Distributional Impacts of Carbon Pricing Policies in the Electricity Sector

The introduction of a price on carbon dioxide will have important effects on the U.S. economy, and especially important effects on the electricity sector, which currently accounts for about 40 percent of carbon dioxide emissions. This paper examines alternative approaches to the distribution of allowance value to the sector, including free allocation to consumers through electricity and natural gas local distribution companies (LDCs). Recent proposals in the U.S. Congress, including H.R. 2454, have suggested this option as a way to address impacts on consumers and potential regional inequities. We compare allocation to electricity LDCs with a system in which allowances are auctioned and revenues returned to households as a per capita dividend. We evaluate the outcomes under alternative assumptions about how LDCs, which are regulated entities, pass through the allowance value to final residential, commercial, and industrial customers. Our results show that the LDC approach raises the price of allowances and imposes greater costs on households than the per capita dividend option. We also evaluate a more complete characterization of H.R. 2454 and show that an incremental reform to that bill would greatly reduce costs and have more balanced impacts across households in different income groups and regions.cap and trade, allocation, distributional effects, cost burden, equity, regulation, local distribution companies

Regulating unverifiable quality by fixed-price contracts

We apply the idea of relation contracting to a very simple problem of regulating a single-product monopolistic firm when the regulatory instrument is a fixed-price contract, and quality is endogenous and observable, but not verifiable. We model the interaction between the regulator and the firm as a dynamic game, and we show that, provided both players are sufficiently patient, there exist self-enforcing regula- tory contracts in which the firm prefers to produce the quality man- dated by the regulator, while the regulator chooses to leave the firm a positive rent as a reward to its quality choice. We also show that the socially optimal self-enforcing contract implies a distortion from the second best, which is greater the more impatient is the firm and the larger is the (marginal) effect of the contractual price on the profits the firm would make by deviating from the offered contract. Whenever the punishment profits are strictly positive, even if the firm were infinitely patient, the optimal contract would ensure a Ramsey condition but with positive profits to the firm. Our result also illustrates that, whenever the firm's output has some unverifiable component, optimal regulatory lag in fixed-price contract should be reduced to limit the reward of the firm's opportunistic behaviour.Quality regulation, relational contracts

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