Waxman-Markey Climate Legislation

House Panel Begins Debate on Climate Bill appeared on the Washington Post website (and in the print edition?) on April 23, 2009, giving a heads-up on a major piece of legislation being drafted by the House Energy and Commerce Committee. The Waxman-Markey bill would comprehensively address climate change with its "calls to reduce the nation's greenhouse gas emissions to 20 percent below 2005 levels by 2020 and by 83 percent as of 2050."

One of the prime initiatives in the bill is a cap-and-trade system for auctioning off "carbon allowances" to electric utilities and others that burn fossil fuels. I have begun seeing op-ed pieces and the like lambasting the bill, which is still in its draft stages, for putative inadequacies relating to cap-and-trade and carbon allowances.

Frankly, the discussions have left me scratching my head. What exactly is cap-and-trade (C&T), what are the various ways in which it might be implemented, and why are some who otherwise support proactively addressing climate change against the bill right from the get-go?

Thomas Friedman, who strongly supports federal involvement in slowing down climate change, recently wrote "Show Us the Ball" in the New York Times opposing C&T and supporting an out-and-out carbon tax. C&T has been called by its critics, including Mr. Friedman, a hidden carbon tax — i.e., one that "hides the ball" of carbon taxation. One of the things I'd like to find out is why C&T has been called a "hidden" tax on carbon.


This Wikipedia article on "emissions trading", another name for C&T, says C&T is basically this:

A central authority (usually a government or international body) sets a limit or cap on the amount of a pollutant [e.g., carbon dioxide] that can be emitted. Companies or other groups are issued emission permits and are required to hold an equivalent number of allowances (or credits) which represent the right to emit a specific amount. The total amount of allowances and credits cannot exceed the cap, limiting total emissions to that level. Companies that need to increase their emission allowance must buy credits from those who pollute less. The transfer of allowances is referred to as a trade. In effect, the buyer is paying a charge for polluting, while the seller is being rewarded for having reduced emissions by more than was needed. Thus, in theory, those that can easily reduce emissions most cheaply will do so, achieving the pollution reduction at the lowest possible cost to society.

I find that confusing already. Is the limit or cap on emissions set for the country as a whole, or for each industry, or for each polluter?

Where do the allowances or credits come from originally?

Are they simply issued by the government to polluters, or do polluters (or other parties) have to buy them, perhaps at auction?

If polluters have to buy them, why would a polluter buy more credits than it needs, such that it might later trade (sell?) excess credits to another polluter?

Would a speculative market in allowances/credits spring up, and if so would that be good or bad?


If allowances/credits are created by the U.S. government and sold at auction on a yearly basis, utility companies and others would presumably bid competitively on these allowances once a year. They would be sold, allowance by allowance, to the highest bidder and might be effective as of, say, January 1.

Say Utility A and Utility B both expect hot summers in their regions. Summer is when most electric companies emit the most carbon pollution, to power all those air conditioners. When the mercury rises, utilities have to bring online generating capacity that is normally idle. This is typically capacity that is old, dirty, and inefficient.

If Utility A's region turns out to have a cool summer and Utility B's region experiences temperatures even higher that anticipated, A can wind up using fewer allowances than it ponied up for on Jan. 1, while B will need to buy additional allowances. A can sell its excess allowances to a desperate B at a profit.

Notice that A has an opportunity to pass its windfall profits back to its customers in the form of reduced electricity rates. But is there any guarantee that it would?

B, meanwhile, might be in the position of needing to charge its customers more per kilowatt-hour than anticipated, to fund buying allowances from A. Would the regulations under which utility companies operate permit this?

Clearly, if a utility could just pass its "surprise" operating costs on to its customers each year, it would have little incentive to modernize by switching to non-polluting sources of energy. The whole point of C&T seems to be to nudge polluters to modernize, so that as total yearly caps come down over time, polluters will already have seen the writing on the wall and planned their "carbon exit strategies."

Ideally, it would seem there should be less, not more, desperate buying of carbon allowances by utilities each year to cover unanticipated fossil-fuel usage, as time marches on.


If the government sells — auctions off — allowances each year to the highest bidders, what the bidders pay in could be considered a "tax," or at least a user fee: use a certain percentage of the country's overall target for carbon pollution in a given year, and you need to pay Uncle Sam a fee. (Then you can subdivide and sell to others portions of the target usage you have bought, if you like.)

Many are asking, then, why not make it an out-and-out tax?

Per Thomas Friedman, a true carbon tax would "show everyone the ball," rather than hiding it from view:

Advocates of cap-and-trade argue that it is preferable to a simple carbon tax because it fixes a national cap on carbon emissions and it “hides the ball” — it doesn’t use the word “tax” — even though it amounts to one. So it can get through Congress. That was true as long as no one thought cap-and-trade could ever pass [under George W. Bush], but now that it might under Mr. Obama, opponents are not playing hide the ball anymore.

Mr. Friedman worries about this aspect of the situation:

In the past two weeks, you could hear a chorus of Republicans, coal-state Democrats, right-wing think tanks and enviro-skeptics all singing the same tune: “Cap-and-trade is a tax. Obama is going to raise your taxes and sacrifice U.S. jobs to combat this global-warming charade, which many scientists think is nonsense. Worse, cap-and-trade will be managed by Wall Street. If you liked credit-default swaps, you’re going to love carbon-offset swaps.”

Some of the refrains from this song have a very catchy appeal. They could easily kill [the Waxman-Markey] effort.

An out-and-out tax, says Mr. Friedman, has been proposed in an alternative bill authored by Representative John B. Larson, chairman of the House Democratic Caucus. The Larson bill

... would impose “a per-unit tax on the carbon-dioxide content of fossil fuels, beginning at a rate of $15 per metric ton of CO2 and increasing by $10 each year.” The bill sets a goal, rather than a cap, on emissions at 80 percent below 2005 levels by 2050, and if the goal for the first five years is not met, the tax automatically increases by an additional $5 per metric ton. The bill implements a fee on carbon-intensive imports, as well, to press China to follow suit. Larson would use most of the income to reduce people’s payroll taxes: We tax your carbon sins and un-tax your payroll wins.

To my simple mind, that sounds like a much better approach than cap-and-trade! Mr. Friedman agrees:

People get that — and simplicity matters. Americans will be willing to pay a tax for their children to be less threatened, breathe cleaner air and live in a more sustainable world with a stronger America. They are much less likely to support a firm in London trading offsets from an electric bill in Boston with a derivatives firm in New York in order to help fund an aluminum smelter in Beijing, which is what cap-and-trade is all about. People won’t support what they can’t explain.