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1. How huge is a “huge chunk”? In a recent Rolling Stone interview, Barack Obama said that he would rebate a “huge chunk” of carbon auction revenue back to taxpayers. I heard this through Peter Barnes’ cap and dividend website. For previous commentary on cap and dividend see here and here.
2. What the hell does T. Boone Pickens want? I’m sure you’ve all seen his new wind commercial:
Am I the only person who finds this ad creepy? He doesn’t even ask for anything. Does he want subsidies for the 4 GW worth of wind turbines he just bought? Also, what’s with the “I’m T. Boone and this is my ad” moment at the end?
3. This sounds familiar. Finally, I started reading Rabbit is Rich last night and here’s how the book, which is set in the 1970s, opens,
Running out of gas, Rabbit Angstrom thinks as he stands behind the summer-dusty windows of the Springer Motors display room watching the traffic go by on Route 111, traffic somehow thin and scared compared to what it used to be. The fucking world is running out of gas.
Monday I got an email from Dan Lewer, co-founder of a brand new company called Carbon Retirement. From the email:
We buy EUAs from the EU Emission Trading Scheme and retire them on behalf of our customers. Voluntary retirement of EUAs reduces industrial emissions by a measurable amount and pushes up the carbon price, encouraging companies to invest in clean technology. The service is packaged as an offset: you can retire any amount and match it up with the emissions from flights or driving, for example.
While this is possibly a good idea, I’m a little skeptical about the actual benefits of such a scheme for two reasons. First, as Daniel pointed out in an email to me, European companies can already substitute CDM offset credits (CERs) for EUAs. Now the assumption might be that CDM supply is somewhat fixed in the short run. Otherwise it seems like retiring EUAs would have very little effect on European emitters’ decisions (This is really Daniel’s area of expertise, so I’m sure he’ll chime in if I’m messing this up).
Secondly, and the real point of this post, I’d be weary about the assumption that once allocated, the permit supply is absolutely fixed. I know that during RGGI negotiations many stakeholders and legislators were worried about “green” outside actors coming in and retiring permits (In such negotiations this outsider is invariably referred to as “George Soros”). The threat of this was somewhat controlled for with safety valve like provisions. Yet, at the end of the day, I think most parties involved just figured that if this ever became an issue they’d simply correct for it legislatively or loosen the cap.
Which brings me to Carbon Retirement’s plan. While its totally feasible for them to purchase permits and hold them, I think there’s probably a political limit to just how much they’ll be allowed to influence prices. When caps are set, it’s assumed that they’ll be binding, and the level of allowed emissions is the result of a long, complicated political process. Some of us may feel that this process is corrupt and the outcome is unjust, but our ability to significantly alter this political equilibrium outside of political channels is limited. If annual emissions start coming in well below the cap or the price gets to high, government could pass a law making it a crime to retire permits or it could simply print more to achieve the initial level. At the very least they would start factoring an expectation of retired permits into future negotiations.
In the long run it’s probably impractical to fully restrict ownership of carbon permits if the carbon market is to function properly. And there is certainly a case to be made that non-use of a privately purchased good is just as reasonable as using it. But for the time being I think its important to recognize the very fragile tenets upon which current cap and trade programs are being agreed to, and to respect the fact that this asset’s value is derived from political decree, which can be altered pretty quickly.
2. Quiz time! See if you can spot all of the errors in this horribly glib Megan McArdle post on emissions permit allocation. Bonus points for citing previous CT posts that provide rebuttals in the comments.
3. RealClimate puts concerns about the global warming impacts from flat screen TVs in perspective.
6. Speaking of the food crisis, here are some sensible policy recommendations, starting with the no-brainer (and non-starter) idea of making U.S. food aid cash rather than crops.
7. I discussed the G-8 summit last week while guest-blogging at Free Exchange. Leaders at the summit have pledged to cut greenhouse gas emissions by 50% from current levels by 2050. Cue muffled laughter. Addendum: Creative ambiguity — whether the 50% cut is from current or 1990 levels was left undefined.
you are sentenced to calling up one of the RFF bloggers and having them explain in detail why you don’t understand this issue.
While we’d love to talk to Matt, there’s plenty of solid explainin going on right there in the comments. For starters, CalDem’s own comment is dead on.
A safety valve at a fairly high price per ton limits the economic cost if carbon reduction turns out to be more expensive than we think it will be. This is especially valuable for short-term implementation, where cheap clean technologies might not be available. You could do something similar by allowing borrowing permits from the future. Or you could have a fed like entity print some more permits if costs are very high.
AE points out that politically there’s always going to be a safety valve, no matter what the current candidates say.
There is always going to be a safety valve, i.e. ultimately the price could get high enough that Congress would dump the whole system overnight.
Josh Bivens notes that the main benefit of a safety valve is to smooth out annual idiosyncrasies, and links to Orzsag (which is always a good thing).
there are ways to do a “safety valve” that make sense from a green perspective (among others, make the extra credits that are made available in one high-demand year come out of future allotments, say), but, i bet this isn’t quite what Chevron has in mind.
still, blanket condemnations of “safety valves” in the context of cap and trade are a bit off the mark.
Peter Orzsag has some testimony on this issue - see the second bullet point
And finally MK simply links to an RFF paper,
A safety valve limits the downside risk. Look it up! e.g., here.
For those of you who crave further discussion, Daniel has written about safety valves here, here and here. I’d agree that a John McCain safety valve would be unacceptably low, but it’s really misleading to say that all safety valves are simply “John McCain environmentalism”.
This week the Economist’s Economics focus column addressed competitiveness concerns in the context of carbon mitigation. The article cited a paper from RFF and if, like me, you did not notice the sidebar titled “Websites”, you might not know where to find the relevant article. So here’s a link to that work from the RFF report “Assessing U.S. Climate Policy Options” by Morgenstern, Aldy, Herrnstadt, Ho, and Pizer. If you’re interested, check out Dick Morgenstern’s other issue brief on related policy options here.
The link for the broader report, which I imagine Daniel will consider to be the eldest sibling of his future human children, is here.
Note: as the RA that worked on the Pew paper cited by the column, I’d like to point out that it’s humbling to have a year of your life summed up in one sentence.
Today’s E&ETV broadcast has coverage of last Wednesday’s event here at RFF:
Beyond the emissions reductions goals of a future U.S. climate policy, how should legislation encourage the development of technology and strengthen global partnerships? During today’s E&ETV Event Coverage of a recent Resources for the Future event, a panel of climate experts discusses the broader objectives of a domestic climate policy. Panelists include, Ray Kopp, senior fellow and Climate Policy Program director at Resources for the Future, Nigel Purvis, visiting scholar at Resources for the Future, Linda Cohen, professor of economics and associate dean for research and graduate studies at the School of Social Sciences, University of California-Irvine, and Bob Simon, Democratic staff director of the Senate Energy and Natural Resources Committee.
The panel discussion at the end of the video (after the three panelists give individual presentations) is particularly interesting. The panelists had a broad range of backgrounds and perspectives, and their insights about each others’ areas of expertise are illuminating.
The session that E&ETV covers here is actually the last of three sessions from an event on designing federal climate policy. The RFF webpage has coverage of all three sessions, including both video and slides from the presenters. I recommend Jake Jacoby’s presentation from the first session, and Howard Gruenspecht’s comments in the second, particularly the last 5 minutes of his presentation and his input from the panel discussion.
Finally, if you’re curious about what the top of my head looks like from behind, you can see it on the bottom-right of the E&ETV video (just left of their logo). I was up front keeping time for the speakers.
Writing on Grist yesterday, cap and dividend ringleader Peter Barnes proposes a “revenue neutral” program. However, what he appears to suggest is a 100% dividend of permits, which would be far from revenue neutral for the government. That’s because after we put a price on carbon, government expenditures go up and tax revenues go down. Terry Dinan of the CBO has looked at this extensively. Here’s an excerpt from a 2003 CBO study on the burden of cap and trade,
However, recent research has demonstrated that a significant share of that revenue might be needed to offset increases in government spending and declines in tax revenues caused by the program.
Using auction revenue to offset those effects could be viewed as compensating the government, but failing to do so would require the government to raise taxes if it wanted to keep its net revenues at their baseline levels (while holding spending constant). A tax increase could boost the cost of the cap-and-trade program.
A carbon trading program would affect government outlays and tax receipts in several ways. First, it would cause the government (like other consumers) to pay higher prices for carbon-intensive goods. Second, because the payments of some government programs, such as Social Security, are indexed to changes in the overall price level, higher prices could result in greater spending on those payments. Third, a cap-and-trade program for carbon emissions would lead to a decline in economic activity and a corresponding decrease in tax collections.
Researchers estimate that together, those effects could account for more than 30 percent of the total value of allowances.
Thus, at a very minimum, a revenue neutral program would involve the government taking a 20-30% haircut. Not sure if Barnes intends these dividend to be taxable, but even that would only get us part of the way there.
As for investing in R&D and transport, I find Barnes’ comments more reasonable but equally as unhelpful. He says,
“To be sure, we’ll need public money to fight climate change. But some of that money can come from shifting current expenditures, and if we need more, we can raise and allocate it later.”
Well then. Since you put it like that.
So the main point of this post is to say now that we’re in the red zone on climate policy, let’s not lose sight of little things like the national debt and government services.
A lot has been written about cap-and-trade in the econoblogosphere during the past week. Everything I’ve read though (which, to be honest, hasn’t been everything) takes as a starting point the Coasean notion that ownership doesn’t effect equilibrium price. The point being that firms care about opportunity costs, which are set by the market’s marginal willingness to pay, not accounting costs. Thus the market price for carbon permits should be the same regardless of how the permits are initially distributed. I’ve actually made this pointseveral times before.
Yet, in practice, this isn’t entirely true. That’s because in half the country the electricity sector, where most expect the bulk of CO2 reductions to come from, isn’t a competitive market. Utilities are publically owned and prices are set at cost of service, as opposed to marginal cost. This means that they don’t make any profit, and customers see a price that is equal to the average cost of producing the electricity they consumed.
In regulated regions, free allocation to utilities would work as follows: Utilities would still consider the opportunity cost of these permits, and would gladly sell them to the market if the price was higher than their own marginal cost. However, unlike in competitive regions, where this money is pocketed and distributed to shareholders, regulated utilities would take this revenue and distribute it to customers, effectively lowering the average cost of electricity.
Thus, giving away permits to the electricity sector in regulated regions would effectively soften the blow for customers in those regions. Price wouldn’t go up by as much as if all the permits were auctioned off. Which brings me to the rub: since price doesn’t increase as much, demand doesn’t decrease as much either. This means that for a given permit price, we get a smaller emission reduction under free allocation - i.e. the efficiency of the whole program goes down. Since the electricity sector in regulated regions does less work when permits are given away for free, other sectors have to pick up the slack, driving up the cost for the economy as a whole. Preliminary modeling results done here at RFF have confirmed this relationship, and my boss, Dallas Burtraw, actually testified before the House on this relationship earlier this year.
Finally, I should note that this is more than just an academic debate, as I think Lieberman-Warner had about 9% of permits going to load serving entities for free as of last week (I’m sure Daniel knows the correct figure). I should also note that, despite the efficiency costs, I’m not necessarily opposed to softening the blow for electricity consumers. Electricity consumption makes up a higher percentage of poor households’ carbon footprint than rich households’, which means that allocating to load could have some nice distributional effects. Again, preliminary results here at RFF appear to confirm this. We’re hoping to have a discussion paper out on this soon.
You knew, dear readers, that the econoblogosphere has been arguing vociferously the last few days about carbon taxes versus cap and trade and to what degree they are equivalent, didn’t you? It seems Robert Samuelson started the entire thing with a grumpy tirade about cap and trade on the editorial pages of the Washington Post. Ryan Avent criticized it, and then things blew up. Here is Tyler Cowen, MarkThoma, and BradDeLong with more, another response from Ryan, and there are many further links at these posts if you want more. The short story is that only Tyler comes to Samuelson’s defense; everyone else agrees that while there are differences they are not the ones Samuelson “identifies” since he actually spends his time whinging about regulation of any kind at all. (Brad DeLong makes this point most clearly.)
I have been on the sidelines the entire time, partially because I have been very busy with my actual life, partially because I already covered this, and partially because I am consciously trying to avoid this malady. But I could not let this statement from Arnold Kling pass without comment:
In theory, you can make cap-and-trade equivalent to a tax. What I worry about is that under cap-and-trade Congress is very unlikely to have a pure auction of permits. Instead, permits will be given to favored industries. The equivalent under a carbon tax would be to set different tax rates for different industries, with favored industries getting anywhere from a partial exemption to a full exemption to a negative carbon tax, or a carbon subsidy.
Wrong.
Giving allowances away for free in a cap-and-trade system and giving (full or partial) exemptions in a carbon tax system are not the same thing. But why not? They seem so similar, don’t they? Some particular industry or firm gets favorable treatment — either free permits or lower tax rates — and this makes them more profitable, right? Why aren’t they equivalent? Briefly, because one system (cap-and-trade with free allowances) equalizes the marginal cost of emissions, while the other (carbon taxes with exemptions) does not.
Once you establish a cap-and-trade system, every regulated entity within that system will have an identical incentive to reduce emissions. The incentive will be the market price for allowances. And this incentive will be the same for all firms regardless of how allowances are initially distributed. Even if firms get allowances for free, they will still face an opportunity cost for emissions.
If you establish a carbon tax system with different tax rates for different sectors, however, firms will face varying incentives to reduce emissions. This will end up making some firms or sectors work much harder to reduce emissions (those with the higher tax rates) and others work less hard. This will have (at least) two unfortunate effects: one is that society will get less bang for its buck now — fewer emissions reductions for the money it spends than it could have done if marginal tax rates were equal. The second problem is that over time the existence of differing marginal tax rates will tend to push economic activities into sectors with low tax rates and away from those with high tax rates. Both these effects mean that the system is less efficient than it would have been if marginal carbon tax rates were equal across the entire economy.
Economics students will recognize this as the classic distinction between equity and efficiency. How allowances get handed out matters a lot for the distributional (equity) effects of the policy, but doesn’t affect the efficiency. Exemptions and carve-outs in a tax system, however, make the program less efficient. (The actual carbon tax policy equivalent to free allowances would be lump sum rebates of tax revenues, while leaving marginal tax rates equivalent.)
In my mind this difference is important, and constitutes a public choice argument for cap and trade. In order to get any climate policy passed you are realistically going to have to make a lot of political side deals. With cap and trade the natural side deal is to give away allowances. This may not be fair, and it may be ugly, but it at least leaves us with a system that is efficient, and this is very important when thinking about policies that will likely be in places for several decades. With taxes, however, the natural side deal is exemptions. And once full or partial exemptions get established in a carbon tax code I doubt they will go away. That might not look too problematic today but the inefficiency will just get larger and larger over time and by 2020 or 2040 we will be very unhappy we have a system that has inefficiently squeezed economic activity into certain sectors. Better to give up some equity now in exchange for a system that is built for the long haul.
Ryan Avent has been doing a lot of good blogging about cap and trade recently. Today he assesses the political environment — the combination of near certain defeat for the Lieberman-Warner bill this summer with likely election returns this fall — and argues:
Congress is almost certain to be more Democratic next year, and the White House will be more friendly to climate bills whoever the president is (but substantially more so if Obama is the victor). … Democratic leaders are watching now to see how their opponents plan to fight, so that next year, they’re prepared to use their majority to effectively counter opposition en route to a truly good climate bill.
I thought this was a bit optimistic about how smoothly Democrats would operate next year, a point I made (rather sarcastically) in the comments.
In response, Ryan offers up a pitch-perfect response:
Ah, but you failed to take into account the fact that Obama is going to CHANGE WASHINGTON WITH CHANGE WE CAN BELIEVE IN YES WE CAN.
This is still making me chuckle after repeated reads.
I happen to agree that among the presidential candidates Obama would get a climate bill with the least amount of political wrangling and infighting. But relative to what? There is going to be pork all over the floor before this thing gets done and that is just the facts. The domestic political machine has to run its course and President Obama is not going to be able to strong-arm Congressman Dingell into rolling over on Detroit or Senator Reid into greenlighting Yucca Mountain.
So why do I think that Obama could get a bill with less partisan hackery even while I’m pessimistic he’ll do much to change Washington? I think it’s because I view Obama as being most concerned among the candidates about America’s standing in the world and with reaching out to our partners. Having America perform an about-face on climate policy could be a key part of a broader diplomatic strategy of engagement and cooperation. This could then put indirect pressure on Congress to deliver a well-designed bill.
In the end I guess I am agreeing that Obama does have the best chance of getting legislators to work with him on climate policy but I am positing a different channel through which this works.
I think the challenge he will face if he chooses this strategy is to simultaneously be realistic about the domestic policy constraints he faces and not promise allies things that he cannot deliver, while at the same time having a clear set of goals that do indeed signal American leadership on global climate policy along with concrete strategies for how he is going to get people on board with his goals.
Those interested in the politics of the climate policy bill are advised to point their browsers to E&ETV at 11 am EDT today. Via ClimateWire:
As the Senate prepares to take up the Senate emissions bill this week, many key provisions are expected to spark heated debate. During today’s exclusive E&ETV/ELI Special Event, NRDC’s David Doniger, Senate EPW Committee’s Andrew Wheeler, Pew’s Manik Roy, and Bracewell & Giuliani’s Scott Segal give their perspectives on the upcoming floor debate. The panelists address prospects for the bill, likely amendments, key floor fights and potential ramifications of the Senate’s debate over the bill.
The amended version of the Lieberman-Warner bill is out. The headline change is the revised cost containment provisions, referred to collectively as “emergency off-ramps”.
The main change is the addition of an annual “Cost-Containment Auction”. Each year from 2012 to 2027 there would be a pool of allowances which would be available for sale at a predetermined threshold price. The pool of allowances is pulled from future allocations in 2030 through 2050. The total size of the pool is 6 billion metric tons — about one years’ worth of allowances early in the program — with only a fraction of this total pool available in any given year. Allowances sold through the auction would have to be made up in the 2030 to 2050 period. And the price of these allowances — oh, the ever-important price — would be between $22 and $30 in 2012. The exact figure would be set by the President, and it would then rise by 5% over inflation each year beyond 2012.
This mechanism is sometimes called a “reserve”. It is essentially a quantity-limited safety valve. There are two main differences compared to a traditional safety valve. First, there are a limited number of extra allowances, so potentially the number of allowances demanded could exceed the available pool. Once the entire reserve is sold then allowance prices could still go higher than the threshold price. Second, the reserve allowances must be “paid back” in the future in the form of lower emissions caps, and so the total emissions across the entire policy period remain the same. Note that there is a spectrum with these policies that goes from certainty about price (safety valve) to certainty about emissions (pure cap), with the reserve trying to fit in between.
My first impression of this change is that it is a positive one. I have much more that I could — and may — say about this in future, but for now let me just say that I view the core question of the climate change policy debate as, “What is the price of emissions?” The fundamental political negotiation is thus one that is about price. In this regard I view any change that makes this negotiating price more explicit and transparent as a step in the right direction.
For those who want more information about cost containment in general — and reserves specifically — I cannot recommend this webpage highly enough. It’s the coverage of the event on cost containment that was held at RFF a couple months ago. In particular watch the video of the presentations by Billy Pizer, who gives an overview of cost containment, and Brian Murray, who makes the case for a quantity-limited safety valve.
Here’s a summary of some of the Boxer amendment changes from Kate Sheppard at Grist, and a couple of her previous posts.
Over on EconomistMom, Diane Lim Rogers notes that economists of all political and ideological stripes appear to support pricing carbon, which, by itself, amounts to increasing taxes. She then muses that part of the appeal comes from the fact that a carbon tax is an efficient tax, and the revenue could go towards alleviating other less efficient taxes. In particular, Rogers’ main interest is in deficit reduction. Now as I noted in the comments, it seems pretty unlikely (at least in my reading of the current political climate) that deficit reduction will garner much, if any, of America’s newly created carbon permit pie. My guess is that it’ll be eaten up by some combination of giveaways to industry (a la McCain), giveaways to the people (a la Boyce and Riddle), and spending on R&D (a la Joseph Romm). These three spending options all have obvious political constituencies, but it wasn’t obvious to me who the deficit reduction constituency is (except the unborn, who, for obvious reasons, don’t seem to carry much political clout). Nevertheless, deficit reduction is obviously a reasonable option, so I decided to check out the Brookings Paper Rogers links to.
Here’s is the comment I left for Diane after reading her paper, in which I show my ignorance of public finance,
I’m curious about the distributional implications of using this revenue to pay down our national debt. In your paper, you say, “Even if one interprets the benefits of deficit reduction as distributed broadly across the current population, i.e., as a fixed dollar amount of benefit to each American, this benefit will be progressive relative to income (a higher percentage of a lower income).”
But why would one interpret the benefits this way? Wouldn’t the benefit be proportional to each person’s share of future taxation? And given that wealthier Americans have higher average tax rates and pay taxes on a much larger ammount of income, it seems to me that reducing future tax burdens would be really regressive.
Diane replied,
Rich, there are debates on this—what is the burden of budget deficits across the income distribution? (It’s easy to figure out the intergenerational burden, not so easy to speculate on the inTRAgenerational burden among rich vs. poor.) Obviously it depends on what we think the form of the future burden will take–higher taxes or reduced government services, or some combination of both. The more it’s higher taxes, the more it depends on how we think taxes would be raised. If taxes would be raised proportionate to the current (progressive) federal tax distribution, then you’re right, that would be a more progressive change, so reducing the deficit and avoiding such future tax increases would be a regressive change. In my paper I was making the assumption that the future tax increases and/or benefit decreases associated with deficits would be distributed fairly evenly across the population, which would mean that relative to income, avoiding deficits would be a progressive change
So there you have it. I’m not surprised to hear that the distributional implications of deficit reduction are highly dependent on how you assume future tax increases were going to be financed. Given this, the real question I have is not “Under what assumptions is deficit reduction progressive?”, but instead, “What are the most realistic assumptions we can make about where future deficit driven tax increases/ decreases are likely to come from?” I know this is basically unanswerable, but any evidence (even anecdotal) or hypotheses would be welcome. I’m currently working on a paper analyzing the incidence of US climate policy, and it seems to me that this is the million dollar question when it comes to deficit reduction.
In lieu of McCain’s recent climate change speech, Matthew Yglesias has written a coupleof posts on the allocation of carbon permits under a cap and trade program. In the first post, he links to Ryan Avent and Kevin Drum, and states a fairly strong preference for auctioning permits (Obama’s plan) rather than giving them away (McCain’s plan). This is a position that CT has supported for a long time. However, in his second post, on what the government should do with the auction money it collects, Yglesias makes some curious statements. On the idea of using some of the money to promote clean energy, he says,
I’m not so high on the popular notion of plowing money into clean energy subsidies. For one thing, I think there’s very good reason to be dubious about the government’s ability to pick technologies effectively. For another thing, the mere fact of the auctioned carbon permits would constitute a large de facto subsidy to alternative energy sources so it’s not really clear that further subsidy is needed. Last, in a lot of ways the whole idea of subsidizing energy consumption goes against one very promising path, namely using less energy overall — lots of elements of current U.S. policy subsidize or encourage lavish energy consumption and that’s part of how we wound up in our current pickle.
Auctioning carbon permits would definitely not consitute a de facto subsidy to alternative energy. It would represent the removal of a de facto subsidy to dirty energy, as emitters currently thrust the cost of their carbon onto society at large. As for his skepticism about the government’s ability to pick technologies effectively, this is theoretically correct, yet practically unhelpful. Just how inefficient is the government solution? Given the market failures associated with energy and climate change, is a private solution even possible? These are very complex questions, and the issue as a whole warrants more consideration than Yglesias gives it.
Matt’s quick dismissal of government energy programs is even more perplexing when you consider the spending he advocates in the final paragraph: invest in “productive infrastructure”. Seems to me that making investments in infrastructure aimed at adapting to a high cost energy environment would require basically the same foresight and faculties as investing in alternative energy. Now either Yglesias believes for some reason that we should only demand efficiency or “effectiveness” in energy investment but not infrastructure investment, or he simply knows something I don’t know about the government’s comparative advantage in the latter. Either way, writing off cheap clean energy in favor of adaptation to more expensive energy seems pretty rash.
* Evan and I were at a sangria roof party on Saturday night and I told him that I thought I saw Matt Yglesias at my favorite bar the night before (yes, I am that big of a dork. don’t worry, everyone else immediately made fun of me for recognizing, let alone gossiping about, other bloggers). As soon as I said this, some guy who had clearly been on the roof for a long time and had a lot more than just sangria interjected and said, “Who are you talking about? Metaclesias?” We tried to correct him but he just kept on saying “Metaclesias” in this grand voice over and over again, telling us that Metaclesias must be some obscure Greek philosopher. We were pretty relieved when he finally walked away, mutttering Metaclesias, but in hindsight the whole scene was pretty hilarious.
The World Bank Carbon Finance Unit has released its annual report on the state of the carbon market. The report summarizes the broader carbon market, with primary focus on two areas: the allowance market in Europe (the EU Emission Trading Scheme, or ETS) and the Clean Development Mechanism (CDM), the primary global offset market. As part of their discussion the authors note some of the criticisms and problems the CDM has faced, and recommend improvements. I’m going to focus on two of their critiques and one of their suggestions. I’m then going to synthesize these to argue that for some types of projects — particularly energy sector projects — we should move from an offset model to a straight subsidy payment model.
I’ve writtenpreviously about the problems with the CDM, including the idea that it is often tricky to measure when offsets are ‘additional’ since we can’t observe the counterfactual — a world without any carbon offsets.
The concept of additionality also becomes problematic when the baseline is unacceptable, or even perhaps immoral. The report authors write:
As clean energy projects begin to dominate the CDM, their developmental benefits are a lot more direct and visible than in the case of so-called “industrial gas” projects. Energy efficiency and renewable energy projects are now emerging as the most common type of CDM projects and this development should be encouraged. Many projects in Africa, likewise, have finally been transacted and this momentum too should be encouraged…
This has been a chief criticism of the CDM up until now. Most projects have been done in the more-developed poor countries — Brazil, China, India — while almost none were conducted in Africa in the first few years. And how could they be? If the ‘baseline’ is the absence of any grid-based electricity, how many emissions do you save installing a wind farm? An Africa with a renewable energy project is better than one without electricity at all, but it is hard to get support for it through the offsets market since there isn’t anything to offset. This is the first critique.
Today the Director of the CBO is testifying before the Senate Finance Committee on the implications of a cap and trade program. In addition to the full testimony, you can read Orszag’s summary comments on the CBO blog. As I read them, two points stood out.
First, Orszag says that the CBO believes a tax is generally more efficient than a cap because of its flexibility. We’ve already debated this issue too much. I’m merely pointing this out to chalk Orszag up in the pro-tax column on the proverbial scoreboard.
The real bombshell comes in the final paragraph:
CBO has concluded that the federal budget should record the value of allowances that are given away by the government if the recipients of the allowances could readily convert them into cash. In particular, the budget should record the value of those allowances, when they are distributed, as both revenues and outlays. That procedure, which CBO has already applied in its estimates for S. 2191, underscores that giving away allowances is economically equivalent to auctioning the allowances and then dedicating the proceeds to the recipients.
It’s one thing for economists and eco-bloggers to point out the reality of pass-through. It’s quite another for the CBO to recommend codifying it in the calculation of the federal budget. This is going to be controversial on the Hill, but if anyone can explain it simply and convincingly to Congress its Orszag.
How well is the carbon offset market working? Not as well as might be hoped; the Wall Street Journal has done much recent reporting on how the architects of the Clean Development Mechanism (CDM) — by far the largest carbon offset program in the world, and a key part of many countries’ strategy to achieve compliance with the Kyoto Protocol — are struggling to determine which offset projects should be eligible, to keep pace with demand for new offsets, and to clamp down on questionable projects.
Now Michael Wara and David Victor have a new working paper with some recommendations for reforming the system:
We argue that the U.S., which is in the midst of designing a national regulatory system, should not to rely on offsets to provide a reliable ceiling on compliance costs. … We suggest that the actual experience under the CDM has had perverse effects in developing countries — rather than draw them into substantial limits on emissions it has, by contrast, rewarded them for avoiding exactly those commitments.
Offsets can play a role in engaging developing countries, but only as one small element in a portfolio of strategies. We lay out two additional elements that should be included in an overall strategy for engaging developing countries on the problem of climate change. First, the U.S., in collaboration with other developed countries, should invest in a Climate Fund intended to finance critical changes in developing country policies that will lead to near-term reductions. Second, the U.S. should actively pursue a series of infrastructure deals with key developing countries with the aim of shifting their longer-term development trajectories in directions that are both consistent with their own interests but also produce large greenhouse gas emissions reductions.
There are many interesting aspects to the paper, and to this topic more broadly. I am going to try to write several posts about it over the next week or two. For this post I’m going to discuss one of the fundamental problems in offset markets that the authors identify.
