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Tuesday, August 14, 2007

What to Do About Global Warming: A Basic Framework for a Good Cap-and-Trade Proposal

David Roberts at GristMill has been writing a series of thoughtful posts on the potential actions the 110th Congress may take to address climate change. As he recognizes in this post, we're now moving beyond simply demanding that Congress do something about global warming and have start thinking about what we want that something to look like. If we can't articulate some simple principles, we risk having growing momentum and calls for action co-opted to pass a weak, ineffective climate bill that fails to get the job done at the same time that Congress declares victory and tells us to pack up and go home.

As David writes, "We need the grassroots to be engaged, pushing back against the many half-ass measures on offer, lobbying on behalf of good measures." And to do that, to engage with the incredibly 'wonky' and complex yet enormously relevant topic of cap-and-trade proposals, people need some simple guidelines to help them see if a climate proposal is a good one or not. We need a few simple points we can latch on to, encourage our legislators to keep in mind and build pressure behind.

To that end, David recently outlined the general elements of what makes a good cap and trade system. Obviously there could be different priorities - Step it UP! 2 has a different, broader-focused list - but these are what both David and I agree are the key elements to a strong cap-and-trade proposal worth supporting:

(More below the fold...)

1) Auction rather than give away emissions permits for free.
Free allowances are a windfall for polluters, forgo an excellent revenue source (that can help offset the costs to low-income energy users and spur clean energy investment ... see point 2 below) and undermine the price signal for polluters that's the whole point of putting a price on carbon.

2) Spend revenue wisely to spur development and deployment of clean energy and reduce impacts on low-income and vulnerable citizens.
Putting a price on carbon will raise energy prices and will do so in a regressive manner: those with lower incomes pay a much more substantial portion of their income to energy costs and will be hit hardest by higher energy bills. The regressive nature of a cap and auction policy can be remedied by pumping auction revenues back into reducing payroll or income taxes for low-income citizens - I would suggest an expansion of the earned income tax credit, for example. The remaining revenue should either be used to fund incentives and R&D in clean energy technologies, or to fund a flat, per-capita tax rebate/reduction for everyone. The former will help further reduce energy bills by decreasing the costs of the clean technologies that will help transition to a low-carbon energy future and the latter will be a politically popular way to help sell the whole concept, building support by producing tangible benefits to voters. Both also help further offset the regressive nature of a carbon price.

3) No 'safety valves' that undermine the integrity of the cap.
A 'safety valve' or cap on emissions allowance prices undermines the integrity of the cap and destroys the price signals necessary to incent investment in low-carbon technologies, sacrificing the goals of the legislation to protect polluters.

These are simple guidelines and principles for what an effective cap and trade program would look like. To David's list, I'll add one more crucial point:

4) Targets that get the job done.
This probably means a target of 10-20% below 1990 levels by 2020 and 80% below 1990 levels by 2050. We've got to cut emissions hard and fast in the United States to a) do our fair share to curb rising global emissions and b) gain credibility with the rest of the world, particularly China and India, as we try to lead an international effort to cut global emissions at least in half by mid-century. That will mean getting developing nations to agree to develop in a less carbon-intensive way and to adopt mandatory caps on their emissions, a tough sell unless we're leading the way with credible, strong actions at home.

To summarize, as David does, "auction permits, spend the resulting revenue wisely, and don't short-circuit the system with safety valves.

We can all remember that, right?" Oh, and don't forget (as David unfortunately does) that we need targets that will actually get the job done - 80% by 2050 - or the whole thing's pointless anyway.


Heiko said...

I'd add that the price should be fixed for a year, and adjusted gradually by government. That avoids needless volatility and gives a much clearer price signal.

What'll otherwise happen is what you see in the EU ETS and to a lesser extent the American sulfur programme, a cold winter (and similar short term events, say a natural gas pipeline explosion) would lead to an artifial shortage of credits, and a warm winter to an artificial surplus.

In the case of heating oil, volatility is important to avoid a sport shortage, the short term high price induces short term demand reductions, short term supply increases and gives an incentive to store heating oil.

None of that applies to CO2 emissions, because it's perfectly ok to average a hot and a cold winter, and really it's quite stupid to needlessly make people suffer in a cold winter (or as said another short term problem such as a natural gas pipeline explosion), and then to give them a free pass when the weather is warm.

Jesse Jenkins said...

Heiko, I'm not sure how you would fix the price for a year if the price is determined by a market, unless you are willing to adopt annual safety valve prices which would undermine the integrity of the cap (remember framework principle #3).

However, if the policy allows banking of emissions allowances and perhaps even some limited amount of borrowing from future requirements (as the Lieberman-Warner proposal does), markets would be able to smooth out short-term price instabilities. Allowances can be banked during warm winters/cool summers and saved for a 'rainy day' - or more accurately, a really damned cold day in the winter or hot day in the summer - smoothing out the supply/demand inconsistencies. Borrowing some amount from the future during times of high market demand would also be another way to control costs, which is what the recent proposal from Senators Lieberman and Warner describes. While the Lieberman-Warner proposal is pretty lame in general (more on that soon I imagine), the borrowing provision is a much better cost control mechanism than safety valves (like in the Bingaman proposals) and may be a workable element to incorporate into a stronger cap and trade proposal.

Heiko said...

I don't think there's a need for a market, except in so far as it helps to sell the scheme to free market ideologues. What's wrong with government selling permits at a fixed price for a year? If it sees that the fixed price isn't enough to meet the target the price gets ramped up, and up, and up, until the target is met. I think that's in agreement with principle #3.

I think the banking/borrowing ideas you mention are very interesting, because they avoid the worst of the volatility and still make the thing look like a real market.

On the other hand, you'll find that export oriented energy intensive industry is going to lobby like hell to get free allowances, or failing that some special tax break. They'll argue that they'll go bankrupt otherwise and the stuff will get manufactured in China instead, and so far, export oriented energy intensive industry has been exceptionally successful at playing this game in Europe.

The reason they like cap and trade is the free allowances, and the fact that they are a much less obvious subsidy than the tax breaks they'd have to extract from government under a carbon tax system.

I usually don't talk about "free market ideologues", but in the case of carbon markets I think many of the proponents seem to think that markets magically produce benefits without thinking this properly through.

Price volatility for goods avoids spot shortages. What exactly is the benefit of having any short term price volatility for carbon, where physical spot shortages just cannot happen?

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