Climate Bill to Cost Average Consumer $175 a Year

The Washington Post's Climate Bill to Cost Average Consumer $175 a Year discusses The Estimated Costs to Households From the Cap-and-Trade Provisions of H.R. 2454, a recent report to Congress from the Congressional Budget Office. This CBO report evaluates H.R. 2454, the American Clean Energy and Security Act of 2009. The bill is also referred to as Waxman-Markey, after the bill's chief Democratic co-sponsors, Reps. Henry A. Waxman (Calif.) and Edward J. Markey (Mass.).

Waxman-Markey's cap-and-trade provisions would set up trading of carbon "allowances" in a national marketplace. This activity would, for the first time ever, put a price tag on U.S. emissions of carbon dioxide and other greenhouse gases. Never before has emitting carbon been anything but free in the U.S.

Under Waxman-Markey, direct and indirect GHG emitters — such as electric utilities that burn coal to provide electricity, and oil companies whose products are later burned in internal combustion engines in automobiles and diesel engines in trucks and locomotives — would buy allowances that the federal government issues, year by year, under a steadily declining overall "cap" on emissions. Instead of buying allowances (or receiving free ones) right from Uncle Sam, many companies would buy ones Uncle Sam has already issued as they are being "traded" — bought and sold — in an open market. These companies would, economists say, pass most of the costs of buying the allowances along to "downstream" entities, and, ultimately, mostly to you and me as consumers.

For example, an electric utility would (unless regulators intervened) raise its price per kilowatt-hour of electricity to cover the costs of allowances, and (say) General Motors, which consumes lots of electric power in its plants, would find its operating costs going up. GM, in turn, would pass along most of its extra costs to its customers as higher prices for their cars.

Meanwhile, GM's customers could also find that a second "stream" by which the new carbon costs affect their pocketbooks — transportation fuels — would show up as higher gasoline prices. Plus, their own electric bills would rise.

Cap and trade would increase everyone's cost of living.


The pinch of rising prices would be partially offset by the fact that the allowances themselves, as they are being bought and sold, would develop a total value measured in the tens of billions or hundreds of billions of dollars. In its early years, Waxman-Markey expressly distributes the market value of the allowances to business firms, federal and state governments, and households in various ways, direct and indirect. Accordingly, allowance values offset costs borne mostly by households, and to a lesser extent by governments (the assumption being that business firms will wind up passing their share of the allowance costs on to their governmental and private customers as higher prices).

Some households would feel the cost-of-living pinch more than others. The lower the income of the household, the sharper the pinch, since low-income households spend a greater percentage of their overall income than higher-income households do. The higher up the economic ladder you are, the more inclined you are to save and invest instead of consuming. Also, a larger fraction of the expenditures of lower-income households go to energy-intensive costs such as electric bills, home heating, and gas for their cars.

The CBO report puts hard numbers on the net effects of Waxman-Markey on households at different levels of income and expenditures.

The CBO report makes clear (see Table 2 on its final page) that the gross costs of cap-and-trade would be steep. But "direct relief to households" and "allocation to businesses and net income to domestic offset producers," as provided for in Waxman-Markey, make the net cost tolerable: $165 per year for all households, independent of income. (I don't quite understand how this Table 2 figure of $165 per year squares with the $175 per year spoken of in the report proper. My best guess: the incidences of some of the "gross costs" of the cap-and-trade system were unable to be allocated meaningfully by level of income, the report says, and so, I imagine, do not appear in Table 2.)

The lowest 20 percent ("quintile") of households by income level would actually benefit to the tune of $40 per year, in 2020, while the second quintile from the bottom would pay just $40 per year. The middle, fourth, and highest quintiles would see sharper increases in their costs of living: $235, $340, and $235 per year, respectively.

These numbers are CBO's estimates for the year 2020, several years after Waxman-Markey would take effect, if it becomes law. The bill would first impose cap-and-trade allowances in 2012, but presumably it would take until roughly 2020 for the transitional adjustments occasioned by the new cap-and-trade system to peter out.

After 2020 — the bill covers the period from 2012 to 2050 — the cost burdens would shift in response to the fact that, as the total size of the emissions cap diminishes, the percentage of the allowances that are auctioned off by Uncle Sam, rather than given away free, will rise. Originally, only 15 percent will be auctioned; by 2035, 70 percent will be auctioned. By that point in time, a large share of the revenues generated by the auction will be returned to households on a per capita basis, while in the early years this so-called "cap and dividend" approach will not be used. Hence, the CBO estimates do not apply to later years beyond 2020.


There's a significant caveat to all the above. As the CBO report makes clear:

The distribution of the gross cost of complying with the [cap-and-trade] policy would be quite different if the price level did not increase as a result of the cap — if, for example, the Federal Reserve adjusted monetary policy to prevent such an increase. In that case, the compliance costs would fall on workers and investors in the form of lower wages and profits. Under that alternative assumption, the gross cost of the program would fall more heavily on high-income households than is indicated in this analysis because the distribution of wages and profits is more tilted toward higher-income households than is the distribution of expenditures.

That's an important point that deserves elucidating. A cap-and-trade system on greenhouse gases would normally be expected to push up the cost of living for all of us, but especially for the relatively poor, in the form of higher prices on energy and energy-intensive goods and services. The Federal Reserve typically tries to hold down cost-of-living increases — otherwise known as inflation — through manipulating the amount of money in circulation and how much it costs to borrow it, otherwise known as the interest rate.

If the Fed intentionally offsets cap-and-trade price hikes in that way, all bets are off. The CBO report makes the (perhaps unwarranted) assumption that Fed monetary policy — setting the size of the money supply and the level of interest rates — will be "hands off" toward cap-and-trade price boosts. If that assumption turns out to be wrong, then consumers will see little if any cost-of-living increase. That in itself is good news.

The bad news is that the costs of cap and trade would be borne instead by workers and investors in affected industries and sectors. For example, coal-mining interests or electric utilities might take a bigger hit than would otherwise be the case. They might have to "eat" the costs of buying greenhouse-gas allowances rather than passing those costs "downstream" to their customers and their customers' customers, in the form of higher prices. Wages and salaries might be lower than would otherwise happen, or more jobs could be lost. Companies might see lower profits and pay lower dividends to shareholders. Stock prices might go down, or fail to go up as much.

Though some of those who are thus adversely affected would surely be low-income families, such as those of coal miners, in general it would be higher-income families that bore the brunt — since the better off among us command the bulk of wages and salaries, of shareholder dividends, and of capital gains from rising stock prices.

In short, cap and trade boosts prices and impacts the budgets of lower-income people inordinately, since they spend a higher percentage of their income on energy and energy-intensive goods. Waxman-Markey builds in several mechanisms to help offset the burden that higher price levels would put on the relatively poor, and the CBO report shows that these anti-regressive mechanisms can be expected to work well.

If the Fed tamps down the cap-and-trade price hikes entirely as it pursues its monetary policies, that would impose a further anti-regressive effect. (Anti-regressive or progressive policies shift cost burdens upward toward the economically better off.) But it would also invalidate the CBO's cost estimates in the report discussed in this post.

This is exceedingly complex stuff.

More on Can Climate Plan Work?

In an earlier post, Caps, Trades and Offsets: Can Climate Plan Work?, I talked about a recent Washington Post article that introduces the Waxman-Markey climate change legislation, a.k.a. the American Clean Energy and Security (ACES) Act of 2009, which is being considered in the House of Representatives. As the Post article says, the bill would "make those who use gas or electricity pay for their share of the emissions that result."

This would be done through a cap-and-trade system on carbon dioxide and the other greenhouse gases, byproducts of burning fossil fuels, that are threatening to overheat our planet. Certain companies that are the most responsible, directly or indirectly, for emitting greenhouse gases would have to buy allowances, on the open market, that they would then use to cover these emissions. The total number of allowances (the "cap") would represent the total amount of emissions allowed per year. This amount would be reduced year by year.

At the time I made that earlier post, I knew little about cap and trade. Now I know a bit more.

For instance, I know that ACES is only somewhat a "jobs bill," as Capitol Hill Democrats are calling it, because although it would create some so-called "green-energy jobs," it would threaten other jobs that now exist in "dirty energy": coal, oil, and natural gas, and all the things that depend on burning them (including much of the electricity generated in this country). There would be winners and losers, jobs-wise.

Republicans that call ACES a "light-switch tax," for their part, ignore the fact that changing over to alternative energy sources — wind, solar, geothermal, nuclear, and the like — would one day let us turn on our light switches tax-free, as we do now.

Like any cap-and-trade system, I have furthermore learned, ACES has the potential to burden us with a higher cost of living ... until such time as conservation, efficiency measures, and innovations in clean energy bring costs down again. And those burdens would fall heaviest on those with the lowest incomes, unless "a consumer assistance section" is added, as promised, to the legislation. (A quick, and somewhat out-of-date, summary of ACES is available here.)

I have also learned that the criticism quoted in the Post article to the effect that "giving all the pollution credits away" — credits and allowances are the same thing — rather than auctioning them off to the highest bidders would not, as Greenpeace spokesman Michael Crocker said, fail to "serve the market principle of making carbon have a cost." Even freebie credits would wind up being traded in a marketplace — this is the "trade" part of "cap and trade" — and have their price determined by the forces of supply and demand. So carbon would still "have a cost." (That is so, and also it is so that Waxman-Markey as currently envisioned would sell 15 percent of the allowances, while giving away 85 percent.)

"The bill's complexity," the article goes on, "led one Republican to cite the adage that a camel is a horse designed by a congressional committee." Fair enough, but this is a complex feat we are trying to engineer, and we need a camel. Cutting greenhouse gas emissions isn't going to happen all by itself. What would the Republicans prefer? A straight-up carbon tax? That's just as much of a "light-switch tax" as cap and trade, and it doesn't let the "trade" part of the system reallocate where cost burdens fall, as a way of seeking market efficiencies. That amounts to a camel with a pronounced limp.

Would the Republicans prefer a higher tax on gasoline to cap and trade? It would violate their vaunted aversion to taxes and be at least as regressive (harmful to lower-income pocketbooks) as cap and trade.

What about having simply having the government mandate that certain percentages of energy production have to come from alternative energy sources? Again, core Republican axioms would vehemently oppose it.

Or, perhaps the Republicans would just do nothing. If that happens and key coastal congressional districts wind up partly under water due to global warming, or mountain snowpacks in the West vanish, leading to a dearth of snowmelt, drinking water, farmland irrigation, and power from hydroelectric dams, will they shoulder the blame?

Will Waxman-Markey Work?

That's the big question: Is the American Clean Energy and Security (ACES) Act of 2009 going to work to reduce greenhouse-gas emissions that are responsible for overheating the globe?

The Waxman-Markey bill, named after Democratic Reps. Henry A. Waxman (Calif.) and Edward J. Markey (Mass.), the bill's two chief sponsors in the House of Representatives, would put a cap on carbon dioxide and other gases emitted into the atmosphere by this country. As a result of burning fossil fuels such as coal, oil, and natural gas, we and the rest of the world derive needed energy to run our lives and our economy. But the combustion of these fuels produces CO2 and other "greenhouse gases." GHGs in the atmosphere act as blankets trapping heat that comes from sunshine. As the amount of GHGs the world produces skyrockets, the average temperature of the earth edges up. The seemingly slight temperature rises that scientists see happening in the near future — they call it "global warming" — might have catastrophic effects. So we seek ways to limit the growth of carbon (and equivalent) emissions before it's too late.

Thomas Friedman's recent book Hot, Flat, and Crowded: Why We Need a Green Revolution and How It Can Renew America tells all about it. In it Friedman talks about how we need to provide our economy with "price signals" that will cause the free market to wean us away from carbon-based energy: "The market will give us what we want, but only if we give the market the signals it needs: a carbon tax, a gasoline tax increase, a renewable energy mandate, or a cap-and-trade-system that indirectly taxes carbon emitters — or some combination of all these" (p. 251).

Waxman-Markey is a cap-and-trade system. If it or any other source of an economic "price signal" is to work, per Friedman it would have to foster innovation in alternative energy. Failure to prompt innovation in alternative energy would be equivalent to failure of the whole cap-and-trade system.

That term, alternative energy, refers to "clean power" from wind, solar, nuclear, geothermal, hydroelectric, biofuels such as ethanol, and other energy sources that are "renewable," meaning that they are naturally, or can be technologically, replenished. They either don't produce carbon emissions at all, or (as in the case of "biomass" or "biofuels" that come from agriculturally grown crops) the carbon they produce when they are burned is, via the "carbon cycle," removed from the air and recaptured in new crops.

Friedman also refers to alternatives to fossil fuels as sources of "clean electrons." Produced by electricity generating facilities that eschew fossil fuels, they move through a new "smart grid" or "Energy Internet" — which sorely needs to be built — to power our businesses, our homes, and even our cars (Friedman assumes next-generation automobiles will be plug-ins).

Right now, our economy runs on relatively cheap fossil fuels — even if oil prices are volatile of late — and "dirty electrons." There's no incentive to change as long as carbon-based non-renewables remain cheap, at least some of the time. To get renewables "down the learning curve" and producible "at scale," there will have to be countless innovations in how they are produced and how energy from them is delivered. Add to that the need for as yet undreamt of types of renewable energy, and you can see that fostering innovation is going to be the litmus test of Waxman-Markey or any other program for weaning us off fossil fuels.

One thing a program like Waxman-Markey would need to do if it wants to be successful, Friedman suggests, is to make sure the price signal set up by the program is a steady, predictable one. For innovation to happen, titans like General Electric, DuPont, and Microsoft need to feel confident that research and development invested in alternative energy sources and in the software that would run the "Energy Internet" will likely pay off. The price of fossil fuels needs to go high and stay high, such that the suddenly relatively low cost of renewables and smart grids looks attractive at all points down the road.

But from what I can tell, may be setting us up for unsteady carbon prices. A cap-and-trade system involves letting a market develop in the allowances required to cover actual or potential carbon emissions. The market puts a price on carbon, but like any market, it would see prices go up and down in response to supply and demand.

What's more, Waxman-Markey would permit allowances to be "banked" and "borrowed" by companies that directly emit, or indirectly engender, carbon emissions. Practices like these might smooth out supply and demand, which is good. But they might also exacerbate price swings, which is bad. If carbon prices fluctuate too much, innovation in "clean electrons" could be stifled.

Sadly, in discussions I have seen thus far, little attention has been paid to Waxman-Markey's ability to promote innovation.

411 on Waxman-Markey

Trying to figure out the cap-and-trade energy bill now in the House of Representatives? You're not alone. I've been examining sources of information on the Waxman-Markey bill, H.R. 2454, officially called the American Clean Energy and Security (ACES) Act of 2009. Here's some of what I've figured out.

A quick summary: I think Waxman-Markey will help us significantly reduce our "carbon footprint" in this country, and that's good; however, there are lots of hard-to-comprehend complexities to it. Some of them might seem at first glance to limit its effectiveness, but are actually good ideas. Others will in fact water it down but seem to have been introduced in order to get enough votes in the House to pass it.

"Waxman-Markey," by the way, refers to Democratic Reps. Henry A. Waxman (Calif.) and Edward J. Markey (Mass.), the bill's two chief sponsors in the House.

ACES's most talked about feature is cap and trade, a way to put a price tag on U.S. emissions of earth-blanketing carbon dioxide and other greenhouse gases (GHGs) into the atmosphere. A quick summary of ACES as a draft bill is available here. Though it doesn't mention "cap and trade" by that name, its Title III ("Reducing Global Warming Pollution")

... establishes a market-based program for reducing global warming pollution from electric utilities, oil companies, large industrial sources, and other covered entities that collectively are responsible for 85% of U.S. global warming emissions. Under this program, covered entities must have tradable federal permits, called “allowances,” for each ton of pollution emitted into the atmosphere. ... The program reduces the number of available allowances issued each year to ensure that aggregate emissions from the covered entities are reduced by 3% below 2005 levels in 2012, 20% below 2005 levels in 2020, 42% below 2005 levels in 2030, and 83% below 2005 levels in 2050."

The "number of available allowances issued each year": that's the "cap." Covered entities, which include "electric utilities, oil companies, [and] large industrial sources" of greenhouse gases like CO2 — but not "entities that emit less than 25,000 tons per year of CO2 equivalent [a general term for greenhouse gases including, but not limited to, carbon dioxide]" — must not emit greenhouse gases beyond the cap. Those gases they do emit must be matched, ton for ton of CO2 or equivalent, by allowances in the entities' possession. No allowances in hand, no emissions allowed into the air.

Oil companies, you may ask? Do they themselves emit greenhouse gases? Well, yes and no. Their refineries emit some GHGs as part of how they operate. But most of the allowances oil companies will need under Waxman-Markey are intended to cover emissions that are expected to take place later on, "downstream" from the refineries, as fuels like gasoline are burned. Emissions from your tailpipe and mine must be covered by allowances at points "upstream" from the consumer.

"Upstream" sources of carbon pollution like oil refineries are petroleum-based greenhouse pollution's great-granddaddy. The gas station is its granddaddy, and you and I are its daddies and mommies, plural, as we tool around in our SUVs (or econocars) and guzzle (or sip) carbon-laden fuel.


The fact that allowances, or "permits," are tradable: that's the "trade" aspect of "cap and trade." Say I am an electric company, and I have some allowances that I don't intend to use this year to cover coal or natural gas that I burn to produce electric power. Perhaps I have found ways to produce electricity more efficiently, or ways for my customers to use it more sparingly. I can sell my extra allowances to another electric company, to an oil refinery, or to any other "large industrial source" of greenhouse gas emissions covered by the legislation. (In fact, I can sell allowances to just about anybody who figures it is in their interest to buy — and use or resell — them.) The going rate at which the allowances are on offer at any given time establishes a price of carbon dioxide emissions (and its equivalents) into the atmosphere.

Of course, GHG emitters that want to sell permits can sell more of them, the more they cut their own GHG emissions. Selling permits on the open market may bring in more money than it costs these emitters to introduce emission-cutting efficiencies. In fact, this is one reason why the "trade" in "cap and trade" is vital. Companies that are in a position to cut emissions relatively cheaply — let's say they are just about to bring a new nuclear reactor online that has been in the works for years — will gleefully sell their permits to entities that can't economically cut back just yet.

In fact, that's a crucial selling point for ACES versus a straight carbon tax, a policy option that some think a better choice. Trading of emissions permits rewards companies that find efficient ways to get more bang for their carbon buck; they can profitably sell the permits they bought earlier, rather than using them and sending them up a smokestack. Companies that don't find cost-effective ways to help cut back on U.S. carbon emissions will, on the other hand, be penalized by having to buy extra permits.

Instead of rewarding companies that find ways to take advantage of the "low-hanging fruit" — cost-effective emissions cutbacks — a straight carbon tax penalizes those companies by simply taxing them on the carbon they continue to emit.


Best I can tell, the ACES summary refers to an early draft of the legislation that has been watered down. According to this one-minute summary of the legislation, "The new bill would require a 17 percent drop in U.S. greenhouse-gas emissions, compared to 2005 levels, by 2020. That's down from 20 percent."

The bill "was watered down somewhat to win over moderate Democrats on the committee," the one-minute summary says. "Afterward, Greenpeace and a few other environmental groups said the bill had become too weak for them to support." (Most environmental groups still support ACES.)

The bill in current form "would also give away many pollution credits for free to electric utilities and other manufacturers, instead of auctioning them off." Some green advocates don't like that. Apparently, over 82 percent of the "credits" — another term for "allowances" or "permits" — would be given away each year, in the years between 2014 and 2019, if ACES in its current form becomes law. The rest would be sold at auction. In 2012 and 2013, only a bit over 70 percent would be given away. In later years, the percentage of allowances auctioned would rise gradually to some 70 percent by 2031, then stay at that level through 2050. (The years between 2012 and 2016 would act as transition years during which bill would gradually come to include the entirety of its gamut of "covered entities.")

Though (says the one-minute summary) "the money generated by government auctions of credits could be used for energy-efficiency programs or a tax cut," such a policy option is undercut by giveaways of permits to companies that, in policy-wonk parlance, are "grandfathered" into the cap-and-trade system. So say certain green advocates.

"But," says the summary, "some Democrats, from states reliant on fossil-fuel energy, say that [the bill] would pose an undue burden on power plants, and heavy industry. They say that this burden could be lessened by giving these polluters some emissions credits for free, instead of auctioning all of them."

Cap and Trade 101: A Climate Policy Primer, from the Sightline Institute, says freebie permits would simply give their recipients windfall profits to the tune of the price the permits will sell for in the allowances marketplace. Sightline and certain other proponents of cap and trade resent that.


Also, the early draft of ACES had some other features that might give environmental groups pause.

One is "offsets." Offsets are different from "credits," "allowances," or "permits." An offset "allows covered entities to increase their emissions above their allowances if they can obtain 'offsetting' reductions at lower cost from other sources." The official ACES summary doesn't enumerate what the candidate offsetting reductions might be. Offset credits, I hear, might bankroll such things as investing in forestation projects — since trees remove carbon compounds from the atmosphere and lock them up until such time as the trees are destroyed. A coal-fired electric power generating company might invest (indirectly) in such a project and apply a certain number of offsets against the carbon it emits.

But environmental gurus say offsets are ways polluters can game the system, since that vaunted forestation project may have become a reality anyway. If it would have, the emissions-reducing value of the offset is nil.

Another possibly problematic feature of ACES is "banking and borrowing." "Banking" allows permits for, say, 2018 to be held until, say, 2021 before they are used to match actual carbon emissions in that latter year. Accordingly, actual 2018 GHG emissions might fall short of the nominal 2018 cap, while actual 2021 emissions might then overshoot the (reduced) 2021 cap. The total quantity of emissions would still adhere to the aggregate amount permitted over the range of years covered by Waxman-Markey: 2012 to 2050.

"Borrowing" is use in one year of an allowance that has been established for use
in a future year, as long as (per the Waxman-Markey summary) the future year is within "a rolling two-year compliance period." The allowances borrowed from future years would cover current carbon emissions. Hence, borrowing would move allowed carbon emissions forward in time, with respect to the 2012-2050 period covered by Waxman-Markey. This would be the opposite of "banking," which would move allowed emissions back in time.

It might be thought that banking and borrowing would result in an uneven, thus unpredictable, price for emissions of CO2 and its greenhouse gas equivalents, making for unsteady profitability for bringing alternative energy sources into the mix. However, studies that model and predict the results of cap-and-trade proposals in general (such as Assessment of U.S. Cap-and-Trade Proposals and The Cost of Climate Policy in the United States from the MIT Joint Program on the Science and Policy of Global Change) seem to indicate just the opposite: banking and borrowing would smooth out greenhouse-gas prices over time, in a cap-and-trade system.

Also potentially troubling to green advocates is the bill's provision for a "strategic reserve": "a small number of allowances authorized to be issued each year" will instead be set aside as "a cushion in case prices rise faster than expected[, such that] when allowance prices rise to unexpectedly high levels," the held-in-reserve allowances would be made available by the EPA through an auction. In other words, instead of depending on private concerns to "bank" their unused allowances prudently, Uncle Sam will seemingly bank some of the allowances himself. One possible objection to that is that the banking, borrowing, and strategic reserve provisions of the bill, taken all in all, would provide so much of a cushion as to keep price signals at bay that would otherwise shock us into forsaking fossil fuels in favor of clean energy.

And green proponents are surely taking gas (pun intended) over this from the ACES summary:

Clean Air Act Exemptions. The draft [version of the bill] provides that CO2 and other greenhouse gases may not be regulated as criteria pollutants or hazardous air pollutants on the basis of their effect on global warming. The draft also provides that new source review does not apply to these global warming pollutants.

That's clearly a concession to Big Oil and Big Energy, who just don't want EPA to regulate greenhouse gases as so-called "hazardous air pollutants."


Another concession: "The [ACES] draft authorizes companies in certain industrial sectors to receive 'rebates' to compensate for additional costs incurred under the program. Sectors that use large amounts of energy, and produce commodities that are traded globally, would be eligible for the rebates." This is to "ensure that U.S. manufacturers are not put at a disadvantage relative to overseas competitors."

In thinking about that provision, we need to keep in mind that there will be bigtime costs to be borne due to carbon cap and trade (a fact that would be true even if we went to a plain carbon tax instead). What used to be free — emitting greenhouse gases — now will have a price tag. It comes from the fact that allowances are bought and sold on a market; without allowances to match their emissions, emitters would have to shut down.

Emitters that want to continue doing business thus have to buy allowances — or, if they get them for free under Waxman-Markey, they have to eschew selling them at the going market price.

If the emitters find some way to avoid having to retire the allowances they possess, in exchange for covering greenhouse gases they emit or engender — say, they avoid having to use allowances by instituting efficiency measures — they'll wind up holding assets that they can either bank or sell.

If they bank them, fine. There will be fewer emissions than policymakers anticipated in the current time frame, though there will be more than anticipated later. However, banking excess allowances rather than selling them counts as a cost of opting to do business in that manner: money that the allowances would fetch on the open market is being forgone.

If emitters sell allowances they own, rather than use them to match emissions, they'll get windfall profits to the extent that they received those allowances from Uncle Sam for free. Looked at in this way, using freebie allowances to match actual emissions in the current time frame, and thereby retiring those allowances, has a cost: eschewed windfall profits.

By extension, using allowances that were paid for at auction likewise has a monetary cost: eschewing the proceeds of selling them on the open market.

Any way you look at it, allowances impose costs. The question is, who ultimately bears these costs?

The answer economists give is: mostly entities (including ordinary consumers) "downstream" from the companies that originally buy the allowances at auction, or receive them for free. Among the affected "downstream" entities are industrial sectors that use (but do not produce) large amounts of energy. Ditto, sectors that produce commodities that are traded globally.

Think of the total system as a series of pools connected by a flowing stream. The pool at the highest elevation represents, for example, a coal mining operation — under Waxman-Markey, it would be a point at which allowances enter the system.

The next pool downstream is, say, a coal-fired electric utility. Under Waxman-Markey, it, too, might be a point at which allowances enter the system.

The electric utility in turn feeds the pool that is next furthest downstream, which could be a company like General Motors that buys electricity to power its assembly plants. GM would presumably not be a point at which allowances enter the system.

Between the GM plant and the car buyer might be other pools representing the transportation system that brings the vehicles to market, the auto distributorship, and the retail showroom. They all require electric power (or, in the case of the transport system, combustable liquids such as petroleum-based diesel fuel that represent a separate cap-and-trade stream).

The overarching point is that each pool in the stream receives water (cost burdens) from each pool that is further upstream.

True, some of the costs that cap and trade imposes are absorbed at each stage (i.e., by each pool). In this analogy, each pool in the stream retains some of the extra water that cap and trade injects into the stream. But the rest of the extra water finds its way downstream. Ultimately, any of the water that does not get retained at various upstream stages finds its way into the lowest pool in the stream: the cost of living faced by end-product consumers like you and me.

The "rebates" provision of Waxman-Markey primarily affects middle-stage pools such as, in this example, GM. GM, the logic goes, shouldn't have to pay the full cap-and-trade cost deluge imposed upon it by upstream stages like the coal-fired electric utility and the coal mine. Hence the rebates.

In concept, these rebates would also reduce some of the extra influx of water (cap-and-trade costs) at downstream stages such as your budget and mine.

Accordingly, although the ACES summary specifically picks out "ensuring that U.S. manufacturers are not put at a disadvantage relative to overseas competitors" as the justification for "rebates," these rebates would also ease average American's "sticker shock" when the costs of cap and trade become evident to them.

But, green advocates would say, is that all good? After all, it is the extra influx of (costly) cap-and-trade "water" that might convince us all to buy smaller, more fuel-efficient cars.

I tend to side with the green advocates in such matters. Still, it is quite clear that this is a complex subject, at least as complex as health-care reform. It will affect the pocketbook of every Harry and Louise in America. The difference is, the ways in which it will affect our pocketbooks are less obvious than the everyday act of paying for a doctor's visit with an insurance card and a copay.

Climate bill to pay hundreds of dollars in rebates

"Climate bill to pay hundreds of dollars in rebates", reads the headline of an Associated Press article online at WashingtonPost.com. The general thrust of the article is that the Waxman-Markey cap-and-trade bill now under consideration in the U.S. House of Representatives would raise money — "$846 billion from 2010-2019" — by "auctioning off pollution permits to companies that release climate-altering gases." Some of that money would get rebated to lower-income families.

I find the article unclear on this point. It says, "The bulk of that [$846 billion] — $693 billion — would be given away as free permits to companies and states to ease costs." OK, one wonders, if permits are given away for free, how can they furnish part of the $846 billion in generated revenue?

Also dicey is this sentence: "The amount of permits that will be sold will increase over time and they will become more expensive, generating $846 billion from 2010-2019 ... ." It is my understanding that the amount of permits will decrease over time, not increase. The "cap" part of "cap and trade" is expressed basically as the number of permits issued, with each permit representing (say) one ton of carbon dioxide, or its climate-changing equivalent, that is released into the air. As the years roll by, the cap is supposed to shrink. That means the number of permits issued must shrink, too — which is basically the only way that "they will become more expensive," by the law of supply and demand.

I'm guessing that the implication is this: Waxman-Markey would start out by giving away fully 85 percent of the carbon-pollution permits but, as time goes on, that percentage would go down, and the percentage of permits that are sold would go up ... a phased-in approach, possibly. I'll have to look further into this ...

Anyhow, the article goes on to say, "The remainder [of the $846 billion generated over 10 years] will pay for research, the energy tax credits and rebates, and a worker assistance program that will provide benefits including lost wages and health insurance to people who lose their jobs because of the limits placed on global warming pollution."

What's going on here?

As it says in Sightline Institute's Cap and Trade 101: A Climate Policy Primer, a regional or national cap-and-trade climate policy, unmodified by tax credits and rebates, would dump more of its cost burden on lower-income people than on middle- and higher-income folks: it would, in the language of economists, be highly "regressive."

Why so? Those in the lowest (say) two-fifths of the income (or household spending) ladder pay more, percentage-wise, for energy costs — home heating, electric bills, gasoline, etc. — than richer households do. What's more, they spend (rather than save) a greater percentage of their disposable income on all that they buy, whether or not it's directly associated with energy consumption. Their groceries, for example, are trucked into their area by big rigs burning diesel fuel, whose costs will go up under cap and trade. So the little folks' grocery bills (including those of the big rig drivers) will go up, too, because they include a new tax — though one that is, effectively, hidden — on carbon.

But, the article says, Waxman-Markey offers rebates only below the relatively paltry $23,000 income level for individuals and $42,000 for families. Is that going to be enough help for the poorer folks among us?

Per the article:

Various studies by the federal government, universities, and think tanks have found that the average household could pay an extra $98 to $1,600 a year for electricity, gas and other goods that need energy to be produced if the government requires mandatory reductions in heat-trapping gases. Lower-income households are likely to feel the burden more because they spend a greater percentage of their income on energy.

That's another instance of bad reportage in the article, since it leaves the impression that Waxman-Markey might cause a relatively petty increase in our electric bills — $98 — or it might boost our bills by a whopping $1600. Something of a crap shoot, in other words.

One problem here is that such a wide range of studies is referred to in the article. A key study by the Congressional Budget Office, "Trade-Offs in Allocating Allowances for CO2 Emissions," has it that (see its Table 1) a cap-and-trade plan that cuts emissions slightly less than Waxman-Markey (15 percent by 2020, rather than 17 percent) would give households in the lowest one-fifth by income a $560-per-year "hit" in terms of extra expenses (expressed in year-2000 dollars). The remaining four income quintiles, in order from lowest to highest, would pay $730, $960, $1,240, and $1,800 extra a year.

For the five quintiles, from lowest to highest, those figures represent expenditure increases, as percentages of income, of 3.3, 2.9, 2.8, 2.7, and 1.7 percent, respectively. Though the highest-income fifth of us would take a much bigger hit than everyone else when measured in dollars, when measured as percentage of income, their hit would be much lower than that of the rest of us.

Still, households at all levels would seemingly take big hits under cap and trade. Why? One reason is that the cost of the permits — is it "$846 billion from 2010-2019"? — will get passed along from (per the article) "companies operating 7,400 facilities nationwide, including power plants, refineries and factories" to (eventually) you and me, in the form of higher rates for electric power, pricier gasoline, and the like.

Now, the article isn't clear on whether the $846 billion is the amount of money auctioning off the permits (those that aren't given away for free) would bring in as direct revenue over ten years. Or, it could be an estimate of the eventual market value of the permits, taken in toto, whether originally sold or given away.

That's right: however much or little the original recipients have to pay for the issuance of permits, what really counts is how much the entities that eventually use them have to pay, at going market rates, at the time that they are used. Those permit-utilizing entities will be big players in the energy economy that are directly or indirectly responsible for producing the carbon emissions that are capped under cap and trade. A coal-fired electric utility emits carbon directly; an oil refinery produces fuels that eventually get burned; the refinery is an indirect polluter. These entities will both need to buy, then use, permits to cover their carbon footprints.

These big guys are the so-called "upstream" carbon polluters. They'll sell whatever it is they produce to, not just households, but corporations, businesses, private institutions, and government agencies — the multifarious "downstream" sources of our nation's carbon pollution. And, experts say, most of the upstream sources' permit costs will float downstream as well. These costs will show up (often in hidden fashion) on every bill that every entity in the economy pays.

This is a crucial point about cap and trade. One of the two main points of the exercise is to send a "price signal" to upstream and downstream polluters alike, saying that it's no longer possible to "dump" carbon into the atmosphere for free.

The other main point? It's to set a firm (and shrinking) limit on the amount of carbon that gets dumped in the first place.

But lots of carbon will still get dumped. That dumping will come, though, for the first time, at a cost.

Yes, most upstream or downstream polluters will (not so gladly) pay that cost, in order to keep from undergoing super-fast changes to our lifestyles, ways of making a living, and ways of doing business.

At the same time, most carbon polluters will start looking for new ways to conserve and economize — to stop wasting energy, and thus to lower the bills which cap and trade has inflated.

At some point, it will become harder and harder to find ways to cut back while still preserving our reliance on carbon-based energy. It will become more attractive, from strictly a dollars-and-cents point of view, to see about switching to alternate, renewable, sources of energy: solar, wind, hydro, geothermal, and so forth.

As the Sightline primer mentioned above points out, making the switch would wind up lowering the cost of carbon permits — not as many permits would be needed, after all is said and done, as originally anticipated — which would moderate the adverse effects of cap and trade on our cost of living.

The "17 percent reduction in greenhouse gases by 2020, and ... 83 percent cut by mid-century" that Waxman-Markey looks for, per the AP article, would very likely not be as expensive in the long run as current news coverage might indicate!

Cap and Trade 101: A Climate Policy Primer

Cap and Trade 101: A Climate Policy Primer, from the Sightline Institute, in the Pacific Northwest, is must reading for anyone interested in climate policy, and in particular the cap-and-trade approach to reducing carbon emissions.

As I've been saying in earlier posts in this Cap and Trade topic, the American Clean Energy and Security Act, a.k.a. Waxman-Markey, is currently before the U.S. House of Representatives. If it becomes law, it would create a cap-and-trade system to put a price tag on spewing carbon pollution into the atmosphere from the United States. Carbon compounds, particularly CO2, are greenhouse gases that hang around in the atmosphere, trap the sun's heat, and ratchet up global temperatures. When we burn fossil fuels such as coal, natural gas, and petroleum products, we produce greenhouse gases by the ton. Any further increase in man-made "global warming" will have disastrous consequences, scientists say, so we need to reduce our dependence on, or find alternative energy sources to, coal, natural gas, and petroleum products such as gasoline and diesel fuel.

Waxman-Markey would set a "cap" on the total number of tons of "CO2 equivalents" that electric utilities, oil refineries, and the like are directly (through burning fossil fuels) or indirectly (through providing fossil fuels for others to burn) responsible for emitting into the atmosphere. This cap, whose total size would be ratcheted downward over the course of several years, would be divided up into "allowances" or "permits" that are either sold at an auction run by a designated governmental authority or given away for free to historically high-volume sources of greenhouse gases. After being auctioned or given away, the permits would then be "traded" — bought and sold in a market for them — until they were finally used by whoever ultimately owned them to sanction carbon emissions in the amount associated with the permit.

The Sightline Institute paper is a primer on cap and trade. It doesn't address Waxman-Markey specifically, but it does provide clearly written insights into what C&T is all about. More that that, it discusses the various ways in which C&T might conceivably be set up, giving reasons why certain options are better choices than others.


For example, there is a policy decision to be made as to whether the permits will be given away free ("grandfathered") to bigtime polluters, or sold at auction. The Sightline position, with which I at least tentatively agree, is that all permits should be auctioned. (Waxman-Markey auctions only 15 percent of the permits, giving 85 percent away for free.)

Why auction all permits? The main reason is that giving them away does not, as many people intuitively imagine, hold down consumers' added monetary costs of buying energy that would likely occur in a C&T system.

For one thing, Sightline asserts that the supposedly greatly elevated energy costs due to C&T will not materialize, since carbon-based energy costs are already much elevated due to relatively low supply and relatively high demand. C&T would simply redirect the high profits now accruing to carbon-based energy's sources to a revenue stream that the government could dedicate to one or more of several good purposes that are described in the primer.

Even more convincing is the other reason to auction all permits, not give them away. If utilities, refineries, and other big players in the energy economy get free permits, the fact that the permits first emerge with no price tag does not set their value in the marketplace. Their market value is actually quite substantial, and it accrues as massive windfall profits to the fat-cat shareholders of the energy titans.

The analogy is drawn to a scalper selling World Series tickets. He sells them at whatever high price the market will bear, based on supply and demand ... regardless of whether he originally found the tickets lying on the ground! The selling price that he receives for the tickets is his windfall profit on those tickets.

On the other hand, if all permits are auctioned for a price set by the dynamics of the auction process itself, billions of dollars will flow into public coffers that can be used (among other uses) to reimburse the low-income families that would be hardest hit if energy prices go up.

The Sightline primer is, as I say, a must read ... even for every latter-day Harry and Louise who are now poring over the various proposals Congress is sorting out for health care reform!

The Folly of Unilateral Cap-and-Trade?

In a recent Washington Post edition, well-known economist Martin Feldstein writes, in The Folly of Unilateral Cap-and-Trade, "In my judgment, the proposed [Waxman-Markey] cap-and-trade system would be a costly policy that would penalize Americans with little effect on global warming."

Dr. Feldstein, a conservative economist, opposes the proposed cap-and-trade system that this liberal blog has come to support: Uncle Sam auctioning off and/or giving away permits to electric companies and other carbon polluters who expect to continue to pump carbon dioxide into the atmosphere, with the understanding that there will be an overall "cap" on the number of tons of CO2 the United States as a whole could emit each year. This cap, made ever smaller over the years, would shrink this country's "carbon footprint" by 17 percent below 2005 levels by 2020, per the proposed Waxman-Markey bill now under consideration in the House of Representatives.

Waxman-Markey not only caps overall CO2 emissions, it expects the permits, once issued by the government, to be bought and sold ("traded") in a marketplace. A company may not need all the permits (also called allowances, rights, or credits) it originally buys, or is given, each year. If it cleans up its act with updated technology — using solar or wind power to generate electricity, bringing online a new nuclear generating plant, implementing carbon sequestration technology, etc. — it can sell its unused permits to another company that has not (yet) so gone "green." There will thus be a market price on each ton of permissible carbon emissions, even if most of the permits would initially be given away.

Is this a bad idea? Dr. Feldstein thinks so.

He complains about several things. First, Waxman-Markey aims to reduce CO2 emissions only "to 83 percent of the 2005 level by 2020, then gradually decrease the amount further." That's a 17 percent reduction below the 2005 level by 2020, as I just said. Dr. Feldstein (I think legitimately) analyzes the 17 percent reduction of Waxman-Markey in terms of the roughly equivalent 15 percent reduction assumed in recent Congressional testimony given by Terry M. Dinan, a Congressional Budget Office senior analyst. (This expert testimony may be downloaded in PDF form here.)

That analyst found that a cap-and-trade system with a 15 percent reduction would boost consumer prices significantly: "CBO estimates that the price increases resulting from a 15 percent cut in CO2 emissions could cost the average household roughly $1,600 (in 2006 dollars), ranging from nearly $700 in additional costs for the average household in the lowest one-fifth (quintile) of all households arrayed by income, to about $2,200 for the average household in the highest quintile."

Meanwhile, this country produces less than a quarter of the carbon emissions of the world as a whole, per Dr. Feldstein. He accordingly says, "a 15 percent fall in U.S. CO2 output would lower global CO2 output by less than 4 percent." Dr. Feldstein doesn't think that reduction is enough to justify raising Americans' average cost of living by (in the CBO's 15 percent scenario) $1,600.


The more I look into cap-and-trade, the more I realize that the results it would produce depend on precisely how the system is tweaked. For example, whether the permits are initially sold at auction or given away gratis makes a difference as to how high the net cost burdens placed on CO2 pollution will be, and who will bear them. (For more on this, see an issue summary prepared by Terry Dinan for the CBO, Trade-Offs in Allocating Allowances for CO2 Emissions.)

Waxman-Markey would give away some 85 percent of the permits to various types of companies (including "30 percent of the permits to local electricity distribution companies," says Dr. Feldstein) and sell the rest. The reason that not all the permits would be sold for a price under Waxman-Markey is apparently to appease congressmen from areas where power companies, coal producers, and other businesses that are heavily dependent on the current carbon economy carry a lot of political weight.

But, according to the CBO's "Trade-Offs" issue summary, the extent to which allowances are given away and not sold is closely linked to the extent that the cost impact of cap-and-trade on shareholders and workers in today's carbon-dependent industries would be lessened — at the price of shunting more of the costs of cap-and-trade onto energy consumers and the economy as a whole.

Clearly, however cap-and-trade is tweaked, there would be costs that someone would have to bear, if only because some polluters would necessarily need to shell out for permits. The "Trade-Offs" issue summary says, furthermore, that even the permits that are originally given away for free by the government would wind up bearing an implicit price tag:

Although producers would not bear out-of-pocket costs for allowances they were given, using those allowances would create an “opportunity cost” for them because it would mean forgoing the income that they could earn by selling the allowances. Producers would pass that opportunity cost on to their customers in the same way that they would pass along actual expenses.

These costs, whether they are actual, out-of-pocket expenses or "opportunity costs," would be costs that don't exist in today's energy economy.


A big question is, how would these costs be distributed? Dr. Feldstein worries that "regulators would require [electricity companies that receive free permits] to pass the benefit on to their customers." Moreover,

If they do this by not raising prices, there would be less CO2 reduction through lower electricity consumption [for those particular companies]. The permit price would then have to be higher to achieve more CO2 reduction on all other products [i.e., products sold by other companies]. Some electricity consumers would benefit, but the cost to all other American families would be higher.

A lot is compressed in those few sentences. First of all, Dr. Feldstein is assuming that the "pass-through of the permit cost in higher consumer prices is the primary way the cap-and-trade system would reduce the production of CO2 in the United States."

This means that companies that do have to shell out hard cash for permits would (Dr. Feldstein believes) pass those costs on to their customers intact. The "Trade-Offs" issue summary agrees:

Researchers conclude that much or all of the allowance cost would be passed on to consumers in the form of higher prices.

The bills of utility companies' customers would go up accordingly. Presumably, consumers of electric power would find ways to cut back their consumption, in order to save money. The utility company would then be able to get by with producing less electric power than it does now, which would result in less carbon flying up the smokestack.

But what happens when permits are given away for free to certain (though not all) utilities? Unlike their counterparts elsewhere, Dr. Feldstein says they would (at regulators' insistence) not raise their electricity rates. There would be no incentive for their customers to cut back. Hence, the U.S. could meet its overall carbon cap only if other companies' customers faced a comparatively steeper rate hike than would otherwise be needed. That would transpire only to the extent that those companies that don't get their permits for free had to spend comparatively more bucks to buy the necessary permits.

At least, this is Dr. Feldstein's argument. And it seems to be borne out in the "Trade-Offs" issue summary by this footnote to the passage cited above concerning "opportunity cost":

One exception is if allowances were given to electricity generators whose rates were set by regulators. In that case, regulators might prevent generators from passing the opportunity cost of holding [i.e., owning] an allowance along to consumers.

If the "opportunity cost" associated with a given-away allowance or permit is kept by regulators from being borne by that electric utility's customers, then it must be borne by other entities in the economy. Dr. Feldstein feels this is bad policy.


He might be right, were it not for a major consideration he does not mention, and neither does either CBO paper cited above: the market price of carbon-emissions allowances will stimulate investment in alternative, renewable, clean, "green" sources of energy such as solar and wind power, geothermal power, hydropower, and the like.

Thomas Friedman, in Hot, Flat, and Crowded: Why We Need a Green Revolution — And How It Can Renew America, says we need a "forest fire of innovation in energy [brought about] by reshaping the market in such a way that will make it easier for clean power technologies to compete and challenge the incumbent dirty [carbon-based] fuels" (p. 249).

"The market will give us what we want," he goes on to say, "but only if we give the market the [price] signals it needs: a carbon tax, a gasoline tax increase, a renewable energy mandated [imposed by fiat by the government upon power companies], or a cap-and-trade-system that indirectly taxes carbon emitters — or some combination of all these" (p. 251).

Waxman-Markey amounts to "a cap-and-trade-system that indirectly taxes carbon emitters." The signal it would give the energy economy by putting a steep price on the right to emit carbon into the atmosphere would encourage the economy to find other ways to produce energy.

Reshaping the energy economy via an indirect, cap-and-trade tax on carbon emission would coerce the players in the marketplace to place heavier bets on solar or wind power generation and other renewable technologies than they now do. Such alternative energy technologies would find themselves moving down their initial start-up learning curve, while at the same time the scale increases at which these technologies are able to compete economically with dirty, carbon-based technologies.

The proverbial "economies of scale," as they kick in, would eventually make renewable energy cheaper than carbon-based energy, as well as less subject to price fluctuations and uncertainties, as is common with petroleum products today. With less price uncertainty for energy as a commodity, energy producers and consumers could plan more accurately for the future, yielding yet a second kind of reduction in long-term energy costs.

Those reductions in energy costs due to the maturation of alternative energy technologies would to some extent offset the additions to energy costs represented by the market price of carbon allowances. Someday they might even match or exceed the total cost of the allowances, who knows?

Dr. Feldstein does not incorporate such cost reductions in his view of the situation, and neither do the CBO analyses mentioned above. That seems to me to be a glaring inadequacy of Dr. Feldstein's criticism of cap-and-trade à la Waxman-Markey.