Transportation Research Part A 45 (2011) 10521065

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Transportation Research Part A

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Personal tradable carbon permits for road transport: Why, why not and who wins?
Zia Wadud *
Department of Civil Engineering, Bangladesh University of Engineering and Technology, Bangladesh

a r t i c l e

i n f o

a b s t r a c t
Personal road transport sector poses a signicant challenge in reducing carbon emissions. This paper evaluates a policy approach known as personal tradable carbon permits to reduce carbon emissions from personal vehicles. The policy is a downstream tradable permit where individuals are allocated carbon emission caps. The policy is qualitatively evaluated in the context of carbon taxes and some upstream tradable permit options. The biggest disadvantage of such a policy is the initial set up costs. Personal tradable permits, however, are more effective than carbon taxes and are also capable of stabilizing the gasoline prices faced by the consumers when the underlying oil prices uctuate. Since equity effects are often a concern to policy makers, the effect of such personal carbon permits on the distribution of burden is quantied in a partial equilibrium framework for the US population. Different permit allocation strategies are investigated in this regard. Using US consumer expenditure survey data, and incorporating a differentiated price response for different households, we nd that all three allocation strategies considered are progressive: a per adult based allocation is the most progressive, a per vehicle allocation nearer to proportional, and a per capita allocation in between the two. Personal tradable permits therefore take care of equity concerns directly through the design of the policy. 2010 Elsevier Ltd. All rights reserved.

Keywords: Personal tradable carbon permits Road transport Carbon emissions Climate change policy Equity Fuel demand elasticity

1. Introduction One of the major drivers of growth in the emissions of greenhouse gases, both in developed and developing countries, is the growth in transport activities. Since the transport sector is almost entirely reliant on petroleum, a major source of carbon emissions, emissions from transport are also increasing. Transport represented 23% of global energy related carbon emissions in 2004 (IEA, 2006). In the OECD countries, transportation was the fastest growing source of GHGs between 1990 and 2002, in the non-OECD countries it was the second fastest (Stern, 2007). In the EU27 and North American countries, personal vehicles are responsible for 60% of total on road transport emissions. The US light duty eet alone emits more carbon than any other country in the world, except China (Greene and Schfer, 2003). Therefore any signicant effort to reduce carbon emissions will need to address personal road transport sooner or later. With recent suggestion that an 80% reduction in carbon emissions is required to stabilize the climate system (Stern, 2007), it is more likely to be sooner than later that personal road transport sector shoulders its share of the reduction responsibility. This paper looks into the application of a new policy tool, personal tradable carbon permits to reduce carbon emissions from personal vehicles, and places it in the larger context of other policies. Although tradable permits are a popular concept in climate change mitigation policies, personal carbon trading is a relatively new concept in transportation arena. Since the

* Tel.: +880 2 9665650x6040. E-mail addresses: ziawadud@ce.buet.ac.bd, ziawadud@yahoo.com 0965-8564/$ - see front matter 2010 Elsevier Ltd. All rights reserved. doi:10.1016/j.tra.2010.03.002

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political acceptability of a policy largely depends on the public acceptability, which is often dictated by the distribution of burdens among the population (Mayeres and Proost, 2004), distributional aspects of such personal tradable permit policies are also analyzed for the US personal vehicle sector. Section 2 of this paper discusses various policy options to reduce carbon emissions from the personal road transport sector. Section 3 describes the personal tradable permit policy while Section 4 discusses the advantages and disadvantages in the context of some other policies. Section 5 carries out a distributional analysis for different permit allocation strategies in the USA. Section 6 draws conclusions.

2. Policy options Carbon emissions from the transport sector can be expressed through the following identity (IEA, 2000):

Emissions Trav el activ ity Mode share Mode fuel intensity Fuel carbon intensity

Various policies addressing different elements of the right hand side of Eq. (1) can be devised to bring about a reduction in carbon emissions from the vehicles. Therefore there can be different policies that can directly or indirectly contribute to reduce carbon emissions from personal vehicles. Examples include road pricing, parking charges, trafc calming, speed limits, trafc management, expansion of public transit networks and frequencies, fees for vehicle acquisition, fee bates, fuel economy or carbon emission standards, emissions standard trading, gas guzzler taxes, land use planning, media campaigns, etc. (IEA, 2000; Galagher et al., 2007). Many of these policies affect carbon emissions indirectly (e.g. road pricing and parking charges discourage use of vehicles, and thus can lower emissions; trafc management, trafc calming and speed limits reduce emission rates during driving; expansion of public transport encourages mode switching, etc.). All of these policies, individually or in combination, help reduce emissions from the personal vehicles, but none of these can guarantee an absolute cap on emissions. For example, the most commonly adopted policy tool to reduce emissions and fuel consumption (important for oil security) is vehicle fuel economy or carbon efciency standards.1 Vehicle fuel economy standards will make the vehicles more fuel and carbon efcient, yet there is nothing that limits total travel since total travel activity can increase simply with an increase in population.2 At the same time modal share of vehicles may increase for other reasons, again rendering uncertainty about the total emissions. Targeting individual elements on the right hand side of Eq. (1) works only if the other elements do not change. Therefore, unless there is a blanket of policies that ensures that each of the right hand side elements does not deteriorate in performance, a target absolute reduction in carbon emissions from the personal vehicles cannot be achieved. One of the disadvantages of addressing the right hand elements individually (even combining a few them in one package) is that the exibility of a system wide efciency gain is lost. For example, by focusing on fuel economy standards alone, a policy forces every buyer to buy a more fuel-efcient vehicle (for a higher price, in general), whereas, some drivers may have opted to change mode or reduce driving to shoulder his share of responsibility in cutting emissions. Forcing every vehicle manufacturer to face the same emission standard can also increase the total cost in the production side since the cost of meeting the emission standards are different for different manufacturers. It may also be more cost effective to change fuel composition to include more renewable fuel into the petroleum mix than changing fuel economy standards of the vehicles, or vice versa, but setting a target standard for vehicles or target volume for renewable fuels to be put into fuel mix can be inefcient, cost wise. Another policy approach, known as the market based approach, which ensures that emissions are reduced at the least cost, sets a price for the emissions and addresses the left hand side of Eq. (1) directly. Two such approaches are the carbon tax or the tradable permits. Essentially both policies make emissions more expensive and set a price for it. A tax policy xes the price of emissions and lets the market decide the quantity emitted, whereas a tradable permit policy xes the quantity emitted and lets the price of emissions to be decided by the market. These policies can benet from a system wide efciency gain since all the actors who can contribute to any of the elements on the right hand side will have a motivation to alter their behavior. For example, a driver will have an incentive to reduce driving or change mode if it costs less, a vehicle manufacturer will have incentive to produce more fuel-efcient vehicles, since drivers will demand more fuel and carbon efcient vehicles (because it lowers fuel and emissions cost. Also, a fuel supplier will have an incentive to add more renewable fuel to its supply mix since renewable fuels will have a lower emission price because of a lower carbon content and therefore have a higher demand than conventional petroleum. We limit our set of policies to market based approaches, with vehicle fuel economy regulation as a non-market based approach, because of continued interest in the policy arena for tightening CAFE standards. In the application of a carbon tax on fuels, the regulator has to know a priori the appropriate tax level to achieve a reasonable amount of certainty in emission reductions, which is difcult. Tradable permit approach, on the other hand, does not have this limitation (Stavins, 1995). There are different variants of policy proposals on the table to utilize the cost-efciency aspect of tradable permits, e.g. emissions standard, fuel economy standard or lifetime carbon burden trading among the vehicle manufacturers, or carbon trading among the transport fuel suppliers. In the emission or fuel economy standard trading,
e.g. CAFE in the USA, voluntary agreement in the EU. EU is considering a mandatory emissions standard as well. Improving fuel economy is an interesting example, since a part of fuel economy improvements may be lost through more driving since improved fuel economy reduces the per mile cost of driving. This is known as the rebound effect.
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manufacturers will be given a target emission standard, and they can trade amongst themselves if they fail to achieve the standard or reach a standard above what is mandated. Lifetime carbon burden trading refers to allocating a cap of carbon emissions from all new vehicles sold by a manufacturer and allowing them to trade. Trading among fuel suppliers would restrict the suppliers to a xed amount of carbon emissions, encouraging renewable fuels to enter the fossil fuel mix for driving. The increase in production costs would be passed onto the consumers, increasing the price of fuel, acting as a carbon tax to the consumers and thus possibly will create some indirect incentive among consumers to alter their travel behavior. 3. Personal tradable permits Both the tradable permits approaches mentioned above do not provide a direct incentive to the actual carbon emitters, i.e. the households, to reduce their emissions. A tradable permit system for individuals, where every individual will have their own allocation of carbon emissions, will provide a direct incentive to the emitters to reduce their emissions and share the burden of emission reduction. The allocated permits can be held electronically in a card and are deducted when purchasing fuel in proportion to the fuel carbon content. People can buy or sell permits depending on whether their demand is above or below the allocated amount. Such transactions can be carried out under the platform of a centralized agency like the government, stock exchange or banks, but through many outlets like automatic teller machines (ATMs), top-up shops, gasoline retailers and the internet.3 The price of the permits will depend on the total number of permits available in the market and the demand for them. Thus, anyone for whom the cost of not driving is more than the market price of the permits will buy permits, whereas, others who feel that the market price of permits is higher than their cost of foregone travel, will have an incentive to sell. The extra price of the permits will increase the real price of fuel and will act as an incentive to the users to be less emission intensive in their travel patterns. The rise in real price of carbon intensive fuel will also increase demand for more fuel-efcient vehicles and for less carbon intensive fuel, thus providing incentive to the players on supply side to alter their product mix and engaging a system wide response.4 Such a downstream, personal level allocation strategy has not been not discussed in the literature until recently, presumably because it would involve a large number of allocation units, households or individuals and it was deemed impossible to administer. Personal tradable carbon permits were rst discussed by Fleming (1997) for household energy use,5 followed by Barnes (2001), Fawcett (2004), Starkey and Anderson (2005) and Niemeier et al. (2008). The UK government also has stated its intentions of investigating personal level carbon trading as a serious long term option to reduce carbon emissions from households (Miliband, 2006). In the road transport sector, the use of tradable permits was rst discussed in Verhoef et al. (1997). They discuss various schemes for downstream trading strategies to reduce externalities associated with road transport, and suggest that tradable fuel permits are amongst the most promising options.6 Subsequently a few more studies appeared, e.g. BTCE (1998), Dobes (1999), Crals et al. (2003), Raux and Marlot (2005), Watters et al. (2006), Wadud (2008) and Wadud et al. (2008a). In the USA, Feldsteins (2006) proposal of tradable gasoline vouchers is also similar to the tradable permit proposal for personal road transport. 4. Evaluation of personal tradable carbon permits In evaluating any policy proposal, it is important to emphasize the performance with respect to efciency, effectiveness and equity (Nordhaus and Danish, 2003). Formulating a policy that incorporates all three components is not always feasible: emphasizing one may undermine another. Therefore, compromises often become necessary in policymaking (Stavins, 1998). Below, we evaluate personal tradable permits with respect to cost efciency, effectiveness, equity and few other criteria and compare it with other policies. 4.1. Cost efciency The market based policy options of carbon taxes and tradable permits perform the best in terms of cost efciency. Although, theoretically taxes and permits are equivalent, there are important differences in application. Taxes can raise revenue, which can be recycled back to the consumers through reducing income taxes, thus lowering the economic burden of the tax and increasing welfare. This is also possible theoretically to raise revenues by auctioning the permits, i.e. selling the permits to the highest bidders. Yet, BTCE (1998) reports that recycling large revenues back to individual transport users through general government services and expenditures may not be optimal, a view shared by Starkey and Anderson (2005) as well. Personal tradable carbon permits, on the other hand, can have signicant transaction costs associated. The transaction costs can arise in the tradable permit market because of searching and collecting information, bargaining and decision making, and monitoring and enforcement (Stavins, 1995). The presence of transaction costs reduces revenue received by
3 4 5 6

Such trading oors already exist for businesses e.g. the European emission trading, the Chicago climate exchange. Note that a carbon tax has all these benets as well. Koutstaal (1996) also discusses carbon permits for households, but in his proposal trading occurred between rms, not households. Verhoef et al. (1997) consider all externalities, not only climate change externalities.

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the seller and increases the price for the buyers, thus suppressing a potentially benecial volume of trading that would have happened if there were no transaction costs (Stavins, 1995). The costs that affect the direct decision of the carbon emitters are search and information collection related costs and bargaining and decision making costs. These could be signicant in an upstream trading system, e.g. emissions standard trading between vehicle manufacturers or carbon trading among fuel suppliers, since the number of rms trading is reasonably small (Woerdman, 2001). It could be difcult to nd a trading partner and the market prices may not be readily available. On the other hand, the costs of trading decrease as the number of traders in the market increases (Nentjes et al., 1995; Stavins, 1995). The level of these costs critically depends on the ease of availability of low cost information and trading partners. The costs of nding a trading partner decreases as the number of participants in the market increases. It would also lead to frequent transactions, reducing uncertainty about the prices. A market of 117 million households or 292 million people in the USA would also have prices more readily and publicly available. All these factors would potentially lower the transaction costs associated with a personal carbon trading. The monitoring, administrative and enforcement costs, which are typically borne by the government (Stavins, 1995; Woerdman, 2001), could be large for personal carbon trading. Since monitoring and enforcement costs would increase with the number of entities monitored, and emissions from a large number of households need to be monitored for personal carbon trading, these costs will generally be high, increasing total transaction costs. However, monitoring of carbon emissions can be easier as compared to other pollutants where tradable permit approach has been previously implemented, since fuel usage can be monitored instead of carbon emissions. Also, enforcement and monitoring can be simplied if gasoline retailers are allowed to sell fuel to permit holders only (Verhoef et al., 1997). Since there are still a large number of gasoline retailers (as compared to fuel producers and reneries), there would be a large number of points to monitor in this case as well (although much less than individual households). It is also possible and more attractive from monitoring point of view if fuel sales are monitored at producers and distributors level as suggested by Koutstaal (1996). This way every fuel distributor has to show permits to the enforcement authority for every unit of fuel sold to downstream users, which should lead to a selfenforcing downstream monitoring automatically. Since monitoring can now takes place among the smaller number of reneries/distributors, the costs of monitoring can be substantially reduced. Thus, a personal level carbon permit trading along with monitoring of fuel use among producers/distributors may bring down the transaction cost signicantly. Note that emissions trading among fuel suppliers or standards trading among manufacturers will not provide a direct incentive to the primary emitters of carbon, the households, and thus may not reap the full benet of mitigation and adaptations possible through system synergies. A carbon tax, on the other hand, involves much less administrative costs, especially since there is a tax collection system already in place, and therefore has cost efciency advantage over tradable permits.7 4.2. Effectiveness The advantage of a carbon tax over tradable permits erodes when the effectiveness of the policy is taken into consideration. For a carbon tax to be effective in producing an absolute cap or reduction on emissions it is necessary to know a priori the tax rate, which is not possible. Another disadvantage of gasoline or carbon taxes is that there are other factors that can increase households travel activities by road transport and thus consumption of gasoline and emissions of CO2. One of these is increasing income, which results in more driving and higher emissions (Graham and Glaister, 2002; USEPA, 2007). An increase in population or vehicle ownership will also increase the total travel activity and accompanying consumption of fuel and emissions of carbon. Thus a carbon tax will not be able to provide certainty in emissions reduction. National Research Council (2002) also argues that a price signal (i.e. tax) does not provide enough incentive in the personal vehicle market, since consumers do not base their vehicle purchase decision on life-time fuel or carbon savings from the vehicles. A tradable permit policy, on the other hand, ensures that the emission cap (target emission by the policy maker) is always maintained, in spite of increases in income, population, or vehicle ownership. Any upward push in the demand for more gasoline would simply increase the price of permits by keeping the total consumption constant (Tietenberg, 2002).8 Crals et al. (2003) also argue the road users are more sensitive to a quantity signal than to a price signal as in a tax policy. Distributing permits among fuel suppliers provides the incentive to consumers through only price signal. A tax policy is clearly susceptible to the world oil price in its effectiveness. The pre-tax price of gasoline could collapse severely, as seen after the oil price increases in 19992000, which would wipe out any benet from a tax policy (Raux, 2004). A fall in the world oil price and thus pre-tax price of gasoline would reduce the market price of gasoline, despite the tax, rendering the optimum price to ensure the target reduction unattainable. Fig. 1 explains the fall in world oil price and its effect on the effectiveness of a gasoline tax policy through a demand curve of gasoline which proxies as the demand curve for carbon emissions from vehicles as well. In the absence of any taxes, the retail price borne by the consumer is the world crude oil price (and renery and transport costs, which we assume remain the same, to keep it simple) CP1. The quantity demanded at this price (CP1) is Q1. t1 is the tax rate required to bring down the consumption to Q2, the policymakers
An economy wide tradable permit or carbon tax will be more efcient in reducing emissions, however, the focus of this paper is road transport sector alone. To some extent, this can be compared with the fuel tax escalator in the UK, where the tax on fuel increased every year till 2002 by the rate of ination such that the effective tax rate remains the same. In the USA, on the other hand, the nominal federal tax rate has been constant since 1993 (Parry, 2002). Since income has been rising, the effective tax rate is in fact declining in the USA.
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Fig. 1. World oil price and price faced by the consumers in a carbon tax scheme.

target reduction. The combined price faced by the consumer is MP1. If the world price of crude oil and thus the pre-tax price of gasoline falls to CP2, the market price for the tax policy is MP2, which is the sum of CP2 and t1, the tax rate. The demand for gasoline is Q3, which is clearly less than the policymakers intended reduction of Q2. For a declining crude oil price, a tax policy would therefore fail to fulll its most important objective: to effectively reduce gasoline consumption and CO2 emissions from vehicles.9 For a rising crude oil price, on the other hand, a carbon tax becomes more stringent (crude oil price CP3 leads to combined price MP3, leading to a reduction up to Q4, which is more reduction than target Q2) than intended by the policy maker. This becomes inefcient, broadly speaking, since more carbon is reduced from the transport sector than intended.10

4.3. Equity One of the arguments against carbon taxes on motor fuels is that it could affect poorer households in a disproportionate way. Santos and Rojey (2004) mention that an efcient and effective policy may still be undesirable and unacceptable due to concerns about the distributional effects of the policy, especially the effect on the poor. Mayeres and Proost (2004) also argue that a policy maker may prefer to sacrice some cost efciency gains in order to obtain a more even distribution of welfare or policy induced burdens.11 Distribution of burdens may serve as a proxy for public acceptance as well (Mayeres and Proost, 2004). It is also argued that the failure to impose the BTU tax in the USA by the Clinton administration was due to unfair burdens on selected industries or households (Morgenstern et al., 2002). Because of the importance of distribution of burdens, we evaluate the equity effects of a personal tradable carbon permit separately in Section 5, but put it in the context of other policies here. Several studies in the United States (Casler and Raqui, 1993; Sevigny, 1998) have conrmed that a gasoline tax disproportionately burdens impoverished households (i.e. is regressive), as they spend a larger portion of their income on gasoline than wealthier households, although this view has now been contested since poorer households may not own a vehicle and may not use gasoline at all. Within vehicle owning households, however, carbon taxes for fuels are more likely to be regressive than not. On the other hand, if the initial permits are allocated freely to the upstream fuel suppliers, then there is signicant windfall gain to them. Since the shareholders of the rms are from among the richer section of the community, much of the benets of the free allocation will be directed toward them (Parry, 2004). Such an unequal distribution may not be desirable from a policy makers perspective. A tradable permit system involving vehicle emissions standards or lifetime carbon emissions among the vehicle manufacturers is slightly different. Such an emissions trading policy would depend on average imputed emissions for the manufacturer instead of real emissions (Winkleman et al., 2000). Since, the extra cost incurred by the producer to develop the fuel-efcient vehicles or to buy the emissions permits for their vehicles will generally be passed onto consumers, every consumer of the new fuel-efcient vehicles will have to bear equal burden in terms of the increased vehicle price of the new vehicles. This implies that users of older, less fuel-efcient vehicles will continue to pay nothing despite possibly polluting more than the new vehicle owners. New, more fuel-efcient vehicle buyers would therefore be subsidizing the emissions from the users of old vehicles through higher vehicle prices. Similarly, those driving less and thus polluting less would be subsidizing those driving more since the initial calculations were done on an average basis. This is in direct violation of the polluter pays principle which is widely followed in designing environmental policy. Thus, a permit trading policy among vehicle manufacturers has distributional consequences that may not be acceptable as a social norm.
9 This simplied diagram, however, does not consider that the price of crude oil may change in response to lower demand resulting from a tax or permit policy. 10 Note that the reduction still takes place cost-efciently. 11 High labour taxes are a good example of such a tradeoff. They are a major source of economic inefciency, yet they nd their justication in equity concerns.

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Fig. 2. World oil price and price faced by the consumers in a tradable permit scheme.

A downstream policy where permits are allocated to households or individuals provides direct incentives to vehicle users to alter their emissions behavior. The gain or loss from such a downstream allocation is directly proportional to the emissions and such an allocation upholds the polluter pays principle as well. There is also strong philosophical justication in favor of a downstream per capita allocation of carbon permits, which is a downstream allocation strategy (Starkey and Anderson, 2005). 4.4. Acceptability In addition to the distributional concerns, there is a natural resistance against the revenue raising policies. US experience indicates that taxes as an instrument of energy and environmental policy have not been accepted by the public or the Congress in the USA (Nordhaus and Danish, 2003). Hammar et al. (2004) observes that increasing motor fuel tax is politically very difcult to implement, especially in countries with low prices and high demand, such as the USA.12 In addition, as Nordhaus and Danish (2003) argue the major problem with a GHG tax is that it is a tax. Auctioned permits for individuals will possibly be equally difcult to implement. Tietenberg (2001) sums up the general attitude: the historical answer (to the question of implementing revenue raising policies) is clearly No. Thus, a carbon tax or an auctioned permit system can have signicantly lower public acceptance (Crals et al., 2003). Because of the inelastic response of consumers to a price signal,13 the carbon tax required to bring about a change in consumption and therefore emissions will be high, generating further opposition. Although, theoretically, carbon taxes can be recycled lump sum to the household to generate the exact same effect as a personal tradable permit, taxes do not have the same direct appeal as tradable permit since the return will most possibly be linked with some other form of payment (tax return, etc.) and may lose visibility. Also, Watters et al. (2006) conducted a small survey to report that consumers in the UK prefer a tradable permit approach where individuals are allocated permits freely, to a fuel price increase through increased taxes. To our knowledge, this is the only survey to have been conducted about the relative acceptability among the two policies.14 4.5. Freedom of choice The government of the UK argues that a downstream policy among individuals or households would empower the people more than an upstream policy through providing them with a direct choice in reducing emissions (Miliband, 2006). In an upstream policy, households do not have any direct inuence on the behavior of the upstream rms (fuel retailers or vehicle manufacturers), since the producers are directly given the emission target. For example, standards or lifetime carbon emissions trading among vehicle manufacturers, an upstream policy, does not allow consumer demand to dictate their vehicle sales mix. A carbon tax or personal carbon permit policy allows the households to choose between various options among the right hand side of Eq. (1) to reduce their emissions, giving them a greater freedom. The personal permits, however, have another potential advantage over carbon taxes. Once set, individuals do not have any inuence on setting the carbon tax. On the other hand, in a personal permit system, environmentally conscious households or individuals can also withhold their permits from the market or sell their permits to environmental NGOs (who would then retire them), thus reducing the availability of permits and further reducing the total emissions (Ahlheim and Schneider, 2002, call it the warm glow effect). This
12 There is signicant public opposition to raising fuel taxes in Europe as well, where the existing fuel taxes are already high (e.g. in the UK the gasoline tax is seven times higher than that in the USA, Parry and Small, 2005). There is a limit to increasing fuel taxes further, as evident by the tax revolt in some of the European countries in 2000 (Raux, 2004). 13 Demand elasticities for gasoline, and therefore elasticities of carbon emissions from vehicles, is 0.4 in the long run (Wadud et al., 2008b), Hughes et al. (2007) argue that demand elasticity in the short run could be as low as 0.05. 14 The RSA Carbon Limited (www.rsacarbonlimited.org) has recently conducted another survey on personal carbon permits (for households), but the results are not available yet.

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way, individuals may have more inuence in setting the emissions target. Starkey and Anderson (2005) also argue that households can trade amongst only the people they want to, again giving them more choice.15 4.6. Buffering gasoline price One of the biggest advantages of a personal tradable permit approach over carbon taxes is the buffer it provides between sudden rise or fall in the price of oil in the world market and domestic gasoline retail price.16 If the world oil price increases, the price of the permits would fall, since the demand for gasoline at the increased price would be less. Thus the total amount (price of pre-tax gasoline + price of permits) paid by the consumer would remain the same. In Fig. 2 the world oil price is CP1, with targeted reduced demand of Q2 generating a permit price of t1 and total perceived price of MP1. Even if the world price of oil rises to CP3, the target demand by the policymaker still remains Q2, which occurs at a combined price of MP1 as before, which is now sum of CP3 and t3, allowing the permit prices to fall. For a falling price in the world market, CP2, the permit price will adjust to become t2, while the total price faced by the consumer still remains MP1. On the other hand, if a carbon tax was enacted, the total price would be MP2 or MP3, which is the sum of CP2 or CP3 and t1, the initial tax rate (Fig. 1). Thus, a carbon tax would make the retail price exactly follow the price of oil in the world market, whereas a tradable permit would provide a buffer to consumers.17 The long term signal for a sustained high total price of fuel is clearly maintained in tradable permits despite a lowering of fuel price in the world market. 4.7. Administrative feasibility One disadvantages to personal carbon permits arises from the huge administrative effort required to set up the system initially. While the organizational and monitoring challenges will be signicant, the technology already exists to carry out the permit trading through electronic medium. Almost all fuel retailers are familiar with electronic transaction through credit cards. As argued earlier, monitoring can take place among the retailers or even higher up the chain, reducing the monitoring burden. Essentially, the issue of administrative feasibility becomes a question of cost-efciency, as discussed earlier.

5. Distribution of burdens In the absence of direct surveys asking people about their preferred policy option, distribution of burdens from a policy may act as proxy for public acceptability. Equity concerns are also important, and may override economic cost-efciency concerns (e.g. income tax) arising from a policy. We therefore specically analyze the distribution of burden from a personal tradable permit policy. We focus on the distribution of burdens resulting from a hypothetical 15% reduction in carbon emissions, and, since carbon emissions are directly related to fuel burn, a 15% reduction in gasoline consumption from personal vehicles in the USA.18 5.1. Allocation strategy Most proposals for downstream tradable permits have placed an emphasis on a free per capita based allocation. The philosophy behind the allocation of the permits is an important issue, especially in terms of perceived fairness of the policy to the public, and therefore warrants some discussion. If allocated free, permits are seen as property rights (Pezzey, 2003): everyone has equal right to the environment and thus the permits are given to everyone whether they drive a vehicle or not. The House of Commons Environmental Audit Committee (2005) in the UK also observes it is difcult to argue with the fundamental principle of equal per capita emissions. In addition to evaluating a per capita allocation, we also investigate per adult based allocation to account for the fact that children do not have same travel need as adults. Alternatively, a VMT based allocation is also possible, where the permits are allocated according to past travel activity. The right to pollute lies with current polluters and larger polluters are actually rewarded for their higher pollution through higher allocations. Another possibility is a per vehicle based allocation, again awarding emission rights to vehicle owners. These allocations also create an entry barrier to existing non-vehicle owners, since new vehicle buyers do not get a share of free permits initially. The allocation therefore may not be equitable from the distributive justice point of view (Dobes, 1999). Note that a carbon tax, auctioned permit or upstream allocation among fuel suppliers all implicitly give the right to emit to those who have higher buying power. We still evaluate a per vehicle based permit allocation, since it could be easier to monitor and could have greater support among vehicle owners.
15 Note that trading among selected partners, withholding or retiring permits will potentially increase the carbon price from the theoretically minimum one, making the policy less cost efcient. 16 The buffer advantage of tradable carbon permits is mentioned in an online discussion forum for personal carbon trading http://leiterreports.typepad.com/ blog/20060/07/personal_carbon.html. 17 Note that a variable carbon tax can offer the same exibility. 18 In Europe, diesel has a higher share and the carbon emissions from diesel and gasoline need to be differentiated.

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1600

Frequency of households

1400 1200 1000 800 600 400 200 0 -1.4 -1.2 -1 -.8 -.6 -.4 -.2 0 .2 .4

Price elasticity
Fig. 3. Distribution of price elasticities for the sample households.

5.2. Welfare model A partial equilibrium analysis, where only the direct effects of reduced gasoline consumption or carbon emission is considered, is carried out to measure the loss in consumer welfare in the USA.19 The partial equilibrium approach directly allows the incorporation of a demand curve for gasoline consumption or carbon emissions. For a target reduction, the corresponding price for the carbon permits (T) can be determined from the aggregate demand curve. Once the price of permits (T) is determined, the post-policy price of gasoline faced by individual consumers becomes P2i (=pre-policy price P1i+T). Post-policy fuel consumption (G2i) for households can then be found by substituting the new market price P2i into the individual demand equations of the households (subscript i refers to households). Finally, with P2i, G2i, and price elasticity (bPi) known, the loss in welfare are calculated using loss in consumer surplus. Added to this loss is the free allocation of permit, which generates a gain in welfare (Gi T), where Gi is the allocated permits depending on the allocation strategy discussed in Section 5.1. A log linear demand specication, as is common in gasoline demand models, gives rise to the following expression for the change in consumer surplus due to personal tradable carbon permits.

P1i G1i DCSi 1 bPi

P2i 1 P1i

1bPi )

Gi T

5.3. Demand model The changes in welfare are directly dependent upon the demand for gasoline or carbon for different households. The price elasticity of demand could be different for different households depending on their location, income, vehicle ownership, family composition, etc. In order to incorporate the variations in demand responses among different household types, we follow a household demand model by Wadud et al. (2008b). Wadud et al. (2008b) used US consumer expenditure survey micro data for years 19972001 to estimate an econometric model for gasoline demand for different households. They accommodated the variations of price and income elasticities by interacting socio-economic variables with price and income. They found that the price response of households decrease with an increase in income. Rural households are less price elastic because they have fewer alternatives to driving. Households with multiple vehicles are more price elastic, possibly because they can switch to a more fuel-efcient vehicle easily. Households with multiple earners are also more price elastic, possibly as a result of the ease to ride share. 5.4. Data We used a micro dataset from the consumer expenditure survey in the USA for year 2002 (US Department of Labor, 2006) to understand the distribution of burden among the households. The consumer expenditure survey data contains information on family size and number of vehicles in a household which we require to determine allocations to each household and total expenditure of each household in a quarter, which we use as a proxy for income. The survey also reports households gasoline expenditure which can be converted to gasoline consumption by using gasoline price data from the USEIA (2006).
19 By following partial equilibrium, we neglect any effect on labor market, which could be substantial. Also a better metric for welfare change would have been mobility instead of gasoline consumption.

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Table 1 Ratio of mean welfare change to income (expenditure) for different deciles. Per person basis With car No car All 2.740 1.169 0.520 0.091 0.082 0.202 0.359 0.320 0.356 0.247 0.557 Per adult basis With car 2.057 0.908 0.354 0.000 0.119 0.271 0.374 0.342 0.386 0.256 No car 4.063 2.284 1.689 1.148 0.830 0.660 0.382 0.421 0.276 0.043 All 2.838 1.214 0.518 0.102 0.067 0.232 0.348 0.322 0.372 0.250 0.881 Per vehicle basis With car 0.986 0.354 0.143 0.051 0.056 0.110 0.177 0.157 0.182 0.063 No car 0.486 0.453 0.485 0.550 0.614 0.540 0.651 0.424 0.408 0.342 All 0.413 0.175 0.066 0.096 0.087 0.128 0.193 0.164 0.187 0.068 0.132

Ratio of mean welfare change to expenditure (%) Decile 1 2.016 3.876 Decile 2 0.831 2.352 Decile 3 0.350 1.737 Decile 4 0.009 1.110 Decile 5 0.126 0.689 Decile 6 0.239 0.652 Decile 7 0.381 0.281 Decile 8 0.338 0.362 Decile 9 0.368 0.239 Decile 10 0.252 0.005 Progressivity

We used Wadud et al. (2008b) parameters to predict the price and income elasticities of all households present in year 2002 consumer expenditure survey. This enables the assignment of a unique price and income response to every household in the sample. The resulting frequency distribution of price elasticities is presented in Fig. 3. These elasticities are interpreted as medium to long run. The median and mean of the distribution are 0.473 and 0.469, generating a fairly symmetric distribution. 5.5. Other modeling issues In any distributional analysis, often the primary concern is vertical equity, where burden among dissimilar groups are compared. Also known as social justice, vertical equity aims is to differentiate people with respect to their dissimilar wealth or ability. Policies are generally designed such that the higher income groups shoulder more of the burden than the lower income groups (e.g. income tax). Horizontal equity, on the other hand, refers to the distribution of the burden within households of similar ability or wealth. The principle of fairness dictates that household of similar nancial means should bear similar costs of the policy. We dene similar or dissimilar groups through household income, as proxied by expenditure. We focus on deciles of income to dene the dissimilar groups and analyze the vertical equity among them. At the same time, we analyze the horizontal distribution of burden within each of these groups. In addition, we briey investigate groups dened by some socio-economic characteristics. In order to determine households of similar state of wealth or well-being, we prefer to use a doubly parametric equivalence scale (Cutler and Katz, 1992) to convert household income to equivalent income and then rank the households according to the equivalent income. This takes into consideration the economies of scale for a larger family and the lower consumption needs of the children in a family.20 5.6. Distribution analysis 5.6.1. Permit prices It is difcult to generate an aggregate price elasticity from the distribution in Fig. 3 since households face different prices and in the econometric model, the price elasticities are functions of prices. Instead, we use an iterative approach to determine the permit price resulting in a 15% aggregate reduction in emissions. This results in a carbon permit price of US$ 0.627 per gallon gasoline equivalent of carbon. This corresponds to a carbon price of US$ 260 per ton. The very high price is a direct result of rather inelastic nature of gasoline demand in the USA. We, however note that the permit prices could be lower if the expectations of a better long term signal of emission caps are materialized. 5.6.2. Vertical equity We present results for the income deciles in Table 1 and Fig 4. Since a tax policy would generally be regressive among the households with vehicles, results are presented for households with and without vehicles as well as for all households combined. We express the total changes in welfare within a decile as a ratio of total income of the deciles to normalize with respect to the burden bearing capability of the households, which could depend on their income.21 A policy is progressive as long as the welfare loss to income ratio is higher for a higher income group (note that burden is marked by a ve sign), or a welfare gain to income ratio is lower for a higher income group. Considering all households, all three allocations are clearly progressive among the lowest seven income deciles (Fig. 4). Even among vehicle owning households only, any allocation is progressive, ensuring a favorable distributional effect of the
20 21

Specically, we divide household income by (adult + 0.4 children)0.5 to arrive at equivalent income. We call the ratio of change in welfare to income as relative welfare.

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Fig. 4. Effect of allocation strategies on distribution of mean welfare change to expenditure (all households).

Table 2 Horizontal distribution of relative changes in welfare for each decile. Per person basis With car No car All Per adult basis With car 84.57 75.87 65.96 59.29 54.14 47.75 40.82 39.30 33.44 30.12 50.83 No car 96.17 93.93 91.45 88.15 86.96 83.77 78.79 85.58 73.75 67.61 91.48 All 89.88 80.33 69.49 62.32 56.30 49.52 42.42 40.84 34.47 30.97 55.66 Per vehicle basis With car 73.56 62.51 57.37 53.12 52.36 48.93 45.45 44.58 41.86 47.37 51.41 No car 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.00 All 39.87 47.06 49.44 47.54 48.90 46.52 43.54 43.10 40.79 46.30 45.31

Proportions of households with positive benets (%) Decile 1 79.33 95.75 86.85 Decile 2 69.72 91.99 75.22 Decile 3 62.81 90.53 66.65 Decile 4 53.73 84.80 56.99 Decile 5 47.34 84.06 52.15 Decile 6 45.47 79.22 47.13 Decile 7 37.59 78.03 39.29 Decile 8 35.96 79.81 37.42 Decile 9 32.56 71.25 33.55 Decile 10 29.04 59.15 29.73 All 47.48 89.76 52.50

tradable permit policy. Among the top 3 deciles, the burdens are more-or-less proportional. Note that the burden to income ratio in the highest decile is always lower than that in the 9th decile. This is possibly because the income outliers in the top decile pulls up the average income of the decile and reduces the ratio. Considering all households, an adult based allocation is the most progressive of the three, where the households in the lowest decile gaining the most (2.838 vs. 2.740 and 0.413) and those in the highest decile losing the most (0.250 vs. 0.247 and 0.068). This is also conrmed by Suits (1977) index for progressivity measures. Similar pattern is seen for households with or without vehicles. Households without vehicles always gain as a whole for a per capita or per adult based allocation. For a vehicle based allocation, households without a vehicle can suffer a loss in welfare. This is because, some households can still have expenditure on gasoline through rented vehicles, but do not receive any permit for their emissions. 5.6.3. Horizontal equity We present the horizontal equity results in Table 2, through the proportion of households that have a positive gain in welfare because of the policy. Again we present the results for households with and without vehicles and for all households combined. Clearly the horizontal distribution of relative welfare is not similar in all the deciles. In the lowest decile, majority of the households (with, without vehicles or combining all) have a positive benet. An adult based allocation results in benets to highest number of households in all income deciles. As expected, households without vehicles do not gain from a per vehicle based allocation. Combining all deciles, a per adult based allocation benets 55.66% of all households and 50.83% of all vehicle owning households. A per vehicle based allocation, on the other hand, generates positive benet to 45.31% of all households and 51.41% of vehicle owning households. We can therefore tentatively expect 55.66% support for the per adult based allocation, 52.50% for per capita allocation and 45.31% support for a per vehicle based allocation. We investigate the per capita based allocation further. The frequency distributions of relative welfare changes for four income deciles (lowest, fourth, seventh and highest) are presented in Fig. 5. The relative changes in welfare are more widely distributed for successively lower deciles. Not only does the lowest decile have more households with positive benets but the number of households with high relative gains is also higher than any other decile. While the progressivity of the per capita allocation strategy comes at a cost to the households from higher deciles, the relative loss of most individual households in higher deciles are lower than the relative gain of many individual households in the lower deciles. For example, in

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800

800

Frequency of households

700 600 500 400 300 200 100 0 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7

Frequency of households

700 600 500 400 300 200 100 0 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7

Relative welfare changes: Decile 1

800 800

Relative welfare changes: Decile 4

Frequency of households

700 600 500 400 300 200 100 0 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7

Frequency of households

700 600 500 400 300 200 100 0 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7

Relative welfare changes: Decile 7

Relative welfare changes: Decile 10

Fig. 5. Distribution of relative burdens within different income (expenditure) deciles for a per capita based permit allocation strategy.

decile 10 there are a very small number of households with relative loss more than 3%, whereas in decile 1 there are a large number of households with a relative gain higher than 3%. Table 3 presents a summary of burden distribution based on some socio-economic characteristics for a per capita allocation strategy. Families with children benet more from the per capita allocation. This is because, families with children get permits for the presence of children, yet the presence of children does not increase consumption linearly. 73.24% of single parent households benet from a per capita allocation, where as for multiple adult families with children the proportion is nearly 64.5%. A higher proportion of households with female heads benets than households with male heads. Also, more households with non-white heads benet as compared to those households with white heads. The proportion of rural households with a

Table 3 Summary welfare change statistics for different types of households (per capita only). Family type Single adult, no child Single parent Minimum two adult, no child Minimum two adult, with children Male head Female head White head Non-white head Urban Rural Vehicle owner Non-vehicle owner Ratio of mean welfare change to expenditure (%) 0.312 0.556 0.325 0.161 0.186 0.026 0.155 0.292 0.066 0.434 0.179 1.505 Medians of ratio of welfare change to expenditure (%) 0.069 0.701 0.112 0.316 0.051 0.193 0.003 0.496 0.072 0.182 0.049 1.942 Proportions of households with positive benets (%) 46.02 73.24 44.28 64.50 47.65 57.67 49.92 65.04 53.41 43.30 47.48 89.76

Z. Wadud / Transportation Research Part A 45 (2011) 10521065 Table 4 Effect of non-participation in the permit market. Reduction Efcient market With car No car All 2.740 1.169 0.520 0.091 0.082 0.202 0.359 0.320 0.356 0.247 Reservation US$ 10 With car 2.041 0.840 0.352 0.012 0.130 0.244 0.389 0.345 0.375 0.256 76.91 67.64 60.44 51.44 48.02 43.82 35.72 34.05 30.82 26.95 45.48 No car 3.938 2.390 1.763 1.126 0.700 0.662 0.285 0.367 0.241 0.005 95.12 91.09 89.15 83.28 82.61 77.92 77.27 78.85 66.25 57.75 88.71 All 2.780 1.184 0.525 0.090 0.085 0.207 0.365 0.326 0.362 0.251 85.25 73.44 64.41 54.79 50.30 45.50 37.47 35.54 31.73 27.65 50.61 Reservation US$ 20 With car 2.108 0.858 0.356 0.018 0.142 0.259 0.408 0.361 0.392 0.268 71.73 61.28 54.56 46.95 42.93 39.22 31.86 30.28 26.89 23.20 40.86 No car 4.102 2.493 1.835 1.172 0.726 0.686 0.292 0.382 0.246 0.006 93.59 90.31 87.53 81.46 79.71 75.32 73.48 76.92 61.25 57.75 87.04 All

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Ratio of mean welfare change to expenditure (%) Decile 1 2.016 3.876 Decile 2 0.831 2.352 Decile 3 0.350 1.737 Decile 4 0.009 1.110 Decile 5 0.126 0.689 Decile 6 0.239 0.652 Decile 7 0.381 0.281 Decile 8 0.338 0.362 Decile 9 0.368 0.239 Decile 10 0.252 0.005

2.884 1.221 0.537 0.088 0.095 0.220 0.384 0.341 0.379 0.263 81.74 68.45 59.11 50.57 45.36 41.00 33.61 31.83 27.77 23.98 46.34

Proportions of households with positive benets (%) Decile 1 79.33 95.75 86.85 Decile 2 69.72 91.99 75.22 Decile 3 62.81 90.53 66.65 Decile 4 53.73 84.80 56.99 Decile 5 47.34 84.06 52.15 Decile 6 45.47 79.22 47.13 Decile 7 37.59 78.03 39.29 Decile 8 35.96 79.81 37.42 Decile 9 32.56 71.25 33.55 Decile 10 29.04 59.15 29.73 All 47.48 89.76 52.50

welfare loss (56.70%) is higher than that of the urban households (46.59%) since rural households not only use more fuel, but also are less responsive to a change in gasoline price. The average relative welfare loss is also higher for rural households than for urban households. On average, households without vehicles benet from the policy, upholding the polluters pay principle. 5.6.4. Non-participation in the market The preceding results are valid when all households participate in the transaction of the permits, i.e. everyone sells their excess permits at the market price. As discussed before, some of the permits may be retired from the market through environmentally conscious consumers. Also households receiving a marginally higher amount of permits than they require may decide not sell the permits in the market. In these cases, the price of permits would be higher because of lower availability of permits. The available quantity of permits in the market can be determined if reservation sales amount is known for each household. We dene the reservation sales amount as the minimum sales receipts that would make the households sell their excess permits. In the absence of any estimates in the literature for the reservation sales amount, a scenario analysis procedure is followed. Two simple scenarios are run assuming the reservation sales amount is US$ 10 and US$ 20 for every household. The distribution of relative changes in welfare for the two reservation amounts is compared with that of a fully participated market in Table 4. The lower income households benet more for a higher reservation amount because of the higher permit prices. If the permits are withdrawn from the market, the proportion of households not beneting from the policy may differ substantially. For a US$ 20 reservation amount, more than 5% more households in every decile cease to benet. These extra households losing out are the households that decided not to sell their permits in the market, as well as those that are net buyers of permits. 6. Conclusions We evaluated personal tradable carbon permits in the context of other policies to reduce carbon emission from personal vehicles in the rst half of this paper. Personal tradable permits for road transport offer an interesting and potentially viable policy approach to curb emissions and are theoretically equivalent to carbon taxes in terms of cost efciency in the absence of transaction costs. One signicant drawback of the policy is the initial administration and monitoring cost, which could adversely affect its cost-efciency aspect. This drawback should be put in the context of the benets provided by the tradable permit approach. The policy provides a clearer and more visible incentive to consumers than a carbon tax. Tradable permits also provide an absolute cap on emissions, which carbon taxes may fail to provide, especially in the context of personal road transport and changing prices of crude oil. Another advantage of personal tradable permits is that it provides a buffer between oil price and retail combined price of gasoline, thus help stabilizing the gasoline market. Tradable permits are also potentially more acceptable to the

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public than a carbon tax. The policy allows consumers to inuence the carbon cap and also provide more choice to adjust their behavior as opposed to an upstream permit trading among fuel suppliers. In the second half of the paper, we evaluated three different permit allocation strategies to understand the distribution of burden among different income groups in a partial equilibrium setting. The progressivity of the policy depends on the allocation strategies. A per adult based allocation is the most progressive for all households, whereas a per vehicle based allocation is the nearest to being proportional. All allocations are generally progressive for vehicle owning households as well. Households without vehicles directly benet from the free allocation of permits, the benets also being distributed progressively. The tradable permit approach therefore directly addresses the equity concerns arising from the policy in a positive way. Rural households, however, clearly loses more as compared to urban households and permit allocations could therefore be adjusted accordingly. We note that a personal tradable permit for entire household energy use will allow more exibility in households decision process, and therefore be potentially more cost efcient. Three important future research areas are: understanding the transaction costs, especially the monitoring and administration costs, incorporating general equilibrium effects and design and implementation of the policy. Acknowledgements This work was carried out at Imperial College London during my Ph.D. and was funded by the Commonwealth Scholarship Commission. I would like to thank my supervisors Dr. R.B. Noland and Dr. D.J. Graham. References
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