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.
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