President Obama has driven a stake in the heart of his carbon cap-and-trade program. By transforming it from a relatively cost-effective environmental program into a cash cow to finance his ambitious health and social welfare agenda, he has encumbered it with very expensive baggage. Blue Dog Democrats and conservation-minded Republicans will gag on its cost to an economy now racked by recession.
In broadening the goal of cap-and-trade legislation from the paramount goal of reducing Greenhouse Gases (GHGs), primarily carbon, and mitigating climate change, to that of raising, conservatively, well over $600 billion in revenue for his social programs, the President has raised the ante on this ambitious proposal. He has guaranteed a contentious fight in Congress, strong Democratic majorities notwithstanding.
A clear sign of what is to come was a February 3rd statement by Senator Bob Corker (R-TN): "I believe there is a growing bipartisan agreement that all of the revenues generated from a cap-and-trade tax should be returned to the American people."
Evidently, the National Association of Manufacturers (NAM) and the U.S. Chamber of Commerce, both of which supported the President's stimulus package, are drawing a line in the sand over the proposed cap-and-trade program.
Most economists who have studied the matter of mitigating climate change and the daunting challenge of reducing GHG emissions have focused on two major policy options: carbon taxes and cap-and-trade programs. The former is more transparent than the latter and, therefore, less popular with politicians.
There are two variants of the carbon tax option. There is one that is designed to generate revenues and another that is "revenue-neutral." The latter one is the preferred option from the perspective of economic efficiency and is defensible on supply-side and security grounds, independent of climate concerns, since it contemplates off-setting tax cuts in either marginal income and corporate tax rates or Social Security taxes. In other words, the government does not gain any significant additional revenue. Any income generated from the carbon tax is returned to taxpayers and plowed back into the economy.
A revenue-neutral carbon tax shifts taxation away from income and productivity ("distortionary taxes") in favor of taxing emissions, pollution and waste. It encourages energy efficiency, a cost saver, while reducing the nation's reliance on international energy markets controlled by less than friendly petroleum states. It is an example of a "No Regrets" response to scientific uncertainty and a changing climate without putting the entire economy at risk. It provides time for the economy to grow, science to mature and new technologies to emerge.
"No Regrets" approaches recognize that there is certainly climate variability out there without resolving ultimate issues as to causality (human or natural) or duration (permanent or cyclical). For instance, a water utility manager in the western United States has to adapt to drought, increased forest fires, and less mountain snowpack, which impacts the quality and quantity of water supplies in reservoirs no matter the ultimate cause.
Jack Kemp once said, "If you tax something, you get less of it. If you subsidize something, you get more of it." A revenue-neutral carbon tax would give us less pollution, reduced energy intensity and more growth and efficiency while preserving political transparency.
Carbon cap-and-trade is the other market-based instrument offered by economists and policy specialists. The concept is simple in theory, less so in practice. A cap or reduction target is set for carbon or GHG emissions that can be achieved in a flexible, least-cost manner by regulated industries. Newer or more efficient operations can over-control and sell credits, say, to older, less efficient plants that may not find it economically feasible to control their emissions. It avoids one-size-fits-all regulation or overkill in favor of a flexible system that takes advantage of control-cost differentials between different sources of emissions.
The poster child for cap-and-trade programs is the one set up to control acid rain and sulfur dioxide emissions in the 1990 amendments to the Clean Air Act supported by the first Bush administration. This program yielded tremendous results at a fraction of anticipated costs.
Whether or not the government should give away or sell carbon allowances or credits in the start-up of a cap-and-trade program is the tricky part. If the idea is to put a price on carbon and create incentives for reducing carbon emissions, selling or auctioning the allowances makes sense. However, this drives up the costs for taxpayers and energy utility ratepayers with deleterious consequences for the economy. In functional terms, it has the same effect on the productive sector as any other tax.
What's the solution? Basically, the most economically efficient response is similar to the revenue-neutral carbon tax: return as much money as possible to taxpayers or ratepayers to offset the elevated energy costs. This could be done through tax cuts, rebates or other kinds of payments.
The Obama administration has decided not to pursue this more cost-effective response to carbon reduction. It intends to sell carbon allowances and pocket the proceeds to carry out its ambitious social agenda. It views the proposed carbon cap-and-trade program as a means to generate more federal tax revenues rather than simply an environmental program to be implemented in the most cost-effective manner possible.
This is a strategic error in the best of times, which these are not. It will yield a great deal of controversy and political acrimony at the expense of both the economy and the environment.
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