Common Tragedies

Thoughts on Environmental Economics

Archive for the ‘cap and dividend’ Category

What about that other climate bill?

Posted by Danny Morris on March 30, 2010

This post appeared originally on Progressive Fix, the schnazzy new blog from the Progressive Policy Institute.

You may not have noticed lately, but there are other major legislative initiatives, including climate and energy, on the Senate’s docket. One climate action bill that has received a lot of attention is the bill sponsored by Sens. Maria Cantwell (D-WA) and Susan Collins (R-ME). When the bill, officially called the Carbon Limits and Energy for America’s Renewal (CLEAR) Act, was first introduced in December, it caught the eye of some in the enviroblog world, but didn’t make much of an immediate splash in the Senate. Between the long build-up of the Kerry-Lieberman-Graham multi-partisan grab bag and the poorly understood Copenhagen outcome, however, it filled a vacuum with a poorly appreciated concept at the time: offsetting costs of climate legislation to consumers by cutting them a check.

The Basics

Also known as “cap-and-dividend,” the Cantwell-Collins bill is pretty simple: starting in 2012, it would mandate monthly auctions of pollution permits, called carbon shares, to the first seller (producer or importer) of fossil fuel carbon into the economy. The bill sets a floor price (shares can’t be sold for less) of $7 and a ceiling price (shares can’t be sold more) of $21 in the first auction in 2012, with the cap lowering — leading to rising prices — over time.

Most of the revenue from these auctions is distributed back to citizens in the form of a monthly check, while the rest is placed in a Clean Energy Refund Trust (CERT) fund established by the bill for use on a variety of different purposes: energy R&D, climate change adaptation, non-CO2 greenhouse gas reductions, international forestry and agriculture offsets, carbon capture and storage projects. First sellers cannot trade carbon shares and carbon derivatives are prohibited. In addition, the legislation has economy-wide emissions reduction goals of 20 percent below 2005 levels in 2020, 42 percent in 2030, and 83 percent in 2050.

The Good

Advocates of Cantwell-Collins praise it for being simple and transparent. As has been noted by others, it is a mere 40 pages, certainly an easier read than Waxman-Markey, the behemoth, 1,400-page cap-and-trade bill passed by the House last June. It regulates fossil fuel-related CO2 as far “upstream” in the economic supply chain as possible, meaning that whoever produces or imports a fossil fuel is on the hook for the CO2 content. Under Cantwell-Collins, coal mines and oil producers are responsible for paying for carbon, which means that only about 3,000 facilities need to be regulated. This upstream approach is administratively more streamlined, affecting far fewer parties than Waxman-Markey, which regulates electricity producers, natural gas distributors and manufacturers (over 75,000 regulated facilities).

The CLEAR Act also rejects the convoluted system of free and auctioned allocations in Waxman-Markey for a straight-up auction of all carbon shares. All regulated parties must participate in open monthly auctions, the revenue from which is split 75-25 percent: 75 percent is redistributed per capita to every American citizen and 25 percent is placed in the CERT. Whether you agree with the approach or not, offering to cut a monthly check for every U.S. citizen is not a bad way to gain some political support. Also, from the perspective of regulated firms, the use of price floors and ceilings, also known as a price collar, would reduce future price uncertainty and help them better predict investment needs.

Finally, the bill is co-sponsored by a Republican and a Democrat. That bipartisan provenance could certainly help its chances for passage.

The Bad

So with a bill that’s easy to read, easy to monitor and easy on the wallet, is there anyone who won’t like it? Well, anyone who favors hard targets for emissions reductions and anyone who believes in markets, for two. First, while the bill establishes economy-wide reduction goals as strong as Waxman-Markey, the auction system alone will not reach them. National emissions are capped at 2012 (note that it only caps CO2 emissions, unlike Waxman-Markey, which covered other greenhouse gases as well), and the cap doesn’t tighten until 2015, at which point it decreases by 0.25 percent that year, then by an additional 0.25 percent every corresponding year (so in 2016, the cap reduces by 0.5 percent, in 2017, 0.75 percent, etc).

This slow lowering of the cap will result in only five percent reductions below 2012 emissions by 2020, well short of the 20 percent reductions by 2020 goal. Even at that, the cap is not rock solid due to the price collar, which functions as a sort of safety valve. That is, if the auction price goes higher than the established ceiling price, then that essentially releases extra carbon shares for firms to bid on until the price falls back below the ceiling.

That means the remaining reductions to be met in 2020 will have to come from technology advances, land use offsets in forestry and agriculture, and reductions of non-CO2 gases, all of which are paid for by the CERT (which will be administered by the Department of Treasury). If we assume an initial carbon price of $15 in 2012 (a middle-range price, based on analyses done by the EPA and EIA), and the projected cap of roughly 7.2 billion carbon shares, then the CERT will get about $27 billion in the first year of the program.

That’s $27 billion to be split among all the uses listed above to help reduce emissions, as well as adaptation projects, energy efficiency efforts, and support for trade-sensitive industries and low-income families. The problem with a bill that’s only 40 pages is that it doesn’t have a lot of room for details — indeed, the CLEAR Act provides no guidance on how to prioritize uses of CERT funds. Although CERT funds will increase as the price of carbon shares rise, it will likely not even be close to enough to compensate for the majority of necessary carbon reductions.

A carbon market could mobilize private capital to help address some of these issues efficiently, instead of leaving all the choices and funding responsibility to the federal government. While it’s understandable that the public and politicians might still distrust markets in the wake of the recent financial collapse, the fact is that when it comes to finding inefficiencies and catalyzing innovation, nothing works better. But the “market” in Cantwell-Collins is simply an auction system. Unlike in Waxman-Markey, regulated firms can’t trade their permits, and carbon derivatives are strictly prohibited. These restrictions are going to severely limit the efficacy of the program to find the cheapest emissions reductions.

Also, there is a huge amount of risk in carbon markets (both in terms of accurate compliance and extreme events), so while they should be tightly regulated, derivatives are a necessary component because they allow firms to hedge against the risk of non-compliance or shifting standards. You will be hard-pressed to find any industry player who will advocate for a market without any trading, and there will need to be at least some industry support for any viable future climate legislation. Moreover, the monthly auction system may generate more carbon share price volatility than a continuous market, making it even more unattractive to firms.

The Upshot

Cantwell-Collins injects some great ideas into the climate policy debate that had not been prominently discussed before. If a policymaker wants to reduce the burden of increased energy costs on consumers, a direct rebate is an efficient and effective way to do it. The bill overall, however, is a somewhat naïve approach that does not fully appreciate the ability of markets to generate efficient emissions reductions and does not limit carbon emissions effectively. Its merits (simplified approach, upstream regulation, price collar) are outweighed by its limitations (extremely slow cap reduction, heavy reliance on CERT-funded reduction programs, draconian market restrictions). The CLEAR Act will continue to play a role in the climate debate of the Hill, but in its current form, it is unlikely to be the last bill standing.

Posted in cap and dividend, Climate Change, Legislation | 2 Comments »

How International Offsets Hurt Low Income Families

Posted by jab12004 on May 19, 2009

There has been some great discussion on the new Waxman-Markey bill including Danny’s previous post.  One aspect of the legislation, however,  that I don’t think has received enough attention is how offsets affect low income Americans.

First it is important to realize how large of a part offsets play in Waxman-Markey.  For a quick refresher on their role, check out Danny’s post on the subject.  Besides their large and increasing percentage of abatement, offsets are a huge factor in allowance price.  Here are a few quotes on the importance of offsets from the EIA analysis of the Waxman-Markey draft.

“Without international offsets, the allowance price would increase 96 percent.”

“The availability of offsets under WM-Draft significantly influences the allowance price.”

And from the appendix.

“Without the use of international offsets, covered sectors are forced to find an additional 39 billion metric tons of abatement.”

So, offsets have a HUGE impact on how the program functions.  Just how huge? Check out this graph from the EPA analysis.

MW-draft graph

Looking at the highlighted statistics, you can see that the 1,677 international offsets dwarfs the 408 domestic abatement in 2015.  Also, this equates to $4 billion being spent on domestic covered abatement, while $17 billion is spent on international offsets.  (The story balances out a bit looking into the future, but it still leaves us spending 50% of abatement costs abroad in 2030.)

Getting back to the original question of how offsets harm low income families, it is important to remember that climate policy is regressive.  One way to remedy this is to redistribute some of the money raised by selling allowances.  International offsets, however, don’t allow this to happen.  The EPA analysis says:

“International offset payments are calculated for each model as the product of the amount of international credits purchased and the international credit price.  Unlike the abatement costs associated with domestic covered abatement and domestic offsets, … international offsets .. are all purchased at the full price of international allowances and those payments are sent abroad.”

So, basically purchasing international offsets is equivalent to shipping money overseas.  For example, if the cheapest international offset in Mexico costs $4/ton to offset, U.S. firms still have to buy it for the international offset allowance price of $10/ton.  The remaining $6 (called the rent) will flow to international firms.  If this abatement or offset was done in the U.S., either the government or U.S. firms would be able to capture this rent.  These captured rents could then be redistributed to low income U.S. households bearing the brunt of climate policy.  With international offsets, this money is lost abroad.

I understand that offsets are being relied upon heavily for cost containment, but why hasn’t the idea of rents being shipped overseas showed up in the political debate?  Considering the average American doesn’t know what cap-and-trade is, this might be an effective way to sway public support towards a more effective system.

Unfortunately, in the current political climate, offsets will continue to be a significant part of climate policy.  Offsets can have many positive components, but they also have a direct harmful effect on low income Americans.  If this is the pill we have to swallow for climate policy to pass, then so be it.  However, I would at the very least like to see this important trade off enter the discussion.

Posted in cap and dividend, Cap and Trade, Climate Change, International, Offsets, Uncategorized | 1 Comment »

WaPo endorses “cap and return”?

Posted by Rich Sweeney on October 23, 2008

Which you may also know as “cap and dividend” and “cap and rebate”. Read the editorial here. Apparently the movement is still unsettled on which word for the disbursement is the most politically attractive. Any CT readers have an opinion/ preference?

For a comparison of the welfare implications of this and other carbon permit allocation schemes check out the discussion paper Dallas Burtraw, Margaret Walls and I have on the incidence of US climate policy.

Posted in cap and dividend | Leave a Comment »

Sure, cap and dividend. But let’s not get crazy

Posted by Rich Sweeney on June 12, 2008

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.

Posted in cap and dividend, Cap and Trade, Government Policy | 1 Comment »

As support increases for cap and dividend, it’s time to look under the hood

Posted by Rich Sweeney on June 5, 2008

Today Robert Reich pens his support for cap and dividend. Not too much new here, if you’ve been following the work of Peter Barnes lately. He does pose two caveats I hadn’t heard before though. The first is allocating dividends on a per adult basis, as opposed to per capita. Not sure why this is preferable, but I’m not opposed to it either (I am an adult, technically).

His other suggestion is that checks be distributed monthly, like Social Security. Again, like the per-adult discussion, the cap-and-dividend debate is still nascent enough that there aren’t many strong opinions staked out on this detail. All other things equal, monthly dividends would probably best alleviate the financial burden of increased monthly utility bills. However, I’ve always just assumed the payment would be annual, like a tax refund. In fact, I’ve also come up with a nifty justification for this arbitrary payment schedule. In Nudge, Thaler and Sunstein muse about consumers’ irrational handling of tax returns. In theory, most people should be able to roughly predict how much they’ll get back from the IRS and incorporate this future payment into current consumption. Yet in practice, people tend to treat these transfers as windfall profits, and blow them on luxury goods. Recent research out of the Chicago Fed has found that recepients of earned income tax credits are likely to spend that money on big ticket items, such as automobiles.

So why does this matter? Well, I’d argue that the behavioral evidence I just mentioned suggests that annual transfers would promote more energy efficiency/ conservation than monthly transfers would. Once we put a price on carbon, people’s utility bills are gonna go up. While this is going to be a bit painful, the idea is to induce a decrease in carbon consumption. Households will be forced to recognize the true costs of their energy usage, and will reorder their relative consumption preferences accordingly. If we simultaneously hand out money to offset these expenditure increase, people won’t conserve as much. In econ terms, the income effect of this policy will somewhat offset the intended price effect. For necessities (which are highly inelastic) this might be desirable, especially for low income households. But at the same time, the point of pricing carbon is to reduce emissions, so it’s important that we think about where we expect these reductions to come from. Though my libertarian friends will surely scoff at this idea, I’m suggesting that maybe its possible to help reshape people’s consumption patterns for the better by smartly structuring a cap and dividend program. If the dividends are handed out once a year, people will irrationally discount them, and the price effect of the policy will dominate. Fortunately, the energy efficiency/ conservation literature suggests that after the initial shock, people will adjust just fine to lower household energy consumption (look at Europe). If you believe the folks at McKinsey on the technical side, or people like Richard Layard on the behavioral side, this switch to a lower energy lifestyle could actually be welfare enhancing. On top of that, at the end of the year, people would get a vacation or a new wardrobe as a reward for conserving carbon. You can think of this as a Christmas account for energy conservation.

Posted in Behavioral Economics, cap and dividend | 3 Comments »