and provide a strategy consistent with transitioning to auctions in the long run.
[Zetterberg, Lars] IVL Swedish Environm Res Inst, S-10031 Stockholm, Sweden; [Wrake, Markus] Int Energy Agcy, F-75239 Paris, France; [Sterner, Thomas] Univ Gothenburg, Dept Econ, S-40530 Gothenburg, Sweden; [Fischer, Carolyn; Burtraw, Dallas] Resources Future Inc, Washington, DC 20036 USA
Zetterberg, L (reprint author), IVL Swedish Environm Res Inst, Box 210 60, S-10031 Stockholm, Sweden.