Sensing that the public is very suspicious of massive new taxes levied on energy, the supporters of “carbon pricing” continue to tweak their messaging. Although Senators Kerry, Graham, and Lieberman (KGL) have yet to formally introduce their version of a cap-and-trade bill, they have informally shared some of its presumed components.

One of the distinguishing aspects of the (rumored) KGL plan will be a 50% rebate for consumers from any auction revenues for emission allowances. This is an explicit admission that cap-and-trade is economically harmful. But all this does is return half of what the government takes away, and it still forces the economy to use less-efficient energy sources. “Cap-and-dividend” will still raise energy prices, will still transfer billions of dollars annually from the public into the government’s coffers, and is still a bad deal for consumers.

The Rumored 50% Consumer Rebate

KGL have released an eight-page draft outline of their pending bill, which contains “[u]niversal rebate checks from 50% of auction revenues.” The idea of “cap and dividend,” as well as some other measures, were incorporated from the CLEAR Act (S. 2877) introduced last December by Senators Maria Cantwell (D-Wash.) and Susan Collins (R-Maine), though the Cantwell-Collins bill proposed giving American citizens 75% of the money back.

The other major feature of the Cantwell-Collins CLEAR Act—which KGL may adopt to win more supportwas strict curbs on the secondary market in emission allowances. In other words, they want to take “cap and trade” and knock out the “trade.” (Why not knock out the “cap” too?) According to E&E (Darren Samuelson, 3/10/2010):

Cantwell said a primary driver on the legislation was to avoid creating a multitrillion-dollar trading platform susceptible to market manipulation and price volatility — something she fears will be created by the Kerry-Graham-Lieberman proposal.

“I think there’s some who believe you have to have trading to have liquidity,” Cantwell said. “I think a clear price market signal without volatility will unleash the investment. We’re not going to look for any backdoors to just allow the kind of manipulation and abuse that’s happened in the European markets or happened in our credit defaults swap market to take place here.”

This is wrongheaded for several reasons. In the first place, the whole (alleged) virtue of cap-and-trade—as opposed to the government laying out command-and-control regulations, a la the EPA—was that it is a “market-based” solution. Well, part of the Ivory Tower justification for that label is that people in the market get to trade the emissions allowances. By hampering the resale of the allowances—and this includes prohibiting derivative products based on the underlying assets—the government would undercut the whole (alleged) purpose for cap-and-trade in the first place.

Contrary to Cantwell, in general the existence of derivative markets helps to smooth out price fluctuations, and makes investors more likely to pour money into a sector. For example, a futures market in wheat allows farmers to concentrate on planting and harvesting, rather than becoming commodity speculators. The wheat farmers lock in a price today for their future harvest, by selling futures contracts. For a different example, airlines can focus on their customers and routes, rather than worrying about the fluctuating price of jet fuel, by buying futures contracts in crude oil. Looking at the actual data, it is not clear that “speculation” caused the massive run-up in oil prices in the summer of 2008.

Now if Senator Cantwell really wanted to provide industry with certainty, she would come out and advocate an explicit carbon tax. With cap-and-trade, the price to emit a ton of greenhouse gases fluctuates based on the demand (and fixed supply) in the allowance market. So in addition to all the other things they need to forecast, the people running electric utilities and other major emitters will need to guess at what the future price of allowances will be.

At least with an explicit carbon tax—where the government says, “The price of emitting a ton of emissions will be $x this year, $y next year,” and so on—businesses know exactly how much pain they are in store for. Indeed, this certainty was one of the reasons that the CBO came out in favor of a carbon tax over cap-and-trade in a February 2008 study [.pdf].

Don’t misunderstand us: A carbon tax would be damaging to the U.S. economy, and it would yield little environmental improvements. But the point is that if Cantwell really cares about limiting the price fluctuations due to greenhouse gas legislation, she could propose an explicit carbon tax. Yet she won’t do that, of course, because policymakers want to continue the myth that a “cap” is somehow less punitive than a tax.

Price Collars?

There is one respect in which the (rumored) structure of KGL will limit price volatility: the inclusion of so-called “price collars,” reportedly in the range of $10 – $30 a ton in the early years, which would then increase at a fixed rate (to be determined). What this measure means is that if the auction price should ever break above the collar, then the government would override the ostensible “cap” and issue more allowances for that time period. The collar thus provides a ceiling on how expensive emission allowances can get, in any time period.

Other things equal, the inclusion of price collars would limit the damage to the economy, but it’s only because they effectively negate the legislation. After all, it’s not really a “cap” if the government is allowed to issue more permits whenever the burden becomes too onerous; “cap-and-trade with a price collar” is essentially a tax. The discussion of these “safety valves” should warn Americans that the government is playing with dangerous legislation indeed.

Cap-and-Dividend Still Raises Energy Prices

The simple fact is that greenhouse gas legislation is going to damage the economy, in terms of conventional measures such as output, income, and job creation. The various tweaks such as “price collars” and “consumer rebates” reinforce this conclusion: the government is acknowledging that caps on emissions can be potentially devastating. The reason consumers will need those rebate checks is that their energy bills will increase—which is the whole point of the legislation, remember.

Consumers will not be able to have their cake and eat it too. If the government’s new regulations really do induce a fundamental shift away from carbon-based energy sources, then total economic output will drop, along with incomes. That’s what happens when you force utilities to produce energy using relative inefficient sources. There is no getting around this basic result.

One of the more odious elements of the Waxman-Markey cap-and-trade proposal is that it would indirectly redistribute money from lower- and middle-class citizens into the pockets of particular wealthy shareholders. This aspect of cap-and-trade would be mitigated, to the extent that allowances were auctioned (not handed out to favored groups) and revenues were rebated to individuals.

However, we shouldn’t fool ourselves into thinking that “cap-and-dividend” is therefore a boon to consumers. At best, it is a way to harm the economy that spreads the pain around more evenly. But we doubt that’s the spin that KGL will put on their bill.

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