The Horizon: Cap & Trade vs. Carbon Tax

By Jeffrey Levine, Director of Government and Regulatory Affairs, GDF SUEZ Energy North America

With the exception of health care, perhaps no issue has sparked more recent debate in Congress and the business community than climate change policy – and, in particular, the cap-and-trade provision that is at the core of proposed legislation. While this debate has shed both heat and light on the issue, one thing is certain:

Any law that emerges will significantly impact the nation’s energy, environmental, and economic future. How much of an impact is impossible to know with absolute confidence. But in a battle of competing rhetoric and research, supporters and opponents are weighing in on a cap-and-trade regime that has been called a historic victory for the planet and a crushing setback for the economy.

Cap and Trade vs. Carbon Tax

The overriding goal of cap and trade is to reduce greenhouse gas emissions, which many scientists believe contribute to global warming. The government places a cap on the total amount of pollution that companies can release into the atmosphere and then issues rights (variously called allowances, credits, or permits) for those emissions. Companies whose emissions are below their allowances can then sell excess permits to companies that exceed their limits.

Although conceptually related to a carbon tax, the two approaches diverge in some critical ways. A carbon tax is a fee levied for each ton of carbon dioxide emitted or for each ton of carbon contained in fossil fuels. Its advantages include simplicity (the tax can be collected at the point of sale or at the well); transparency; reliability; and less sensitivity to fluctuations in prices.

On the other hand, cap-and-trade does have one important edge:

Aggregate emissions from all sources cannot exceed the mandated ceiling. Accepting the argument that government-set limits are, in fact, sufficient to reduce the threat of global warming, then cap-and-trade should deliver its promised benefits. In contrast, a carbon tax provides no such certainty. It is, at bottom line, a revenue generator that simply places a fixed cost rather than a limit on emissions. Companies can release whatever amounts they choose as long as they’re willing to pay the price (or pass it through to customers).

Currently, cap and trade is the preferred system. It is a centerpiece of the so-called Waxman-Markey bill passed by the U.S. House in June that calls for a 17 percent cut in carbon emissions by 2020 and an 83 percent cut by 2050. A companion bill in the Senate, introduced Sept. 30 by Barbara Boxer and John Kerry, goes even further by calling for a 20 percent cut by 2020. It does not include specific references to “cap and trade,” preferring to redefine greenhouse gas trading as a “Pollution Reduction and Investment” program.

Higher Cost For Industrial Customers Likely

Regardless of what it’s called, however, cap and trade is likely to raise electrical rates for commercial and industrial users – especially for those in energy-intensive sectors.

According to The Wall Street Journal, “The whole point of cap and trade is to hike the price of electricity and gas so that Americans will use less.” President Obama as much as confirmed that observation, telling a San Francisco reporter in January, “Under my plan of a cap and trade system, electricity rates would necessarily skyrocket.”

But how much those prices will increase is unclear:

• The Congressional Research Service analyzed the findings of multiple reports assessing the impact of Waxman-Markey, and concluded that industrial rates could rise between 2 and 13 percent by 2020 and 24 to 49 percent by 2030.
• The U.S. Energy Information Administration (EIA) also predicts that prices will jump significantly after 2030, with electricity costing household and industrial customers between 10 and 77 percent more.
• The National Association of Manufacturers (NAM) projects electricity prices would increase between 5 and 7.9 percent by 2020 and as much as 50 percent by 2030.

The Emissions Trading Scheme used by the European Union, while not an exact replica of what is working its way through Congress now, offers what Investor’s Business Daily calls “a cautionary tale” for U.S. policymakers: That cap-and-trade regime was established in 2005; between 2004 and 2007 industrial rates rose an average of 32 percent among the 25 EU counties.

General Economic Impact: Promising and Pessimistic

Predictably, competing analyses of the general economic impact of climate change legislation range from the promising to the pessimistic.

On the positive side, the New York University School of Law’s Institute for Policy Integrity assessed Waxman-Markey and concluded that the benefits of the bill more than justify its costs:

 “Using conservative assumptions, the benefits of H.R. 2454 could likely exceed the costs by as much as nine-to-one, or more. The estimated benefits do not include a significant number of ancillary and un-quantified benefits, such as reduction of co-pollutants…and lower maintenance costs for energy infrastructure. Due to those limitations, the benefits estimates should be considered to be very conservative.”

There is also the matter of cost avoidance.

A study from Tufts University shows that if no effort were made to curb emissions, the annual impact from four scenarios – more severe hurricanes, residential real estate losses due to sea level increases, and higher water and energy costs – would be more than 1.5 percent of Gross Domestic Product by 2100. That translates to about $1.6 trillion. Given that the Tufts researchers focused only on those four scenarios, they believe “the total cost of inaction is inevitably much higher.”

This is in stark contrast to other available research, however.

Waxman-Markey, the EIA concludes, “increases the cost of using energy, which reduces real economic output, reduces purchasing power, and lowers aggregate demand for goods and services.” That amounts to an estimated $3.1 trillion cumulative loss in GPD between 2012 and 2030, according to the NAM study, and up to 2.4 million job losses. The Heritage Foundation forecasts a total GDP loss of $9.4 trillion between 2012 and 2035 under the legislation.

Environmental Impact

Although cap and trade is an environmental protection mechanism, there is disagreement as to its real effectiveness in limiting global warming.

Referencing the emissions limits established by Waxman-Markey, the Natural Resources Defense Council applauds the bill for setting the nation “on the right path toward a clean energy future.” The Environmental Defense Fund, a supporter of cap and trade, says the legislation will take the equivalent of 720 million cars off the road; provide cleaner air that saves “thousands of lives every year”; and help “avoid the worst impacts of global warming and leave a better world to future generations.” From a global perspective, the Congressional Research Service predicts the measure – combined with the efforts of countries that have signed the Kyoto Protocol – will contribute to a 0.5 degree Celsius reduction in the anticipated rise in global temperatures.

Critics, however, often point to the European example, in which emission rates actually rose 3.5 percent under cap and trade. While rates dropped 3 percent in 2008, most observers attribute the decline to the global recession, which crippled industrial output and drove down energy consumption. Martin Feldstein, a Harvard economics professor, wrote that the proposed cap and trade system “would have a trivially small effect on global warming,” and NASA’s James Hansen – widely credited with bringing global warming to the public’s attention – has called cap and trade an “abject failure.”

Seeking Balance Amid Dueling Data

Although President Obama hoped to have a law in place before the U.N. Climate Change Conference in Copenhagen this December, the fight over health care has dimmed that prospect. But the debate – whenever it resurfaces – will likely not cool off. Clearly, there are pros and cons to cap and trade. The challenge for lawmakers is to fashion a policy that balances environmental, economic, and energy concerns. Given the dueling data and diverse opinions, that may be easier said than done.