Most reasonable and informed individuals agree that there is a genuine need to reduce fossil fuel use in the United States and throughout the world but there are two overarching problems related to a Cap-and-Trade system. The first problem is that Cap-and-Trade proponents operate on a misguided assumption. They want to make carbon-based energy more expensive rather than concentrating on making clean and renewable energy cheaper. So long as fossil fuels are cheaper than low-carbon fuels, both developed and developing countries will follow the laws of economics.

The second problem is that, to this point, there is little serious economic analysis available on the real costs on the production of goods and services within an imposed Cap-and-Trade regime. The “computable general equilibrium” (CGE) models that use actual economic data t estimate how a multiple market economy might react to changes in policy and technology are burdened by some unrealistic assumptions. First, there is no consideration of actual business cycles with the characteristic unpredictable up and down movements in the economy. The CGEs assume the economy will experience solid growth rates with full employment and that the economy can routinely accommodate major changes without serious disruptions. Secondly, there is the assumption that, if the prices of fossil fuels rise, consumers will immediately use less of them and the new supplies of clean, alternative energy will be readily available for replacement. So, given these inherent flaws within the CGE models, the questions that must be asked are: what are the real, long-term impacts of Cap-and-Trade on economic growth? Since economic markets are characterized by Supply and Demand, how will Supply and Demand curves shift to meet changing market conditions? Will a Cap-and-Trade initiative create more unpredictability in already unpredictable and unstable economic markets?

Overall, the debate about taxing carbon through Cap-and-Trade is a false debate. To this point in time, no government has been willing to establish and sustain a high price on carbon because of the much higher energy prices to consumers, the power of conventional energy interests, the impact that higher energy prices will have on energy-intensive sectors of an economy, and the wide price gap between fossil fuels and clean, alternative energy. Certainly, developing economies like Brazil, China, India, and the Eastern European economies are unwilling to commit to rigorous caps on carbon because of the potential regressive impact on growth.

In the 1960s, University of Wisconsin graduate student, Thomas Crocker, actually developed the Cap-and-Trade solution for pollutants. He wanted to cap emissions of pollutants and then allow firms to trade permits that would allow them to pollute within those cap limits. Now 73, he has openly professed that he is skeptical about Cap-and-Trade being the most effective way to regulate carbon. Mr. Crocker has serious doubts about the system being able to work on a global scale because there are no institutions existing with that kind of power. He also wants to see more precise science that quantifies the effects of climate change and, subsequently, makes a realistic determination on the severity of the emissions caps. Mr. Crocker prefers a carbon tax because of its transparency, enforceability, and its flexibility.

Other notable flaws in Cap-and-Trade are that it does not offer a clear price signal like a straight carbon tax; it relies on sophisticated trading systems such as hedging and options and futures. As we all know from recent history, these complex trading mechanisms have the potential of destabilizing markets. The “cap” in Cap-and-Trade is fixed and not adaptable to changing conditions. Cap-and-Trade has a “voluntary reductions” dilemma. If a business or utility takes extra steps to further reduce its CO2 emissions, these positive steps can be cancelled out by corresponding increases in emissions somewhere else. Lastly, it is improbable if not impossible to establish a normative quantity-reduction target for greenhouse gases (GHG). If the U.S. had an emissions reduction goal of 20 percent for 2020, by what criterion should that target be seen as appropriate for any other country?

In theory, Cap-and-Trade sounds reasonable but in the European Union (EU) and other prominent countries, where the protocol has existed for nearly a decade, it has been an expensive failure for energy consumers and provided windfall profits for energy companies, while failing to produce carbon price stability. According to the United Nations Framework Convention on Climate Change, from 1990 to 2006, GHG emissions are up by 15.2 percent in Austria, 18.5 percent in Germany, 24.4 percent in Greece, 25.5 percent in Ireland, 9.9 percent in Italy, 6.2 percent in Japan, 28.5 percent in New Zealand, 37.6 percent in Portugal, and 49.5 percent in Spain. Only the French have seen a decrease in GHG emissions (15.9 percent) and analysts believe that a significant drop in French emissions was due to stagnant economic growth. In the U.S. for the same period, GHG emissions increased by 14.7 percent without any Cap-and-Trade program and in 2008, the EPA calculated that overall air emissions in the U.S. decreased by 7.6 million tons.

Ultimately, as lawmakers attempt to piece together Cap-and-Trade legislation, they should be cautious about the unintended consequences of the initiative. In the EU and in California, a Cap-and-Trade mechanism called “offset” credits (buying and selling the “right” to pollute) has not been successful in reaching predetermined targets. These “offsets” are supposed to represent additional GHG reductions but are not actual reductions in CO2. In fact, EU countries have learned to “game” the system. Some manufacturing companies have actually reduced employment and output to focus on using these securitized emission offset credits to make a profit in a market-based setting. In 2009, because of the global recession, the price of carbon allowances has dropped from $30 per ton to $1 to $2 dollars per ton. Few EU countries are expected to buy emission credits this year and their enthusiastic participation for 2010 is problematic. After the recognition that Cap-and-Trade goals have failed to even moderately reduce emissions, the EU countries are less eager to impose the substantial costs that a second phase cap on CO2 emissions would impose and the mere purchasing of “offsets” simply calls into question the credibility of the EU protocol in actually reducing GHG emissions.

According to the Energy Information Administration (EIA), fossil fuels currently provide 86 percent of our current energy needs. Over the next decade, there will not be enough alternative energy resources available to meet our energy needs. The EIA projects demand for energy to increase 26 percent from 2009 to 2030. Coal-fired energy generation provides approximately 50 percent of the U.S. electricity generation. That percentage is only expected to fall to 47 percent by 2030. Total electricity generation from coal-fired power plants will increase 19 percent by 2030. In 2008, renewable energy was 7 percent of the total U.S. energy output and 8.4 percent of the total electricity generation. The EIA has projected that renewable-generated electricity will increase to 15.8 percent of total output by 2030. This number is hardly enough to adequately meet our energy needs.

In order for a Cap-and-Trade system to function properly, there must be complete participation by all nations. China is expected to surpass the U.S. in GHG output in late 2010 or 2011. At current growth rates, China’s CO2 emissions could equal the output of the entire globe by 2030 . In the shorter term, rapidly developing nations are opting for cheaper energy over expensive energy and for economic growth over cleaner air. The choice for developing nations is buying conventional carbon-based energy for 4 to 5 cents per kilowatt (kW) or clean, renewable energy for 15 cents per kW. Realistically, the industrialized world will not be able to make a dent in overall CO2 emissions when 5 billion poorer people have easy access to trillions of tons of cheap carbon-based fuels to meet their growing demand.

Comprehensive, broad-based transformational changes, such as Cap-and-Trade, must be researched, analyzed, and closely scrutinized before implementation. The current House and Senate climate bills would give away CO2 more than half of the total emission allowances. This free distribution of a portion of the allowances will add volatility and uncertainty to the marketplace and affect accurate pricing.

Finally, since a Cap-and-Trade initiative can only be effective with global participation, it must disadvantage all manufacturers more or less equally. Failure to achieve this relative equalization will cause companies to relocate to the least regulated and least expensive country and create economic dead zones in national economies.

CL