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Abstract
A general proposal is made for initially distributing the total value of tradeable
carbon permits in a developed country, which tries to balance allocative and informational
efficiency, political acceptability, and equity. Because of the macroeconomic significance of
carbon, the proposal is quite different from and more complex than, say, the distribution used
for SO2 permits in the US sulphur trading programme.
We suggest that acceptability requires a political (but not legal) principle of compensating for
the profit that an industry loses because of carbon control. However, fossil fuel demand is
relatively inelastic, so making all permits free (grandfathered) to industries while reducing
total carbon use would give them large monopoly profits which would overcompensate for
their losses. Compensation therefore requires only a small proportion (much less than half)
of an industry’s carbon permits to be free. Remaining permits would be auctioned, or given
free to households. If a sizeable part of permits is auctioned with revenues recycled as lower
rates of corporate and/or personal income tax, then most firms outside the fossil fuel
industries would benefit from carbon control, and so need no compensation.
We argue that consumers also deserve compensation for higher prices of fuel and carbonintensive
products. The split of such compensation between lump sums (free permits or cash)
and personal tax cuts depends on the desired balance between equity and efficiency.
Arguments are also discussed for distributing permit value as assistance to workers that face
unemployment caused by carbon control. Many other details of a distribution scheme are
discussed, such as where permits should be acquitted, whether free permits distort
competition, whether foreign-owned firms should get free permits, and whether free permits
should be phased out.