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How Would a Federal Cap-and-Trade Climate Policy Affect Profits and GDP?

Aug 2009
Policy Brief
By  Michael Dworsky, Lawrence Goulder, Marc Hafstead

In late June the House of Representatives approved the American Clean Energy and Security (ACES) Act, a federal climate bill sponsored by representatives Henry Waxman (D-CA) and Edward Markey (D-MA). The Senate is now preparing to draft its own climate bill. Many would place good odds on the U.S. enacting a national climate program by the end of the year.

Cap and trade is a central component of the ACES Act and is likely to be a key feature of the Senate bill as well. In the Act’s cap-and-trade provisions, total emissions of greenhouse gases (GHG) from major U.S. sources face declining cap. GHG emissions from covered sources would need to decline by 17 percent relative to 2005 levels by 2020 and by 83 percent relative to 2005 by 2050.

The prospect of cap and trade has raised major concerns about its potential impact on industry profits — especially in industries that supply primary carbon-based fuels (such as coal mining and crude petroleum extraction) and those that use these fuels intensively (such as petroleum refining, electric power generation, primary metals production, and chemical processing).

This policy brief examines the potential profit impacts of a U.S. cap-and-trade program. Drawing on previous analytical and numerical work3, it shows that these impacts depend crucially on the program’s method of allocating emissions allowances (permits). In fact, the method of allocation can determine whether cap and trade causes major industries to suffer significant losses or enjoy large windfalls. This brief also shows that the uses of policy-generated revenues critically affect the policy’s economy-wide costs. We relate these general findings to the specific design of cap and trade in the ACES Act.