Climate Reality Eludes the Business Press

By John Miller, Dollars and Sense. Posted August 27, 2008.

Cap and Spend. As the Senate opens debate on its mammoth carbon regulation program this week, the phrase of the hour is "cap and trade." This sounds innocuous enough. But anyone who looks at the legislative details will quickly see that a better description is cap and spend. This is easily the largest income redistribution scheme since the income tax.

-- Wall Street Journal editorial, June 2, 2008

Climate Reality Bites. Cap and trade is a tax imposed on business, disguising the true costs and thus making it more politically palatable. In reality, firms will merely pass on these costs to customers.

... politicians like cap and trade ... because it gives them a cut of the action and the ability to pick winners and losers. Some of the allowances would be given away, at least at the start, while the rest would be auctioned off, with the share of auctions increasing over time. This is a giant revenue grab.

The Environmental Protection Agency estimates that this meddling would cause a cumulative reduction in the growth of GDP by between 0.9% and 3.8% by 2030.

-- Wall Street Journal editorial, May 27, 2008

The Wall Street Journal's editors are celebrating having dodged a big-government bullet when the cap-and-trade global warming bill sponsored by Joe Lieberman and John Warner, as amended by Barbara Boxer, went down to defeat this June in the Senate.

But the Lieberman-Warner Climate Security Act of 2008 was a fairly low caliber munition in the fight against global warming. While undoubtedly the most comprehensive global warming bill ever to reach the Senate floor, its emission reductions fell well short of those called for by environmental groups or by the Clinton and Obama campaigns.

Inside Cap-and-Trade

"Cap-and-trade," introduced in the 1990 Clean Air Act to regulate sulfur dioxide (SO₂) emissions or acid rain, is now the favorite form of environmental regulation for politicians and big business. They find it far preferable to either command-and-control regulation, such as federal directives ordering electrical power plants to install smokestack scrubbers, or emissions taxes, such as a broad-based carbon tax.

Cap-and-trade, referred to variously as incentive-based regulation or market-based regulation, works this way. The federal government sets a mandatory, nationwide cap on carbon dioxide (CO₂) emissions that it gradually reduces. At the same time the government requires companies, or any emitter, to hold allowances for their emissions. Typically each allowance entitles a company to emit one ton of CO₂.

After the government either auctions off allowances or issues them to companies based on their energy output or usage, holders are free to buy and sell them. Companies that can reduce emissions cheaply, usually those with newer plants, will likely cut their emissions below the standard for their industry and sell their unused allowances (or, if allowances are auctioned rather than issued for free, buy fewer of them), reducing their abatement costs. Companies with relatively high abatement costs, usually those with older plants, can be expected to buy additional permits (either from other companies or the government) at a price well below their cost of abatement so that they can reduce emissions by less than the industry standard. The flexibility, or "non-uniform abatement," afforded by permit trading allows the least costly abatements to be carried out first, lowering the overall cost of meeting any given environmental target.

The Climate Security Act would have required the Environmental Protection Agency (EPA) to establish a cap-and-trade program to cover U.S. electrical power, transportation, manufacturing, and natural gas sources that together account for 87% of U.S greenhouse-gas emissions. Beginning in 2012, the EPA would steadily reduce the cap on total emissions, down to 71% below their 2005 level by 2050.

Over the life of the program the EPA would auction off the majority of allowances, but initially about 40% would be given away, ostensibly to help industries make the transition to lower emissions. Revenue from the auctions, estimated at $5.6 trillion over the life of the bill, would be used to finance some relief for the poor to offset increases in utility bills, training and assistance for workers, deficit reduction, research on clean-energy technologies, and an array of subsidies for electric and gas utilities, the coal industry, auto manufacturers, oil refiners, and the nuclear industry.

Big But Not Big Enough

That is the giant revenue grab the Journal's editors protest. Still, it's over the top to compare $5.6 trillion over four decades -- that's $147 billion a year, or less than 6% of current federal government revenue -- to the income tax, which increased government revenue nearly eightfold when it became a broad-based tax during World War II. And today, the $869.6 billion collected in payroll taxes in 2007 and redistributed through the Social Security system dwarfs the revenues that would be collected by this cap-and-trade proposal.

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John Miller is professor of economics at Wheaton College and a member of the Dollars & Sense collective.