Cap-and-trade, taxes, and distributional conflict

Enacting market-based environmental regulation, such as emissions taxes and cap-and-trade programs, often create rents that are contested by agents. In this paper, we create a framework that compares social welfare from alternative market-based environmental policy instruments under the presence of rent seeking. We show that, contrary to the commonly held view, non-revenue-raising instruments (NRRIs) are in many cases preferable over revenue-raising instruments (RRIs). We find that the choice of instrument depends on the size of a potential revenue-recycling effect and the level of preassigned rents.

► We compare welfare from alternative environmental policy instruments under distributional conflict. ► We show that non-revenue-raising regulations often dominate revenue-raising instruments. ► Instrument choice depends on the size of a revenue-recycling effect and levels of preassigned rents.