Cap-and-trade will Make the Climate Problem Worse, Not Better

Executive Summary

The Larson bill for regulating carbon emissions (essentially a fee-and-rebate) would be a superior alternative for everyone: generators, the public, the economy, and the environment. Conversely, the Waxman-Markey and Boxer-Kerry bills would a major step backwards, hurting the environment, economy, public, and causing unpredictable price for generators.

Four key reasons why it is important that we use a fee-and-dividend approach to regulating carbon emissions:

1) Fee-and-dividend is, without any doubt, the best way to regulate carbon emissions. There is near universal agreement among experts including Al Gore, Jim Hansen, the inventors of cap-and-trade, economists, the CBO, EPA regulators, and Sierra Club that fee-and-dividend is the best way to achieve the goal of carbon emission reductions because it puts a predictable price on carbon. Conversely, the current cap-and-trade bills, even in the most optimistic scenario, would achieve virtually no reductions and in any practical, real-life scenario, would actually make the problem worse because at best it would lock in today’s emissions for decades.

2) Fee-and-dividend is popular with voters. Fee-and-dividend is politically viable. In British Columbia where the opposition party made it an election issue, they proved it was political suicide to oppose it. The opposition party now supports it. There are now carbon fee laws all over the world, including in the US.

3) Fee-and-dividend helps our economy and our environment: it is a double-dividend. Fee-and-dividend helps our economy whereas cap-and-trade would hurt our economy. So fee-and-dividend is a great idea even if you don’t believe in global warming; we pass the bill for the economic benefit and we get the environmental benefit for free. Economists call this double benefit (economy and environment) the “double dividend.” Cap-and-trade does not have a double dividend.

4) Cap-and-trade would irreparably harm our environment and hurt our economy. The current cap-and-trade bills would, even under ideal circumstances, insignificantly reduce emissions by 2020 according to the CBO analysis. Under any practical scenario, it would hurt the environment irreparably because it allows business as usual (BAU) for 17 years or more (and Stanford Professor Michael Wara’s graph of emissions under Waxman-Markey shows that under Waxman-Markey, emissions can keep increasing until 2030). This is why Jim Hansen is so against it and why key individuals within the green groups are personally opposed to the cap-and-trade part of the House and Senate bills. Cap-and-trade is a “double whammy,” hurting both our economy and environment.

Cap-and-trade must be defeated because it will do irreparable damage to our ability to mitigate climate change and hurt our economy at the same time. There is no analysis anywhere that disputes what Hansen says.

The alternative, substituting Congressman Larson’s bill for the cap-and-trade section of the Senate bill, will help both the economy and the environment. Unfortunately, nobody is paying attention to Larson’s bill because cap-and-trade is sucking all the oxygen out of the room.

The four biggest myths about fee-and-dividend

Myth #1: The cap-and-trade bill isn’t perfect, but it will get the job done and it has everyone behind it so it’s the only game in town. If you want to get something done, this is the train to get on. This is our only chance. If this is defeated, nothing will get done. This is better than nothing.

That’s what people thought when they originally supported it. The truth is that, at best, would reduce emissions by 2% by 2020 according to the CBO analysis. But the more likely scenario is that, because it allows offsets (which are impossible to regulate), it will allow actually emissions to get worse until 2030 while the same time hurt our economy through higher and unpredictable energy prices. It will also drain dollars from the US and send them overseas for a questionable environmental benefit. That is a “double whammy:” hurts the environment, hurts the economy. A fee-and-dividend provides a “double dividend”: helps the economy, helps the environment. Unfortuately, people are locked into their position and the only way they can rationalize their continued support is to ignore the facts and hope that things will turn out better than all the unbiased analyses say. This is stupid when there is a superior alternative, fee-and-dividend, that has no downsides (other than a perception myth) that virtually everyone is saying is the superior solution including the CBO, Al Gore, Jim Hansen, the creators of cap-and-trade, economists, EPA regulators, and even Exxon Mobil and the Chinese government.

Myth #2: Fee-and-dividend will never pass. It’s a tax. There is no traction for this.

This is a self-perpetuating myth that is true only as long as people contine to believe it is true. The reality is that if properly positioned (see communication tools for making a carbon tax palatable to the public), a carbon fee and rebate is not only politically viable, but it is political suicide to oppose it, as the lawmakers in British Columbia now know. Look what happened in Finland. Finland’s carbon tax has reduced emissions by 5% below the previous trend and stimulated renewable energy investment and development. Energy taxes are now a major source of government revenue, and are curbing growth in energy use and promoting efficiency while Finland’s economy expands. Finland’s climate policy has created jobs, including more jobs for women. See Carbon Tax is on the (Round) Table at the Cosmos Club.

Myth #3: Fee-and-dividend is unfair. It will result in a net transfer of wealth from states that use a lot of coal for electricity to states that have a cleaner energy mix.

States relying heavily on coal have lower power costs than states with a cleaner mix, so a fee-and-rebate would have the effect of evening out power costs across America. However, the transfer of wealth will be small in the early years when the tax is ramping up. If disparity is a problem, a portion of the fee could be used to even out regional differences, for example, taking 20% of the fee and disbursing it all back to the states to even out regional disparities.

Myth #4: It will unfairly hurt poor people because they pay a greater percentage of their income for energy prices.

Exactly the opposite is true. Percentages don’t matter. As long as rich people use more energy than poor people, poor people will always benefit from fee-and-dividend. Fee-and-dividend is the only solution that is progressive and will help the economy. Suppose we have two residents: a rich person and a poor person. The rich person makes $100K/yr and pays out $100 per year in the fee because he has a big house and a private jet. Our poor person makes $1,000/yr and pays $10 per year in the extra fee since the poor person uses less energy than the rich person. What happens is that each person gets a $55 rebate. So the poor person doesn’t pay more for energy under this plan…he actually makes money! So instead of paying out $10, the poor person  is now $45 a year richer. So the people who can least afford higher energy prices are always better off in a fee-and-dividend scheme.

Background

This is the biggest issue of our time…maybe for all time…

If we get it right, we save the planet.

If we get it wrong, we’re toast. Game over. No chance to fix it, possibly forever.

Unfortunately, we’re poised to get it wrong. Really wrong. Here’s why…

On May 4, 2009, NASA’s leading climate scientist, James Hansen, said he hoped that the Waxman-Markey bill fails because the bill would lock in dangerous emissions for decades. The Boxer-Kerry bill in the Senate is substantially the same, so his criticisms apply equally well to that bill. Hansen’s new book, Storms of My Grandchildren (available December 8) makes the case against cap-and-trade in detail in Chapter 9. He points out that fee-and-dividend, where a carbon fee is assessed at the source and 100% of those fees are paid back to the public on a per capita basis, is superior to cap-and-trade and will get the job done.

A day later, Joe Romm wrote a detailed response on his website saying Hansen is wrong. Romm argues that that fee-and-dividend won’t work.

Who should we believe? And how can we be sure they are right? This is really important. We cannot afford to get this wrong. The fate of our planet depends upon it.

What I found when I looked in detail at the evidence was that Hansen is right and Congress and Romm got it wrong. It wasn’t even close. Many others who have looked objectively at the arguments came to the same conclusion I did: see the Supporters list at the Carbon Tax Center.

So all these emails you are getting from the green groups urging you to ask your legislators to vote for the climate bill is bad advice. Doing so will make the problem worse, not better.

If you really want to save the planet, you should be urging your legislator to not support cap-and-trade and to support fee-and-dividend instead.

I’m going to summarize the reasons why cap-and-trade won’t work, why fee-and-dividend will work, and why most of the green groups got it wrong and will not change their position.

Australian climate scientist Barry Brook summed up the fundamental differences quite nicely (emphasis mine):

Carbon tax and fee and rebate are both more difficult to manipulate than a cap-and-trade, and for that reason are better. The cap-and-trade has a couple of theoretical advantages (potentially lowest costs abatement, best guarantee of actual reductions) but in practice it is distorted to hell with grandfathering, free permits etc. So KISS. The key thing is to get a price on carbon to make the alternatives much more attractive as a medium-term investment.

In short, cap-and-trade in theory works better, but in practice, especially for climate change, it probably won’t work at all, even if the bill was perfectly written. If the bill is not perfectly written, it can make things a lot worse. That’s the situation we have today with the bills in Congress.

Green groups support cap-and-trade: because in theory it gets the job done with certainty and because it appears to be politically viable. Members of Congress like it because, according to one Senator, “that’s what we did in 1992 and we’re comfortable with that.” Those groups didn’t spend enough time talking to people like Laurie Williams and Allan Zabel who are enforcement attorneys with US Environmental Protection Agency. Zabel has over 20 years of experience with cap-and-trade and offsets. They told me that even under ideal conditions, it is not possible to write an effective cap-and-trade law for climate change (more on this later). Their arguments can be found on their website at www.carbonfees.org including this excellent paper which should be read by anyone seriously interested in comparing the options:  Keeping Our Eyes on the Wrong Ball: Why Acid Rain is the Wrong Template and the 1990 CFC-Tax is Closer to the Mark and Why Cap-and-Trade Won’t Solve the Climate Crisis But Carbon Fees with 100% Rebate Can. They independently came to the same conclusion Hansen did, for a similar set of reasons.

One thing you never hear the green groups or Joe Romm talk about is that the inventors of cap-and-trade, Thomas Crocker and John Dales agree with Hansen that for climate change, an outright carbon fee is better than cap-and-trade as noted in this Wall Street Journal article “Cap-and-Trade’s Unlikely Critics: Its Creators: Economists Behind Original Concept Question the System’s Large-Scale Usefulness, and Recommend Emissions Taxes Instead.” That article also says that the economist who did the most extensive work on cap-and-trade also agrees with Hansen:

Another economist, David Montgomery, advanced their ideas in the 1970s, converting their theories into the complex mathematical formulas to demonstrate that they weren’t merely an idea but were also economically feasible. Mr. Montgomery, too, is a skeptic of cap-and-trade for greenhouse gases. He prefers an outright tax.

So now we have one of the world’s leading experts on climate change, Jim Hansen saying cap-and-trade would be a disaster for the climate and also the inventors of cap-and-trade and the economist who did the most work on cap-and-trade theory agreeing with Hansen. We should pay serious attention to this.

Suppose you were dying of cancer and had a year to live. The doctors tell you have only time to take one drug: Drug A or Drug B. Most of your doctors say in theory Drug A should work best (even though it has never worked on your cancer), but the world expert on your cancer says it will kill you and the company that invented the drug says Drug B will work better. For Drug B, almost everyone says it will work, it has worked in real life for people in British Columbia, but some doctors are skeptical of whether you’ll decide to actually take it.

Which Drug do you choose to save your life? Most of us would choose Drug B. But a lot of members of  Congress want to force us to take Drug A because they don’t think you’ll take Drug B. So you can see, we have a big problem here.

One of the main reasons Hansen doesn’t like cap-and-trade is precisely the same reason Brook pointed out: in any practical implementation that has the complexity of climate change, it really gets messed up. Indeed, the climate bills in both the House and Senate will both allocate permits to coal plants and allow enough emission offsets so that the owners of the coal plants will not have to do reduce their emissions for decades. So it locks in a bad result for a time that is long enough to permanently eliminate any hope of controlling climate change. I’ve not seen any analysis with a credible argument as to why Hansen’s most-likely-case-scenario won’t happen.

Critics say fee-and-dividend isn’t politically possible. But is that really true? The critics (including Romm) seem unaware of what happened when British Columbia passed a fee-and-dividend law for climate change. First, the law was put in operation in only 4 months whereas cap-and-trade would take many years to implement.  Second it became an election issue with the opposition party campaigning hard against this “tax” — but the public liked it as the money was returned via a reduction in payroll taxes.  When the opposition lost the election, they changed their tune — now both parties support it. So much for the “not politically viable” argument. BC proved just the opposite is true: that it is not politically viable to oppose fee-and-dividend! For more on the British Columbia experience, see these 3 links: http://www.carbontax.org/progress/where-carbon-is-taxed/, http://www.carbontax.org/blogarchives/2009/05/13/bc-voters-stand-by-carbon-tax/, and

http://www2.macleans.ca/2009/05/26/a-new-coalition-a-different-politics/.

So now let’s sum up the key reasons cap-and-trade is bad and fee-and-dividend is good.

Here are a few reasons why cap-and-trade is the wrong answer for controlling carbon emissions:

1. Experts say both the Senate and House bills will lock-in high emissions for decades. This is the most significant argument against these bills. It’s not just that cap-and-trade won’t work. It’s that it will make things worse. See G-8 Failure Reflects U.S. Failure on Climate Change and Hansen hopes lawmakers’ cap-and-trade approach to climate will fail for details. Also, Rainforest Action Network and International Rives released an analysis of Waxman-Markey which pointed out “In reality, emissions from the major sources of greenhouse gas pollution in the US would be allowed to increase until 2025 and the 20% reduction supposed to happen by 2020 would not actually be required to occur until 2036.” If the full amount of offsets allowed by the Waxman-Markey draft legislation were utilized by polluters, the report concludes that any actual emissions reductions in capped sectors of the U.S. economy would be delayed until 2026, allowing a full seventeen years of continued business as usual. Yikes. That’s a fatal blow.
2. Even the most optimistic projections only show minimal reductions under cap-and-trade. The analysis of Waxman-Markey by the non-partisan Congressional Budget Office (CBO) show that it would reduce cumulative emissions by just 2% between 2012 and 2020 in the sectors of the U.S. economy regulated under the bill’s cap and trade program. That’s better than nothing, but still not good enough. If it were only really this bad, it wouldn’t be such a big problem. But this is the optimistic scenario because it assumed that everything was on the level (no gaming or fraud). While we can hope for this to be exceeded, it is much more likely that we’ll have business as usual for the next 17 years.
3. It drains money from consumers which hurts our economy without reducing carbon emissions. Cap-and-trade will take money out of your pocket (in higher energy prices). But instead of going to building new clean energy, that money is more likely to go into the pockets of Wall Street investors who set up the cheapest offsets and to foreign countries that implement them. This will be a net drain on our economy. Furthermore, basic economic principles dictate that all those funds will go to the cheapest offsets. Those inexpensive offsets will either be shams or be very ineffective. In short, there will be a net transfer of money out of the US for virtually no benefit to the consumer. Consumers lose, Wall Street wins, foreign countries win. That’s really bad for us. That’s not what we need to help our economy. Offsets allow funds to be diverted into shams instead of building a clean energy economy.
4. It will not create any incentives to exceed the cap. Cap-and-trade basically sets a floor. Once your emissions are below the cap, there is no incentive to do better than that. This is particularly bad because the floor contemplated in the bills in Congress are actually above the current emissions for nearly 20 years. Take a look at the graph at Is Waxman-Markey’s “Cap” and Trade System Full of Hot Air? So a high floor and no incentive to do better than the floor is bad news for the environment.
5. Cap-and-trade cannot deal with unanticipated fluctuations in demand. Cap-and-trade amounts to rationing. If the economy needs more fuel beyond the “cap” you had set for the year, the alternative may be to turn off the lights.  Assuming this is unacceptable, there would be an huge incentive to suspend the program as occurred with the RECLAIM cap-and-trade program in Los Angeles.  Or alternatively, you get price volatility, because as you bump up against the cap, and there is demand greater than the cap at the prevailing price, you get scarcity and price spikes.
6. The creators of cap-and-trade and the economist who knows it the best are dubious it will work for climate change. They all believe that fee-and-dividend is the superior approach. See this Wall Street Journal article “Cap-and-Trade’s Unlikely Critics: Its Creators: Economists Behind Original Concept Question the System’s Large-Scale Usefulness, and Recommend Emissions Taxes Instead
7. It has not worked in practice when applied to climate change. There are no success examples; it hasn’t worked anywhere where it’s been used to regulate carbon emissions. In Europe, it produced harmful price volatility, few legitimate green house gas reductions, higher energy prices for cosumers, and billions in windfall profits for utilities. Uh oh. Big red flag. The proponents of cap-and-trade never like to talk about this; they say we’ll get it right even though our system isn’t that different from those that have been tried before
8. It will create unpredictable prices. Cap-and-trade, in theory, locks the emissions and allows prices to fluctuate, sometime quite violently as it did in the EU. It is just the opposite of fee-and-dividend which creates a stable price, but an uncertain emission reduction at any point in time.
9. It is not affordable. Where are consumers going to get the money to pay for this? It would be one thing if it were effective. But these bills increase costs for no benefit. There is no rebate to consumers to help them pay for the increased costs.
10. A lot of very smart people say cap-and-trade will not work. See the Supporters list at the Carbon Tax Center. A lot of people are afraid to speak out or just not aware of the fee-and-dividend alternative.
11. It will delay investments in the clean energy economy that the Obama administration wants. The money you pay won’t flow into building clean energy in the US. See this analysis.
12. The proponents of cap-and-trade for carbon emissions fail to distinguish why cap-and-trade worked for acid rain, but why it won’t work for carbon emissions. Cap-and-trade works for some things and not others. The proponents of cap-and-trade in general fail to appreciate this; they think that since it worked for acid rain, it will work for reducing carbon emissions. In fact, they use this argument when arguing for cap-and-trade. But that argument is flawed. Williams and Zabel call this this argument “the big lie” in their video. Cap-and-trade cannot be applied successfully to all situations. And the acid rate program did not include offsets, a key feature of both the House and Senate versions of cap-and-trade that destroys its integrity. For details on this, see Keeping Our Eyes on the Wrong Ball: Why Acid Rain is the Wrong Template and the 1990 CFC-Tax is Closer to the Mark and Why Cap-and-Trade Won’t Solve the Climate Crisis But Carbon Fees with 100% Rebate Can.
13. Carbon offsets don’t work. Carbon offsets destroy the integrity of the cap-and-trade program. Williams and Zabel call this “the big rip-off.” See this video.
14. Cap-and-trade with offsets provides too many opportunities to game the system. A very senior Senate staff person acknowledged that cap-and-trade isn’t the most efficient way to achieve carbon reductions, but politicians like it because it is “an easier tool for politicians to use as a revenue grab for purposes other than addressing climate change.”
15. There are too many uncertainties. Even if you had cap-and-trade without any offsets, that would be better, but there are still problems. Suppose you are PG&E. You can’t predict next year’s power demand since it depends on climate and economy. So what do you do? Overbuy the permits? Or under buy and risk having to buy later on the open market? What happens if the economy goes wild and demand goes up. You’re screwed. The price on any permits remaining goes sky high. What incentive I have to cut my emissions once I have my permits. Do I reduce so I can sell my permits? But how do I know there will be a market after I do that? Could be that everyone else is doing the same thing. There is no certainty so I can’t plan effectively.

Here are a few reasons why Hansen, economists, regulators, and even Exxon Mobil, like fee-and-dividend:

1. Most experts who have looked at both systems admit that fee-and-dividend will work better than cap-and-trade for carbon emissions. Among experts who really understand both systems, there is pretty much universal agreement that fee-and-rebate is the superior solution for regulating carbon emissions. The regulators, in particular, love it. One EPA economist when asked about Williams and Zabel’s fee-and-rebate proposal for climate change said, “Anyone who knows anything knows they are right.” Climate Change: Caps vs. Taxes , a report from the conservative American Enterprise Institute (AEI) says the same things the experts have been saying: ” A cap-and-trade approach to controlling GHG emissions would be highly problematic. A program of carbon-centered tax reform, by contrast, lacks most of the negative attributes of cap-and-trade, and could convey significant benefits unrelated to GHG reductions or avoidance of potential climate harms, making this a no-regrets policy.” The report goes into detail about the impossibility of enforcement of cap-and-trade, and the incentives for cheating would be high.
2. The Congressional Budget Office agrees that fee-and-dividend is the superior approach. Here’s what Peter Orszag, Director of the Congressional Budget Office, told Congress on April 24, 2008:

“Within the relatively efficient category of approaches that rely on the power of markets, a tax on emissions is generally more efficient than a cap-and-trade system. The reason is that although both a tax and a cap-and-trade system encourage firms to find the lowest-cost reductions at a particular point in time, a tax provides greater flexibility over time, allowing firms to achieve reductions when they are least expensive. In particular, a tax encourages firms to make greater reductions in emissions at times when the cost of doing so is low and allows them leeway to lessen their efforts when the cost is high.”

1. Unlike for cap-and-trade, fee-and-dividend can be totally justified on pure economic grounds alone. Fee-and-dividend is just good economic policy on its own. It has a fringe benefit in controlling climate change, but if the dividend paired with a reduction in taxes, it can be totally justified on economic reasons alone (known as the “double dividend”). Cap-and-trade removes money from the wallets of consumers and transfers it to wealthy investors and foreign countries. Fee-and-dividend does the opposite: it keeps all money within the US and has the effect of redistributing it from wealthy people (who tend to emit more carbon) into the hands of poorer people (who tend to emit less carbon), i.e., it’s progressive. Since the marginal propensity to spend is way higher for poor people than rich people, the economy is stimulated because you are now transferring money into the hands of people who are more likely to spend it. That is why fee-and-dividend is a positive benefit to our economy and it can be justified on that basis alone. See, for example, this New York Times OpEd: “An Emissions Plan Conservatives Could Warm To” which was co-authored by a Republican and an economist. The AEI report Climate Change: Caps vs. Taxes says the same thing: fee-and-dividend: ” … a carbon tax can be paired with a reduction in other taxes in a manner that improves the overall efficiency of the economy. Where such a double dividend is available, a carbon tax swap would be desirable, even if the environmental benefit of reduced carbon emissions failed to be realized.”
2. It is politically viable; arguably more than cap-and-trade seems to be. Look what happened in British Columbia which passed a fee-and-rebate law: the opposition party made it the key issue for the next election. When the opposition lost the election, they changed their tune and now support it. The public loves it. So when you hear the argument that “fee-and-dividend” isn’t politically viable, ask them to explain why we would be any different here than in British Columbia, Boulder, Colorado, and many other places all over the world that have successfully implemented carbon taxes. British Columbia proved that it was not politically viable to oppose fee-and-dividend. Also, cap-and-trade doesn’t seem to be a political slam dunk since it increases fees to consumers and doesn’t give them the money to pay for it. It appears the only way to get cap-and-trade to pass is to water it down even more. The big myth in this debate is that fee-and-dividend isn’t politically viable. The British Columbia experience showed conclusively that it wasn’t politically viable to oppose fee-and-dividend. But it’s truly amazing how many people still cling to the big myth, mostly because they don’t know the facts.
3. It works in real life when applied to carbon emissions. It’s been used in British Columbia to reduce carbon emissions. It was implemented in record time (about 4 months). The public loves it. It didn’t destroy the economy. Politicians who campaigned against it lost (and changed their position to support it). It works in the US too. Boulder, Colorado implemented the first tax on carbon emissions in the US on April 1, 2007. It costs the average household $1.33 a month, but households that use renewable energy get an offsetting discount. The Carbon Tax Center has a long list of places where carbon taxes are in place and working, proving without a doubt it is politically feasible all over the world. That page references materials are essential reading for any carbon tax advocate seeking to master not only the details of carbon taxing but communication tools for making a carbon tax palatable to the public.
4. It gives predictable prices. Unlike cap-and-trade, prices are very predictable. There is never a rationing situation. Industries can emit as much carbon as they want. By steadily and predictably increasing the fee on a regular basis, results are guaranteed.
5. It creates a stable climate for the massive investment in clean energy that we need. Cap-and-trade will not create confidence by investors that clean energy will become profitable because it creates an unpredictable price on carbon. Fee-and-dividend, on the other hand, guarantees that clean sources will steadily become more attractive than fossil fuel sources by setting a gradually increasing and predictable price on carbon. See this video.
6. Everyone is incentivized to find alternative solutions at their own pace. Unlike cap-and-trade, industries determine for themselves the rate of compliance. Fee-and-dividend rewards them for doing it sooner and more completely. But the rate is up to them.
7. Everyone is incentivized to continue to reduce their carbon emissions to zero. Unlike cap-and-trade which sets a floor on the incentives to reduce carbon emissions, there is no floor in fee-and-rebate. Industries are rewarded for (but not forced to) reducing carbon emissions to zero as fast as they can. That’s exactly the type of incentive we want.
8. It cannot be gamed with offsets of dubious effectiveness. Gaming in a fee-and-rebate system is nearly eliminated. Gaming in a cap-and-trade system would be rampant.
9. It’s affordable. Because 100% of the fees are rebated to the public, it’s very affordable. In essence, it amounts to a net transfer of wealth from people who emit lots of carbon to people who emit less carbon. In other words, the money goes from people who can most afford it to people who can least afford it. Most importantly, unlike cap-and-trade, none of your money goes to Wall Street investors and none of your money flows out of the country. In fee-and-dividend, the money flows from US consumer to US consumer. That’s why it was so popular in British Columbia and the reasons for its popularity there should be exactly the same here.
10. NRDC likes it. NRDC economists like but but they just doesn’t think it will pass Congress. That’s odd considering the British Columbia experience. Most Americans would actually come out ahead in a fee-and-rebate system. So why would it be not politically possible to do this?
11. Nobody says it will make things worse than the status quo. This is perhaps the most important argument. If you have one solution where a lot of experts say it will make things worse, and another solution where nobody says it will make things worse, why would you ever opt for the first solution, especially on an issue where if you get it wrong, you will most likely irreparably damage the environment? Fee-and-dividend is the safe solution and the only logical choice where you cannot prove beyond a reasonable doubt which expert is correct about cap-and-trade.
12. Al Gore agrees that fee-and-dividend is the best way to reduce carbon emissions. Al Gore originally insisted that a carbon tax was the only way to go. Although he later came out in support of cap-and-trade, he is still of the opinion that fee-and-dividend is the best way to go.
13. It can be easily adjusted for regional differences. One critic of fee-and-rebate claimed it was unacceptable because it would be a net transfer of money from states with high emissions to the cleanest states (like California). However, the system could be easily written to keep the cash flows within each state or within groups of states who start out with similar emissions.
14. Exxon Mobil likes it. So it has support from all of the players.

There is also an excellent 10-minute video entitled “The Huge Mistake” which summarizes the case for fee-and-rebate. I highly recommend this video.

Hansen points out:

Regarding “cap” versus “fee” versus “tax”: none of these approaches will work (slow down emissions fast) unless they increase the price of carbon emissions.  “Cap” is dishonest, as they pretend that it will not increase fuel cost.  “Tax” is unnecessarily self-flagellating, making it practically impossible to be accepted.  “Fee” seems to be an appropriate middle ground.  Of course the big question is: what happens to the money collected.  Cap-and-trade pulls another big swindle — Congress wants to decide what happens to the money, so it can hand out favors to the usual suspects, who will hand some back to them.  The public needs to insist on a 100 percent dividend.

So why, if fee-and-dividend is so good, don’t all the green groups align behind it? I think there are three reasons:

1. They honestly think cap-and-trade will work…eventually. They believe if it fails to achieve the goals, that Congress will tweak it so it will work. However, others are skeptical that that will happen in time to make a difference. For example, in RECLAIM, despite the presence of accurate monitors and sophisticated regulators, the initial cap was inflated (set too high, also called “over-allocation”), which delayed most emission reductions for approximately seven years (see Why Acid Rain is the Wrong Template and the 1990 CFC-Tax is Closer to the Mark and Why Cap-and-Trade Won’t Solve the Climate Crisis But Carbon Fees with 100% Rebate Can). We don’t have seven years to waste.
2. They think that cap-and-trade has the political momentum to pass Congress now and that fee-and-dividend can’t get enough votes to pass. So they’d rather have something than nothing. Virtually all the political momentum is behind cap-and-trade.
3. They are now so publicly committed to supporting cap-and-trade it is difficult to impossible to change their position. To change their position now would hurt their credibility, even if they now realize they made a mistake. The leader of one of the largest green groups told me, “I am very sympathetic to this critique.  It has been almost impossible to turn the greens from cap and trade.”

Is it possible for Congress to create an ideal law that would make cap-and-trade work for climate change? When I asked Williams and Zabel if they could write a cap-and-trade bill that would work for climate change, here’s what they said:

As Steven Stoft has said, in general, cap-and-trade provides an incentive to pollute up to the cap, to the extent that you are relying on the cap as a limit.  So even if there was a perfect cap-and-trade system, with no offsets, then you would be less likely to get reductions below the cap.  This doesn’t occur with an appropriate fee, because there is always an incentive to avoid the fee.

If we were designing a cap-and-trade, there would be no offsets; all allowances would be sold at the floor price, set to insure that fossil fuel energy became more expensive than clean energy within a known time frame.  To avoid the enforcement nightmare associated with tracking emissions, we would have an upstream cap, applied to fossil fuels as they entered the economy.  We would essentially get rid of the trade, because the cap would just be the maximum amount of fossil fuels that could enter the economy.  Trading would occur after the initial purchase of fossil fuels, where the cap/fee would be applied.  This would essentially be cap-and-dividend as proposed by Peter Barnes, but would be more explicit about the price (i.e., getting the price above the currently available price of clean energy at the start of the program within a known time frame)

Another reason that a cap system is inferior to a fee system is that it amounts to rationing.  If the economy needs more fuel beyond the “cap” you had set for the year, the alternative may be to turn off the lights.  Assuming this is unacceptable, there would be an huge incentive to suspend the program as occurred with the RECLAIM cap-and-trade program in Los Angeles.  Or alternatively, you get price volatility, because as you bump up against the cap, and there is demand greater than the cap at the prevailing price, you get scarcity and price spikes.

A steadily declining cap assumes that there are technical/infrastructure improvements in clean energy that will match the required carbon decreases.  Economic activity and innovation are not that predictable in a real economy.  Rather these things are unpredictable.  So a fee (rather than a cap) is more economically flexible and rational.  It provides clear incentives, but doesn’t create price spikes from specifically imposed limits/caps.  What pulls innovation and investment in clean energy forward is the price structure making clean energy competitive with fossil fuels within a known time frame.  Planning is then possible.

There is a great report on why cap-and-trade will lead to price volatility and delays in clean energy investment by the Brattle Group. see http://www.brattle.com/_documents/UploadLibrary/Upload737.pdf

One final comment. Williams and Zabel have been two of the most outspoken critics of cap-and-trade for carbon emissions for some time. They are also in a position to know exactly what they are talking about because they have been involved in enforcement of California’s cap-and-trade law. I asked them whether anyone from Congress including any staff member has ever talked to them to seek their advice or ask them to testify in front of any Congressional committee. The answer is no, not one person has contacted them. So if you thought Congress seriously and carefully weighed the arguments against cap-and-trade, think again.

Collectively over the years, Hansen and the Carbon Tax Center have discussed cap-and-trade and fee-and-dividend with several dozen members, mostly on the House side, with varying degrees of receptivity.

A better solution: Larson’s bill

On the House side, Congressmen Larson (D-CT) and Stark (D-CA) are the strongest advocates of this approach– they introduced a bill that has carbon pricing with corresponding reductions in payroll taxes on wages. Unfortunately, they are being ignored by the Democratic leadership and the White House. However, the Chinese government noticed the wisdom of this bill and is apparently going to take this approach. For a quick synopsis of Larson’s bill, see: http://www.carbontax.org/progress/carbon-tax-bills/.

From the graph below (from Carbon Tax is on the (Round) Table at the Cosmos Club), you can see how Larson’s bill is vastly superior to W-M and it will help the economy to boot.

Congressman Dingell has championed a carbon tax at times. Congressmen McDermott (D-WA) and Doggett (D-TX) both introduced proposals to “manage (carbon) price” which work more or less like a carbon fee but with some of the (alleged) advantages of a cap. On the Republican side, Bob Inglis (R-SC) has tirelessly pressed the case for a carbon tax; he’s very assertive about saying it must be revenue-neutral– no expansion of government.  He’s a big supporter of wind electricity generation, and understands that a carbon price is essential to making the shift.

In the Senate, Dorgan (D-ND) has often asked why get Wall Street into the carbon market and why not a direct fee instead. Senator Corker often asks similar questions.

Senator Cantwell (D-WA) has been working on a Cap/Dividend proposal that would be a huge improvement, for example eliminating offsets. Like other bills, Cantwell allows a coal-burning company that sequesters CO₂ to get a refund of the fee if the CO₂ is sequestered. This is because the power company is paying the fee when the buy the coal, so by “refunding” that same fee if they later capture the carbon that they already paid a fee on, it becomes revenue neutral to the power company which is perfectly fair since they aren’t emitting any carbon. And if the CCS cost is lower than the carbon fee, the utility makes money on the deal giving them a huge economic incentive to do the right thing. Without this credit, a power company would have no incentive to sequester their emission since they had to pay for the emissions when they bought the coal. Although her carbon price starts out low, it increases over time, though arguably not enough and . Cantwell returns 75% of the auction revenue as per capita dividends and allows 25% to be used for transition assistance and green public investments.  Using 25% of the revenue for other things, such as evening out the regional impacts caused by higher carbon prices, is a reasonable approach. Such regional impacts are a big political issue, esp. among Democratic Senators from carbon-intensive states. Cantwell also has a provision whereby the President can adjust the cap downward in the event that changing climate science ‘demands’ such a revision. Cantwell just about eliminates ‘the stupid markets and traders.’  No offsets; permits can only be acquired (at auction) by actual first sellers of fossil fuels; and the permits expire quickly.  So it’s ‘use ‘em or lose ‘em,’ with extremely limited trading and speculation.

Peter Barnes pointed out the following:

Fee and Dividend is effectively the same as Cap and Dividend, where the cap is upstream (at the fuel source, the exact same place the fee would be), 100% of permits under the cap are auctioned (in effect, the permit price = the fee), per capita dividends are then paid, and there is ZERO trading of offsets for permits. Sen. Maria Cantwell has a bill to this effect.  It is ‘fee and dividend’ in all but name

Senator Murkowski (R-Alaska) said positive things about the cap/dividend idea at a recent Energy and National Resources Committee hearing.

At this point, it’s fair to say that cap-and-trade has “sucked so much of the oxygen out of the room” that it’s near-impossible to get real focus on Capitol Hill on alternatives such as fee-and-dividend. There seems to be great reluctance to break with the “party line(s)” on cap-and-trade.  The Democratic party line: cap/trade “guarantees” emissions reductions and is the best we can do; the Republican party line: it’s too expensive and will disadvantage US firms because no other country will follow.

James Handley, a former enforcement attorney with the US EPA and volunteer with the Carbon Tax Center explained his personal views on this: “Both are wrong, of course, but frankly, the Republicans have a point about other countries not following cap/trade because it’s just too complex  and linking caps especially with offsets would be a nightmare.”

A defeat of cap-and-trade, however, may allow Congress to seriously discuss the better alternative, a revenue-neutral alternative that doesn’t increase the size of government that should garner bi-partisan support if it is seriously considered. It seems like lots of Hill staff and members understand fee-and-dividend, but they’re not free (yet) to embrace or even talk about it.  And they won’t be until the current proposals fade and they hear from constituents and the President in support of something better.

How the bills stack up

James Handley rates the laws in order of preference:

Larson > British Columbia > Cantwell >> Kerry-Boxer/Waxman-Markey.

Larson’s rate would go high enough to actually get substantial reductions.   British Columbia’s bill is strong because it’s rev-neutral.  Cantwell avoids markets but doesn’t have a signficant price and is mostly a subsidy (for CCS) bill.  All of these bills are much better (hence the >>) than Kerry-Boxer/Waxman-Markey which will mostly fund offsets without driving reductions here.

Summary

So there it is. Now you know the arguments. It’s time to cast your votes: cap-and-trade or fee-and-rebate?

The online version of this document is at: http://dl.getdropbox.com/u/390139/ifr/cap%20and%20trade.doc

Appendix 1: A short argument for fee-and-dividend

This is the biggest issue of our time…maybe for all time… If we get it right, we save the planet. If we get it wrong, we’re toast. Game over. No chance to fix it, possibly forever.

Unfortunately, we’re poised to get it wrong. Really wrong.

A lot of people came on board cap and trade early on, when they thought it would work. Later, when it became clear that in any possible real life situation, cap and trade would actually hurt the environment and our economy, it was too late to change their position. So they are still locked in as supporters because they want to believe they were right and that somehow, magically, the bill will do what it claims to do and because they think it is the only game in town. This myth feeds upon itself.

This is amazing that this is happening but it is high time for someone to point out that the emperor has no clothes.

The belief of environmental benefit is fantasy. Let’s look at the objective facts. The CBO analysis was realistic, but in a sense very optimistic since there no gaming and fraud and everything works as planned. It showed you got virtually no reduction by 2020. The reality of course will be much worse. Supporters of course then discredit the truthtellers since it makes them look bad.

The fact is this: Al Gore, Jim Hansen, the inventors of cap and trade, leading economists (including conservative economists), and epa regulators …and even Exxon Mobil, say fee and dividend is superior in every respect.

Fee-and-dividend is also the only solution to this problem that is progressive and will help the economy. The environmental benefits are significant and a nice plus. This is the “double dividend” that the economists talk about for fee-and-rebate.

The “politically impossible” is a self-perpetuating myth as the British Columbia experience showed.

Someone needs to stand up and pull the plug on the myth and go with the better solution.

Congressman Larson has taken the first step in doing that. His bill is an excellent framework. Nothing is more important that putting a predictable price on carbon and helping the economy. His bill does both.

The more you check into this, the more convinced you will become that fee and rebate is the way to go.

Steve Kirsch, stk@propel.com, 650-279-1008