Allocation of CO2 Emissions Permits: A General Equilibrium Analysis of Policy Instruments

What are the effects of different ways of allocating CO2 emissions permits under a tradable permit scheme? Numerical simulations show that using the permit revenue to lower existing taxes implies by far the lowest welfare cost but also a large reduction in employment in energy-intensive sectors and substantial stranded costs. Grandfathering the permits compensates owners for losses on stranded investments but comes at a welfare cost and does not mitigate the adjustment imposed on the economy. Finally, distributing the permits according to market shares reduces the degree of sectoral adjustment but also comes at a high welfare cost.