In designing a cap-and-trade program, one of the more controversial and challenging questions for policymakers is how, to whom, and for what purpose to distribute the emission allowances. Concerning the question of how to distribute allowances, policymakers could (1) sell the allowances through an auction process (2) allocate the allowances at no cost to covered sources, (3) provide allowances to non-covered sources, who would, in turn, sell them to covered sources via the emissions trading market, or (4) use some combination of these methods. The strategy would not affect the environmental integrity of the emissions cap. Potential Minimization of Costs on Society

If Congress decides to use an auction to distribute emission allowances to covered sources—as opposed to providing allowances to covered sources at no cost—the auction revenues could be used to substantially minimize the overall costs on society of the cap-and-trade program. Economic studies have found that, if revenues are used in the most economically efficient manner , the overall costs imposed by a cap-and-trade program could be reduced by approximately 50%. Auction Design Issues

Although many of the cap-and-trade proposals in the 110 th Congress would employ an auction to some degree, none of the bills specifies the design of the auction. Policymakers may consider various auction designs . Reserve Price

One issue that arguably transcends auction design considerations is whether or not the auction should have a reserve price, and if so, at what level. However, when covered sources receive allowances at no cost ( Figure 2 ), consumers in price-regulated and competitive regions experience dramatically different price changes. Emission allowances would become a valuable new commodity, potentially accounting—in aggregate—for tens or hundreds of billions of dollars ( Table 1 and surrounding discussion). Policymakers would face a choice between minimizing the costs imposed on the entire economy (society's costs) or using the allowance value for other purposes. The combined costs of these activities are the "compliance costs" of the cap-and-trade program. Options for Allowance Value Distribution

			Provide Transition Assistance to Carbon-Intensive Industries

Several economic studies have estimated the percentage of allowances (a comparable amount of auction revenues could also be used) that would provide compensation for projected profit losses to specific carbon-intensive industries. For example, Congress may decide to allot allowance value to electricity consumers, particularly those in low-income households. Distribution to Support Specific Objectives

Policymakers may also consider distributing a percentage of the allowances or auction revenues to support a range of objectives, including:
Technology development: Promotion of emission mitigation technology is widely recognized as a vital step towards making substantial GHG emission reductions. Energy efficiency: Improvements in energy efficiency could make considerable contributions in achieving GHG emission reductions. Such compensation would forgo the opportunity to reduce the overall cost of the emission program.
When designing a cap-and-trade program, one of the more controversial and challenging questions for policymakers is how, to whom, and for what purpose to distribute the emission allowances. Regarding the method of distribution to covered sources, policymakers could (1) sell the allowances through an auction process, (2) allocate the allowances at no cost to covered sources, (3) provide allowances to non-covered sources who would, in turn, sell them to covered sources, or (4) use some combination of these methods. Although the emission allocation method would not affect the environmental integrity of the cap-and-trade program, the selected allocation strategy could have considerable consequences.
Using auctions as a distribution method could avoid certain concerns that are likely to occur if covered sources receive all (or most) of the allowances at no cost: (1) consumers in different electricity markets may face inequitable price increases; (2) a weak price signal for electricity may be sent in areas with the most carbon-intensive fuel portfolios; and (3) no-cost allowances may overcompensate covered sources. In addition, auction revenues offer a unique opportunity to reduce the overall costs of the emissions program. Several economic studies indicate that if used in the most efficient manner, overall costs could be minimized by almost 50%.
A greenhouse gas (GHG) emission cap-and-trade program would create a valuable new commodity: the GHG emission allowance. EPA estimates that allowance value could potentially account—in aggregate—for tens or hundreds of billions of dollars each year. When distributing this value, policymakers would face a choice between minimizing the costs imposed on the entire economy, minimizing the expected burden on specific parties, or supporting a range of climate- or non-climate-related policy objectives.
For example, Congress may consider providing transition assistance to carbon-intensive industries. Studies have estimated profits could be maintained in the energy production and electricity generation sectors, if approximately 20% of allowances were provided to those sectors at no cost. Members may also consider allotting allowance value to consumers, particularly low-income households, who are expected to bear the majority of the compliance costs via higher energy prices. Another option would involve distributing the allowance value to support various objectives: technology development, energy efficiency improvements, biological sequestration, climate change adaptation efforts, or non climate-related purposes, such as deficit reduction. Of these objectives, technology advancement is arguably the most crucial in terms of mitigation. Moreover, deployment of new technologies could potentially lower the overall costs of the program.
Although many of the proposals in the 110th Congress (e.g., S. 2191, S. 1766, and S. 3036) would employ an auction to some degree, none of the bills specifies the design of the auction. Congress may want to consider including specific design elements in legislative text, particularly auction frequency and whether or not the auction should have a reserve price, and if so, at what level.