CAMBRIDGE, Mass., June 4, 2010 — Environmental concerns drive much of the debate about how to reduce greenhouse gases, but new research by an MIT Sloan expert on climate change has produced a surprising economic finding: Higher energy prices resulting from cap and trade bills before Congress would tend to be progressive by placing a larger cost burden on wealthier rather than lower-income households.
Under the proposed legislation, economy-wide emissions are “capped” and companies that produce emissions must buy or “trade” allowances from businesses with an excess or from a government auction. “Conventional wisdom holds that by raising the cost of energy, policies to price carbon will have a negative effect on everyone,” said MIT Sloan Senior Lecturer John Reilly. “Our research concludes that by itself, pricing carbon tends to be progressive, rather than regressive. The progressive effect is amplified because of how the allowances from [carbon trades] are distributed in the bills.”
Though lower income households spend a large fraction of their income on energy, they also derive much of that income from government transfers, such as social security and welfare payments, that are generally indexed to inflation. As a result, Reilly said, they “are relatively insulated” from the effects of higher prices for energy and goods that use energy. But because wealthier families derive more of their income from wages and capital, they are more adversely affected by climate policy.
In their paper, which will appear in The Berkeley Electronic Journal of Economic Analysis and Policy, Reilly and fellow researchers Sebastian Rausch, Gilbert E. Metcalf, and Sergey Paltsev also compared the regional effects of different climate change policies. In general, states such as Florida, with populations that receive a large share of income from transfers, are less affected than states where household income comes more from wages and capital. States and regions that depend heavily on fossil energy production or host large, energy-intensive industries bear proportionately higher climate policy costs.
While the House-passed Waxman-Markey bill and various proposals now before the U.S. Senate would yield similar overall cuts in greenhouse gases, Reilly, who is also the associate director for research of the MIT Joint Program on the Science and Policy of Global Change, said they differ in how they would distribute revenue from the auction of carbon allowance. “Some proposals have elaborate approaches for distributing allowances,” he said. “They aim the revenue from their auctions to assist low income households and states and regions that are likely to be more negatively affected. Other proposals focus on a cap and dividend approach, where allowance revenue is distributed on a per capita basis, with each household receiving a check. But one way or the other, all of the proposals actually benefit low-income households because the allowance allocation they receive is greater than their increases in energy costs and effects on income.”
These findings “put new information on the table for people to work with,” said Reilly. “Clearly, people were aware of differential household and regional effects. But now policy makers and others have specific numbers they can use to further correct the effects of climate change policies on both households and regions.”