Cap-and-Trade (Part II)

(Read Part I of this story here)

Managing the Money

(1/15/2009) - Now that the government has sold a bunch of emission permits, what should they do with the money?  The two most common approaches to this question are investing the money in renewable energy and returning the money to citizens, either through targeted relief or a cap-and-dividend plan, or some combination of the two.

The relatively small amount of money collected by RGGI (about $145 million between the two auctions) is going to be split among the ten participating states and spent on renewable energy projects and subsidies.  Obama’s plan calls for a mix of the above two approaches.  Under Obama’s campaign proposal, a “small” portion of the proceeds (“$15 billion per year”) will be used to fund clean energy R&D, as well as “provide new funding to state and federal land and wildlife managers to restore habitat, create wildlife migration corridors, and assist fish and wildlife to adapt to the effects of a warming climate.”  The remaining money (an unspecified amount), “will be used for rebates and other transition relief to ensure that families and communities are not adversely impacted by the transition to a new energy, low carbon economy.”

How will a stiff carbon cap-and-trade system have an ill effect on Americans?  Carbon emitters will most likely pass on the new costs of emissions to consumers in the form of increased prices.  For example, a utility company that depends on coal-fired plants will increase the price of its electricity in order to pay for its emission permits, or it risks going out of business.  When prices increase for so-called “essentials” – food, gasoline, electricity, heating oil/gas, etc. – it can squeeze the budgets of poorer people to a breaking point, where as people who have more money can divert money from discretionary spending.  This is why energy and consumption taxes are generally considered to be regressive.

Cap-and-Trade vs. Cap-and-Dividend

The possible advantages of investing in clean energy research are fairly straight forward.  There is no requirement, however, that this funding need come from the cap-and-trade program.  Indeed, there are some compelling political reasons why it would be a better to invest in clean energy with “normal” taxes, and rebate all of the cap-and-trade income in an annual dividend in what is known as a cap-and-dividend plan. 

One of these reasons is philosophical.  Greenhouse gases pollutes the atmosphere, which is about as close to pure communal “property” as you’re going to get.  If companies are going to pay to emit greenhouse gases into the communal atmosphere, shouldn’t everyone receive payment for the use of their “property?” Under the cap-and-dividend plan, every man, woman, and child with a social security number would receive a payment.  In this way, it would be very similar to Alaska’s Permanent Fund’s annual dividend.

A dividend-only plan also offers some practical advantages for popularizing and building the much needed continuing political support for cap-and-trade, as the program will need to exist for many years and become increasingly stringent as time goes on.  Enacting a cap-and-dividend plan will instantly make it the most widely known government plans in the United States, as everyone with a social security number (so, just about everyone) will receive an annual check from Uncle Sam.  The amount of money in each check will vary depending on how much money was raised by the permits auction.  However, even after including costs carbon emitters will pass on to consumers, most Americans will come out ahead, because more than half emit less carbon than the average American.

Let me explain.  Wikipedia estimates that the United States released 6,049,435,000 metric tons of carbon dioxide in 2004, or about 20 tons a person.  However, the average person (the median, as opposed to the mean), doesn’t produce 20 tons of carbon dioxide a year.  This difference is due to the fact that on average rich people produce much more carbon than poor people, and the richest group of Americans earn and spend much, much more than the poor.

Cap-and-Dividend is Revenue Positive

Many people refer to cap-and-trade programs that redistribute the collected money as “revenue-neutral,” because the government isn’t taking in money, but simply transferring the money between people who use more than their share of carbon and people who don’t.  It is much more likely that a cap-and-dividend program will be “revenue-positive.”  That is, on the aggregate people and companies will spend less on energy than they would have otherwise, because a cap-and-trade system will provide incentives to use energy more efficiently, which has time and again improved bottom lines for companies.

Carbon Cap-and-Trade vs. Carbon Tax

Many people advocate for a carbon tax instead of a cap-and-trade system, and there is something to be said for the prior method.  First of all, it is much simpler.  Cap-and-trade lends itself to the creation of complicated financial instruments for trading the right to pollute.  Cap-and-trade sometimes amounts to a government give-away, and they can be much easier to riddle with loopholes.

I believe, however, that a properly executed cap-and-trade system offers a number of advantages over a carbon tax.  A cap-and-trade system will addresse the problem - greenhouse gas emissions - directly.  It will be difficult to know how much a new carbon tax will reduce greenhouse gas emissions, which would lead to regular squabbling over what levels the tax should be set at.  A cap-and-trade system, on the other hand, sets the carbon cap and lets market mechanics figure out how much its going to cost.  This would make it much easier for climate scientists to influence policy. 

Pragmatisim vs. By the Book

Passing a good cap-and-trade program is only the beginning of the fight to prevent catastrophic global warming (at this point, some warming is inevitable).  As I have discussed previously, a cap-and-trade program is much more effective at preventing some types of emissions than others.  Basically, a carbon cap-and-trade will be most effective at limiting the use of coal.  A cap-and-trade, at least at first, will only have limited effects on other sources of carbon, such as petroleum.  If you want to limit the use of petroleum for reasons other than greenhouse gas emissions, a straight-up gasoline tax would probably be a much more efficient way of doing it. 

Another issue is that carbon dioxide is just one of several greenhouse gases.  Wikipedia estimates that methane and nitrous oxide emissions compose about 27% of carbon dioxide equivalent emissions.  Even if we eliminated 100% of our CO2 emissions, we will need to significantly reduce methane and nitrous oxide emissions if we’re going to reach emission targets.  The problem is that regulating these emissions will be a bureaucratic mess.  Nearly all CO2 emissions – especially in the United States - come from easily measured sources.  If we put 10 gallons of gasoline in a car’s engine, or a ton of coal in a furnace, a simple chemical equation can calculate how much carbon dioxide was produced.  Methane and nitrous oxide our released in a much less controlled manner.  Cow flatulence, for example, is responsible for a large percentage of methane emissions.  The amount of methane prodced by cows varies greatly depending on diet, living conditions, and individual biology.  It’s also hard to measure how much methane escapes from gas and oil wells, as well as from landfills.  Because of these issues,  a cap-and-trade system might not be the best way to limit non-CO2 emissions, because overseeing the cap would be very hard. 

Finally, policy makers need to remember that there are two ends to the carbon cycle – the sources and the sinks.  Almost all government policy proposals are concerned with the sources of carbon, which makes sense because that is where the risk of global warming comes from. 

On the other hand, I think that we should also build in some sort of credit for promoting natural carbon sequestration into the cap-and-trade system.  For the record, I am a huge skeptic when it comes to massive, “scientific” carbon sequestration or global cooling projects – pumping carbon dioxide into old mines, dumping iron into the ocean, building giant mirrors, etc.  On the other hand, there are some concrete steps we can take to assist natural carbon sinks in doing their job.  Promoting forest preservation is one way, for example.  If the permit prices from the cap-and-trade program could somehow be linked to re-forestation, landowners would have more incentives to see healthy trees growing on their land.  This would be especially important if an international cap-and-trade system were to develop, because many of the world’s most important forests lie outside of America’s borders.