A System of Emission Rights Auction With Revenue Plowback

This paper demonstrates that “grandfathering” of pollution rights may be inefficient when existing polluters enjoy market power or when there are increasing returns to abatement efforts. On the other hand an “auction and refund” approach, by effectively charging producers for the pollution they cause and refunding them in proportion to the value of their economic output levels, will result in greater efficiency and equity. Moreover, this will resolve the possible complaint that a revenue-raising auction constitutes a “taking” of private property, and will address the worry that emission rights auctions may lead to higher electricity prices. It is argued that thin trading of emission rights need not undermine the value of the emission rights auction.