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.
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