Even among those economists who want the government to “do something” about global warming, most prefer an explicit carbon tax to the stealth tax of “cap and trade” under discussion in the Waxman-Markey bill. Many economists, even those employed by the federal government, have explained the technical reasons [.pdf] that a stealth tax of cap and trade could be more damaging to the economy than a transparent carbon tax. However, beyond these technical issues, cap and trade is also much more susceptible to simple corruption. Precisely because it is so confusing to the general public, the stealth tax of cap and trade allows politicians to transfer wealth from consumers and hand it over to special interests in a much more disguised fashion.
Politicians have championed cap and trade, and have run from an explicit carbon tax, because they understand how much easier it will be to reward their favored constituencies with cap and trade. The latest update [.pdf] on allowance distributions under the Waxman-Markey legislation illustrates these lessons. We just hope the reader hasn’t already spent his “rebate check” from cap and trade revenues, because that money is already gone.
Consumer Rebates: Having Your Cake and Eating It Too?
The first stated goal of handing out free emission allowances is to “protect consumers from energy price increases.” For example, we read that
The electricity sector will receive 35% of the allowances, representing 90% of current utility emissions. Local electric distribution companies, whose rates are regulated by the states, will receive 30% of the allowances, which they must use to protect consumers from electricity price increases.
This is pure deception. The whole point of cap and trade legislation is to raise the price of energy derived from fossil fuels, in order to wean consumers from their (alleged) addiction to cheap gas and electricity. Don’t take our word for it; we can quote from the president himself to make the point:
“Under my plan of a cap and trade system, electricity prices would necessarily skyrocket. . . . Because I’m capping greenhouse gases, coal power plants, natural gas—you name it—whatever the plants were, whatever the industry was, they would have to retrofit their operations. That will cost money. They will pass that money [cost] on to consumers.” – Barack Obama, January, 2008, video here.
Now it’s true, the impact of the higher energy prices resulting from capping carbon emissions could be partially mitigated by appropriate government policies. For example, many economists propose that the government auction off all carbon allowances, and then use 100 percent of the receipts to send lump-sum checks back to citizens, or to fund income-tax rate cuts or reductions in the Social Security tax.
In this way, the government wouldn’t be increasing the amount of resources it siphons away from the private sector; it would simply be substituting a (stealth) tax on carbon while lowering its explicit taxes on labor. The mantra for this philosophy is “tax bads not goods,” meaning that government policies should discourage possibly harmful emissions of greenhouse gases, rather than discouraging work.
Politicians Will Take Their Cut
The economic logic of a massive new (stealth) carbon tax, in exchange for 100% rebates to consumers, is plausible on the surface but it is hopelessly naïve. As the Waxman-Markey discussions ensue, it is obvious that the one group who will not get a piece of the action is the general public.
The issue is very subtle—and that’s just how the politicians like it—but ironically, giving “free” allowances to utilities and other energy producers would largely represent a simple transfer from the public to the shareholders of those companies. The latest summary tells us that the allowances to the electricity sector “will be distributed according to a formula recommended by the utility industry and will phase out over a five-year period from 2026 through 2030.” Anyone who believes this timetable should consult the history of government “emergency” or “wartime” measures—such as the withholding tax instituted during World War II—or allegedly temporary tariffs given to protect “infant industries.”
To see why handouts to industry won’t protect consumers from rate increases, we can quote from OMB Director Peter Orszag (who at the time was head of the CBO):
“Under a cap-and-trade program, firms would not ultimately bear most of the costs of the allowances but instead would pass them along to their customers in the form of higher prices. Such price increases would stem from the restriction on emissions and would occur regardless of whether the government sold emission allowances or gave them away. Indeed, the price increases would be essential to the success of a cap-and-trade program because they would be the most important mechanism through which businesses and households would be encouraged to make investments and behavioral changes that reduced CO2 emissions.” – April 24, 2008, testimony here [.pdf]
It’s difficult for some non-economists to understand why handing back allowances to producers wouldn’t significantly alter energy price increases, but the point is crucial so we’ll walk through it: Suppose the government auctioned off 100 percent of the carbon allowances, and the resulting market price for a ton of emissions was (say) $25. If the government spent all of the auction receipts to pay for universal health care, leaving the burden of the cap and trade system to fall entirely on the energy sector, it is clear that prices for consumers would rise. Ultimately, it wouldn’t be the utilities, but rather their customers, who would foot the bill. Because of the cap on emissions, the costs of producing energy rise, and so the price of electricity for consumers rises as well.
Now suppose instead of spending all of the auction revenues on health care, the government chose to give, say, $10 million to every major electricity producer. Would that push down electricity prices? In general the answer is probably “no.” In order to push down prices, more electricity would need to be produced (because consumers would try to buy more after the price cut). But that means firms would have to use some of their $10 million handout to enter the carbon allowance market and buy the rights to emit more CO2, or to invest in a larger capacity for carbon-free generation, in order to ramp up their operations and sell more electricity (at a lower unit price).
But why would firms use their $10 million handouts in this way? If it made sense to buy more carbon permits (at the going price of $25 each), or to invest in a larger carbon-free capacity, the producers could have relied on private sources of capital to make these changes. But the firms chose not to, because on the margin the $25 price for each ton of carbon emissions made it sensible to scale back their operations. This logic doesn’t change just because the government writes them a check for $10 million (unless the subsidy is somehow tied to market share).
Even though it is counterintuitive, the important point is that even if the allowances are handed out for free to utilities, they still see their costs of production go up because of cap and trade. A coal-fired power plant still “loses” $25 per ton of emissions
, because it could choose to scale back operations and sell its allowances into the market at $25 each. The logic is inescapable: the consumers will ultimately pay for cap and trade through higher energy (and other) prices. By giving some of the potential auction revenues to individual firms in the form of free allowances, the government doesn’t thereby prevent price hikes, all it does is lay subsidies to these beneficiaries on top of the other effects of Waxman-Markey.
We can now see why OMB Director Orszag claimed in the block quotation above that electricity prices would rise, regardless of whether emission allowances are auctioned off or given for “free” to utilities. Whether the government hands a company a check for $10 million, or 400,000 free allowances with a market value of $25 each, either way the firm will pocket the handout for its shareholders. To repeat, the whole point of a cap and trade system is to make carbon-intensive operations—such as electricity produced from fossil fuels—more costly, so that producers reduce their activity in this arena.
If the government attaches strings to the handouts of carbon allowances, or establishes watchdog regulators on the new carbon market and related activities, then utilities and other entities might not be able to pocket the entire subsidy. For example, the government might give allowances to local electricity producers, but insist that they in turn send lump-sum rebate checks to their customers. Yet a much simpler way to achieve this result would be a direct program of tax relief with 100 percent of the receipts from auctioning the permits. One doesn’t need to be a cynic to realize that these schemes are smoke and mirrors, intended to confuse the public as to what is really going on.
Winners and Losers
As the latest clarifications make clear, Waxman-Markey will mean an enormous transfer of wealth from average consumers into the pockets of particular utilities, as well as state governments, “low- and moderate-income households,” and industries that are “energy-intensive” and “trade-exposed.” These are the groups who are slated to receive handouts of carbon allowances, which will be quite a valuable asset once a cap and trade regime is in place. The government could just as well be doling out stocks or bonds to these groups, in the name of protecting them from the energy price hikes that their program will necessarily cause.
Within the energy sector, the biggest losers of course will be producers whose operations emit relatively more carbon dioxide per unit of output, while the biggest winners will be those with low emissions. Thus, coal-fired power plants will need to buy more carbon allowances above and beyond their “free” allocation from the government, whereas nuclear plants will be able to sell any allowances they get to the highest bidder. This simple fact explains the thousands of lobbyists currently jockeying in D.C. over the precise formulas to be used for allowance handouts.
Cap and trade is a massive swindle of the general public, in the name of fighting global climate change. It tries to achieve the emissions reductions of an explicit carbon tax, while pretending that rebates and other tricks can shield consumers from any painful adjustments. Even many scientists who are very concerned about global warming hope that Waxman-Markey fails. They realize that “cap and trade” is a diversion that will do very little to reduce global temperatures, but will instead reduce household budgets while benefiting special interests who get their cut of the allowance handouts.