Properties of Revenue Neutral Auctions: An Analysis for Tradable Pollution Rights

The paper is the first to derive and analyse theoretically the equilibrium properties of 'revenue neutral auctions', in the context of tradable pollution rights. By 'revenue neutrality' we mean that the objective of the agency distributing the rights is not to maximize earnings from the auction but to have an efficient allocation of rights by identifying the most deserving buyer through the process. The revenues earned are distributed back to the bidders following a rule. The experimental literature addresses the problem by analysing the behavior of the bidders in a revenue neutral auction but so far there has been no theoretical analysis on the equilibrium properties of such auctions. The analysis is done in a game theoretic framework. We introduce revenue neutral auction as a mechanism for reallocation of rights in the original tradable permit framework (Montgomery, 1972), in a single unit set up. The paper shows that a standard second price auction fails to be incentive compatible if revenue neutrality is introduced in the framework. Also, the efficiency of a tradable permit system with a revenue neutral auction for reallocation of rights is not independent of the initial distribution of permits, which is contrary to what has been established in the original work with a competitive secondary market.