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Cap-and-Trade Handouts

"The largest corporate welfare program ever enacted in the history of the United States"

Ronald Bailey
April 9, 2009

Two major climate change-related events happened in Congress last week. First, Rep. Henry Waxman (D-Calif.) and Rep. Edward Markey (D-Mass.) introduced the American Clean Energy and Security Act, which aims to cut U.S. emissions of greenhouse gases by imposing a cap-and-trade scheme. Under a cap-and-trade program, in order to emit greenhouse gases a company—say an electric utility or an oil company—would need to have permits equal to the number of tons of carbon dioxide they want to emit. The federal government would then reduce greenhouse gas emissions by issuing fewer and fewer permits each year. The goal is to encourage energy producers and manufacturers to find new ways to produce goods and services using less energy derived from carbon-rich fuels like coal, natural gas, and oil.

Once allocated, the permits could be bought and sold on an open market. Producers or manufacturers that cheaply abate their emissions can then sell their extra permits to other emitters that find the process more expensive. In this way, a market in pollution permits ideally finds the cheapest way to cut emissions.

The Waxman-Markey bill would mandate that U.S. emissions be cut by 20 percent below 2005 levels by 2020, 42 percent by 2030, and 83 percent by 2050. This is a faster pace in greenhouse gas reductions than that proposed by President Barack Obama, who seeks a 15 percent reduction by 2020.

The Obama administration's proposed cap-and-auction scheme would yield an estimated $646 billion in additional federal revenues between 2012 and 2020. Each year, $65 billion of that revenue would support the Making Work Pay tax credit for lower income workers while another $15 billion would be disbursed for clean energy research and development projects. To raise that revenue, the Obama administration wants to auction off all of the emissions permits.

Crucially, the Waxman-Markey bill ducked the issue of just how emissions permits would be allocated, although Waxman and Markey have apparently agreed to allocate 15 percent of the allowances for industries considered particularly vulnerable to international competition, including iron and steel, aluminum, cement, glass, ceramics, chemicals, and paper. These allocations are clearly in line with the desires of the leading climate lobby group, U.S. Climate Action Project (USCAP), which consists of 25 big emitters and five big environmental groups. USCAP members want a significant proportion of the permits to be given away to emitters for free.

But should emissions permits be given away or should they be auctioned? (Another alternative is a carbon tax, but let's set that aside for now.) Consider the example of the European Union's Emissions Trading Scheme (ETS). Launched in 2005, the ETS cap-and-trade scheme handed out nearly all of its emissions permits gratis. The result was windfall profits for emitters and higher energy prices for consumers, and, until the advent of the global economic recession, almost no reduction in carbon dioxide emissions.

But if the emitters are getting permits for free, why don't they pass along the lower costs to consumers? Think of it in terms of an analogy put forward by liberal economists James Barrett and Kristen Sheeran: Tickets from scalpers for last night's NCAA basketball championship game were going for more than $1,000. Would the price have been lower if a scalper had found them on the ground? No. "The supply and demand for tickets is the same no matter how much the scalper paid for them, and so the price he charges you will also be the same no matter how he got them," note Sheeran and Barrett. The same thing is true of carbon dioxide emissions permits.

A 2007 Congressional Budget Office (CBO) study reported the results of a hypothetical 23 percent cut in carbon dioxide emissions (the Waxman-Markey bill proposes a 20 percent cut by 2020). The CBO found that "giving away allowances could yield windfall profits for the producers that received them by effectively transferring income from consumers to firms' owners and shareholders." And how big would the windfall be? "If all of the allowances were distributed for free to producers in the oil, natural gas, and coal sectors, stock values would double for oil and gas producers and increase more than sevenfold for coal producers, compared with projected values in the absence of a cap," concluded the CBO report.

In 2007 Congressional testimony, then-CBO Director Peter Orszag explained, "The government could either raise $100 by selling allowances and then give that amount in cash to particular businesses and individuals, or it could simply give $100 worth of allowances to those businesses and individuals, who could immediately and easily transform the allowances into cash through the secondary market." More recently, in his March testimony before the House Budget Committee, Orszag, who is now President Obama's budget director declared, "If you didn't auction the permits it would represent the largest corporate welfare program that has ever been enacted in the history of the United States. All of the evidence suggests that what would occur is that corporate profits would increase by approximately the value of the permits."

Congress' second significant action dealing with climate change last week was to pass a $3.5 trillion budget resolution for 2010 which did not include the $646 billion in climate change revenues that the Obama administration is counting on to finance tax credits and renewable energy R&D. In addition, the Senate included in the budget resolution, by a vote of 67 to 31, an amendment that ensures that any future climate change legislation mandating emissions cuts would need 60 votes to pass in that body. Supporters of emission reductions had hoped that Congress would adopt a parliamentary procedure called reconciliation, which allows legislation to be fast tracked and passed by only a simple majority. Requiring a Senatorial super-majority means that it will be a lot harder to get any climate change legislation passed.

The Supreme Court's decision last year that the Environmental Protection Agency (EPA) has the authority to regulate carbon dioxide under the Clean Air Act and the EPA's ruling in March that carbon dioxide threatens the public's health and welfare, have put considerable pressure on Congress to act. Naturally, when the federal government puts hundreds of billions of dollars in play, it attracts a lot of rent-seekers. "The special interests that seek to derail, blunt, or tailor any new climate policy to their narrow agendas have already gathered in staggering numbers," declared The Climate Change Lobby, a study conducted by Center for Public Integrity. In 2008, more than 770 companies and interest groups spent an estimated $90 million funding 2,340 climate change lobbyists in Washington, DC.

The prospects of carbon rationing and permanently higher fuel prices are going to produce far-reaching changes in the ways companies do business and hit consumers hard in their pocketbooks. In March 2008, House Energy and Air Quality Subcommittee member Rep. Mike Doyle (D-Penn.) told the Capitol Hill newspaper Roll Call, "You are either at the table or on the menu." Mixing his metaphors, Doyle added, "This train is leaving the station." Now it's largely a question of whom it's going to run over.

Ronald Bailey is Reason magazine's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is now available from Prometheus Books. This column first appeared at

Ronald Bailey is Science Correspondent

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