Dividing the Loot from Cap and Trade
Now that the Senate Finance Committee has finished doing whatever it did to health-care reform, it is turning to cap and trade with this morning's hearing on "allowance and revenue distribution." This sounds like a boringly technical topic, but in fact it's one of the most important aspects of climate change legislation.
A brief review: A cap-and-trade system to regulate carbon emissions is one in which, to emit a ton of carbon, you have to have a permit - these are the "allowances." Those permits can be traded on an open market. The point is that because the allowances have a market price, they create an incentive for firms to emit less carbon. Say I emit 100 tons of carbon, I have 100 permits, and permits trade at $20 each; if I can reduce my emissions by 10 tons, I can sell those permits and make $200; so if I can make that emission reduction by investing less than $200, then I will do so. (Without cap and trade that investment would be a pure cost, so I wouldn't do it.) In any plausible cap-and-trade bill, the total number of allowances will start high and go down over time; this is how emissions get reduced.
The thing that gets complicated, and that makes this a Senate Finance Committee issue, is that those allowances have value, and a lot of it; according to the Congressional Budget Office, the allowances for the year 2020 could be worth $300 billion. Since these allowances are an asset that is being created by an act of Congress, they currently "belong" to the federal government. And the question is how they should be distributed to the firms that will actually use them.
A fair amount of economic research has shown that how you distribute allowances can have distributional effects (obviously) but also efficiency effects. To take the example I know best, Sylvia Brandt of the University of Massachusetts, Amherst, (who happens to be my wife) has shown that when firms anticipate a particular allocation formula, they will take strategic action in anticipation of regulation, which may affect outcomes. For example, because fishing firms expected that tradable permits would be allocated based on the number and size of vessels in the fleet prior to the regulatory change, they had an incentive to re-introduce old, inefficient vessels into the fleet, simply because it would increase their share of the permits being given out.
The fight, then, is over what to do with the hundreds of billions of dollars that the carbon emission allowances are potentially worth. The House bill, which was most closely defended by Nathaniel Keohane of the Environmental Defense Fund, distributes most of those allowances to firms in ways that are designed to promote specific economic objectives. According to his analysis (see especially pages 6-7), 43 percent of the total value will go to consumers, either as tax refunds or because energy distribution companies will be forced to pass on the benefits of their allowances to consumers; 29 percent will go to industry or small business, much of it to protect energy-intensive sectors against job loss; and 27 percent will fund programs such as energy research and environmental protection.
Alan Viard of the American Enterprise Institute, by contrast, takes the relatively "purist" stance that messing around with allowances is inefficient and that the right answer is a carbon tax - something that many environmentalists have advocated for but that the Democratic leadership presumably thought was politically unachievable, because it includes the word "tax." Given a cap-and-trade system, Viard's preference would be to simply auction off the allowances and use the revenue to reduce marginal tax rates or, alternatively, to subsidize low-income consumers who will be most affected by rising energy prices.
Dallas Burtraw of Resources for the Future also argues for modifying the House bill to provide direct tax rebates to households rather than funneling benefits through local energy distributors. One issue he focuses on is how to provide incentives to households to reduce energy consumption; he worries that if households do not see the cost of emission allowances showing up on their energy bills, they will not respond as necessary by reducing consumption.
Given that cap and trade seems the likely outcome - unless we end up with nothing - how this debate is resolved will have a major impact on who gains from the ultimate legislation. After hogging the spotlight on health care, the Group of Six is prepared to grab it once again.
August 4, 2009; 2:00 PM ET
Categories: Energy and Environment , Regulation
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