CARBON REDUCTION POLICY: CAP ‘n TRADE?, or CARBON DISCHARGE FEES?

Why have the media, the Obama Administration and most commentators on energy policy, global warming and climate change lined up behind a policy of “Cap‘nTrade” as the main mechanism to reduce discharges of carbon into the atmosphere? Why called do they treat the choice as a slam dunk for Cap ‘n Trade?, practically ignoring the alternative? Why?

 

Most economists favor the use of carbon discharge fees. One major reason politicians have avoided this alternative approach is that it has been mislabeled -- as a “carbon tax.” Pinning a “tax” label on anything is like the kiss of death. True political leaders would confront the untruth of a bad label and try to inform the public as to the true nature of the choice at hand. For a “carbon tax” is not a tax at all. It is a fee, an effluent fee --a continuous penalty for on-going air pollution. In the case of carbon, it is a charge per pound of carbon discharged into the atmosphere. The greater the number of pounds discharged, the greater the cost to the polluter; the lesser the number of pounds, the lesser the cost. So, a carbon discharge fee can serve as a strong incentive for a company to reduce harmful discharges.

 

Notice that pollution is a classic “externality” of a market economy – a cost to others that the source doesn’t pay for so that, unless there is some offsetting cost, there is no incentive to reduce the pollution. Thus, a carbon discharge fee is a market-perfecting device. It provides incentives in the right direction. People are induced to behave in a better way.

 

By contrast, Cap ‘nTrade is a system that relies far too much on bureaucratic decision-making and allows far too much horse-trading – between politicians and large companies, and among companies, too. Regulators establish a “cap” on the total tonnage of carbon that polluters can discharge in an area, then establish a “market” for trading discharge permits. There’s too much scope for abuse and corruption. Members of Congress, already corrupted by big money, would be subject to strong pressures to favor firms or industries in or out of their districts.

 

Three other major factors figure into decision-making and legislating on this issue:

 

1. The EPA: An alternative to both the Cap’nTrade and Discharge Fee approaches is for the EPA to follow through on its threat to regulate carbon emissions as dangerous under terms of the Clean Air Act of 1970. EPA’s ability to do this at the agency’s discretion has survived court challenges all the way up to the Supreme Court (decision of 2007). Those who think the European Union alternative is OK may not be fazed by the EPA!

2. Our European allies: The EU is lobbying the USA to join them in adopting a Cap’nTrade system. Why? -- Because creating a much larger (EU-USA combined) market for discharge permits would lower the high administrative costs of their bureaucratic system. EU allies’ pressure may explain why the Obama administration is pushing Cap’nTrade, but that doesn’t make it an American system.

3. Who gains financially from the program?: Here is where the differences are least. The process of answering this question would be difficult, contentious and controversial under either alternative. Why? -- Because tremendous new revenues to government would be generated either way. Under Cap’nTrade, a government agency would auction or otherwise sell permits to emit a certain number of tons of carbon per year. The immediate gross revenue yield to the government is estimated to start at $20-30 billion per year and rise steadily year-after-year as the carbon cap is decreased and the prices of permits rise. Under a Discharge Fee arrangement, polluters would pay a price per ton of carbon actually discharged over a period of time. The price of carbon, “the core of any climate plan,” could be similar either way. [i][i]

 

How would the new revenues be used? Would they be dedicated to “green” programs, used to fund other government programs, or returned to poor people via an income redistribution scheme? These questions require political answers. Wouldn’t it be nice if the politics of carbon reduction were limited to the one area where “differences are least”? Impossible. Thus, a key consideration in the choice of alternatives is: Which option minimizes reliance upon political incentives?

 

The Cap’nTrade alternative fails to take into account that politicians’ incentives work in the wrong direction. One should avoid setting up any system that leaves too many levers that politicians can try to manipulate for the benefit of their reelection. Cap’nTrade makes several such levers available, including:

 

(1) Initial allocation of “free permits” to major polluters like power companies;

(2) Estimation of the amount of carbon emitted by companies;

(3) The setting of fuel taxes (still necessary, even under Cap’nTrade); and

(4) Regulatory determinations, including allowable offsets, system oversight andaccountability.

 

Surprise, surprise! The Congress, anxious to push through President Osama’s “climate” bill -- the American Clean Energy and Security Act [a.k.a. the “Waxman-Markey“ bill] -- has pulled every lever that Cap’nTrade makes available. Once again, we see that there is no limit to Congressional corrupt-ability -- the tendency of Congress to ensure reelection of its Members by pandering to big money contributors and special interests.

 

Perhaps the most fundamental problem is the bill’s complexity. Its 932 pages challenge both accountability and transparency, not only of the Act but of Congress itself, an institution already averse and practically immune to transparency and accountability. Other levers pulled by the bill compromise the main purpose of the Act and deny it integrity. These include:

 

L Only 15% of the permits would be auctioned; 85% would be given away, primarily to power companies. Alan Viard, analyst at the American Enterprise Institute, “likens giving permits to polluters to handing the proceeds of a tobacco tax to the shareholders of Philip Morris.”[ii][ii]

 

L According to the May 23rd - 29th Economist, the bill “includes a dizzying array of handouts....(including) a huge increase in “offsets....open to abuse.”

 

What is not to like about the Discharge Fee option? -- very little. It does far more to avoid the bureaucratic command and control nature of most environmental regulation. They are more easily adaptable to deal with other greenhouse gases, like methane. They offer simplicity compared to complex Cap’nTrade arrangements. In order to work well, the latter require permit auctions, a command and control regulatory system, and oversight of “offsets.” The latter are carbon reducing projects, like planting trees in the Amazon, that may have nothing to do with the carbon output of the offset buyer.

 

It’s not that Cap’nTrade cannot be made to work. The EPA has successfully applied the system to sulphuric acid (“acid rain”) emissions. The New England states are having some success with RGGI -- The Regional Greenhouse Gas Initiative.[iii][iii] The issues are comparative ease-of-use, cost-effectiveness and in-corruptibility. The Waxman-Markey bill doesn’t pass these tests.[iv][iv] The public deserves to be better informed about the alternatives. We need full debate rather than one option, badly crafted by a corrupt Congress, crammed down our throats as part of the President’s initiative on climate change.

 

PETER BEARSE, Ph.D., International Consulting Economist, 5/23/09




 

 

 


[i][i] Quote from Drum, Kevin (2009), Up Trading: How Obama can fix the climate, raise billions for clean tech, and send you a fat check,” MOTHER JONES (March/April, p. 53).

[ii][ii] “America and climate change: Cap and trade, with handouts and loopholes: The first climate-change with a chance of passing is weaker and worse than expected,” The Economist, May 23rd-29th, 2009.

[iii][iii] “Carbon Market Matures: New England’s Financial, energy acumen boosts cap and trade system,” MASS HIGH TECH (April 24-30, 2009), p. 21.

[iv][iv] Telford, Eric (2009), “Tell Congress to Vote NO to Cap-and-Trade,” Americans for Prosperity / Right Online (May 15).