The Costs of Cap-and-Trade

[Richard_Parker]

The United States House of Representatives recently passed HR 2454. The bill does a very wide range of things for which there is bipartisan support, but the controversial centerpiece of the bill is the establishment of a cap on certain greenhouse gases, with provisions for adding other gases to the list. Sources covered by the bill will be given a certain amount of allowances such that the national total does not exceed the cap. These sources are allowed to buy, sell, or trade these allowances, thereby harnessing the power of the market to efficiently allocate costs. The bill also allows for offset credits for projects that result in reductions or avoidance of greenhouse gas emissions, or sequestration of greenhouse gases.

The debate over the cap-and-trade part of the bill has largely turned on the cost-benefit question of whether its worth the cost of capping emissions to reap the benefits of reducing these emissions.

The CBO estimates that in 2020, what it claims to be a representative year, the bill would cost about $175 per household. But this Heritage Foundation Study takes issue with the CBO estimate. The study claims that the costs to families will be twenty to thirty times higher than the CBO estimates (its hard to say exactly since the two studies aren’t using the same dollars–the CBO is using 2010 dollars while Heritage evidently is not).

This is a pretty wild divergence. Obviously these analyses make some widely different assumptions. The biggest differences seem to be that the Heritage Foundation assumes a significant loss of GDP and Heritage rejects the ability of the government to mitigate the increase in energy costs:

In The Heritage Foundation’s analysis of the Waxman-Markey climate change legislation, the GDP hit in 2020 was $161 billion (2009 dollars). For a family of four, that translates into $1,870–a pretty big chunk of change that the CBO is ignoring. . . . The CBO and Congress [also] seem to assume that energy price increases can be mitigated by giving allowance revenue back to businesses and consumers. This is not how the economy works. Prices are merely an information signal about the relative scarcity of real resources that are being used. For example, if farmers use their land, labor, and equipment to produce offsets, instead of planting more food crops, the price of food will go up. Yet the CBO report ignores this reality.

My questions for debate are these:
[ul]
[li]Is the Heritage Foundation right that the bill will damage, rather than improve long-term GDP, given the massive investment in renewable industries represented by the program? Is their estimate of the damage reasonable?[/li]
[li]Similarly, is the Heritage Foundation right that energy price increases cannot be mitigated by giving allowance revenue back to businesses and consumers?[/li]
[li]Since cap-and-trade is a way to internalize the costs of pollution, should we really view the payment of those internalized costs as a cost to the economy as a whole? After all, someone has to pay for pollution in the form of illnesses, environmental clean-up, etc., if not the polluters themselves. [/li]
[/ul]

[Magiver]

@Richard_Parker

The CBO estimates that in 2020, what it claims to be a representative year, the bill would cost about $175 per household. But this Heritage Foundation Study takes issue with the CBO estimate. The study claims that the costs to families will be twenty to thirty times higher than the CBO estimates (its hard to say exactly since the two studies aren’t using the same dollars–the CBO is using 2010 dollars while Heritage evidently is not).

[/LIST]

When this was first discussed I ran the numbers and calculated it would cost me an additional $367 per year in higher charges for electricity.

I hae no way of estimating the value added tax that will be hidden in the cost of other products.

[Frylock]

Quick factual question:

Haven’t we already been doing cap and trade? Or is this new?

I had always thought we were doing it already.

[Richard_Parker]

@Frylock

Quick factual question:

Haven’t we already been doing cap and trade? Or is this new?

I had always thought we were doing it already.

It is new.

Many other countries in the western hemisphere have instituted forms of cap-and-trade, with varying success. The 1990 amendments to the Clean Air Act instituted a smallscale cap-and-trade program for sulfur dioxide in California.

[NinetyWt]

I have similar questions about the actual cost of the plan. The only thing I’ve read so far doesn’t really answer your questions (or mine) but here is a snippet:

@WSJ

The European Union, keen to show global leadership, introduced the world’s first Emissions Trading Scheme (ETS) in January 2005, just before the Kyoto protocol came into force.
<snip>
Not only does the taxpayer carry the cost of any cap and trade scheme, but their money also provides profit for a whole new industry: the new carbon trading sector, the middlemen who make the system work.

Unlike normal tradable commodities, carbon dioxide emissions can only be estimated, rather than quantified exactly.

<snip>
There is another major problem with cap and trade: its lack of predictability. Prices vary considerably. On June 15, the right to emit a tonne of carbon dioxide cost €12.50. Since the inception of the ETS, this price has varied from below €10 to peaks of more than €30. While these fluctuations may encourage businesses to increase energy efficiency – for which they will in any case receive a direct financial benefit – it is of no help for long-term investment decisions to permanently reduce carbon emissions. For this, a significantly higher minimum price is needed, perhaps about $140 per tonne, according to a U.K. government-sponsored report from Cambridge university, due to be published shortly.

Given the system’s inherent flaws, it comes as little surprise that the ETS didn’t quite work as intended. According to European Commission figures, emissions from the 27 member states rose by 1.9% in the first three years of the regime. Following criticism, the caps for the period to 2012 were reduced for the majority of member states, but only to a little lower than actual emissions in 2005, and the evidence is that the recession is having a much more direct impact on emissions than the trading scheme (incidentally putting a lot of low-priced permits on the market).

Despite the system’s questionable results, the costs are considerable. In 2006, individual business and sectors had to pay €24.9 billion for over one billion tones’ worth of permits. The WorldWatch Institute estimates that the costs of running a trading system designed to meet the EU’s Kyoto obligations at about $5 billion. The estimated costs of a trading system to meet the EU’s own and far more demanding commitments of a 20% reduction (against a 1990 baseline) by 2020 are around $80 billion annually.

From here.

[Richard_Parker]

I would be curious to dig deeper into the European numbers. Or rather, I would like to see some economist dig into those numbers and explain them. There’s just a lot of moving parts, and it isn’t clear to me what variables different studies are taking into account.

[NinetyWt]

Here is something else which speaks to your question 2. This is from an article on factcheck.org. Part of the problem (as I see it) of getting a good estimate is that Waxman-Markey is different from the scenarios used to come up with the estimates which we have.

@factcheck.org

In past years, others have analyzed the possible economic impact of a cap-and-trade system and found that consumers’ energy costs would increase, but that they could be lessened with the appropriate action.

Testifying before the House Subcommittee on Income Security and Family Support in March, Terry M. Dinan, a senior adviser for the nonpartisan Congressional Budget Office, conceded that price increases from a cap-and-trade system would increase energy costs for American households. According to Dinan’s testimony, a 15 percent cut in CO2 emissions could run the average household about $1,600 (in 2006 dollars). The range: $700 for the average household in the lowest one-fifth of all households, according to income, to nearly $2,200 for households in the highest quintile.

But the CBO’s estimate did not include “any benefits to households from lessening climate change.” And the CBO also concluded that cost increases for some families, at least, could be offset if revenues from the allowances were returned to consumers. In his testimony, Dinan said that a 2000 CBO study “concluded that lower-income households could be better off as a result of the policy (even without including any benefits from reducing climate change) if the government chose to sell the allowances and use the revenue to pay an equal lump-sum rebate to every household in the United States.”

Elsewhere in the article, it talks about Waxman-Markey:

The initial 15 percent of auctionable allowances would be used for the specific purpose of protecting consumers from higher energy costs. According to an outline of the proposed allowance allocation, “15% of allowances will be auctioned each year and the proceeds of these allowances will be distributed to low- and moderate-income families to protect them from other energy cost increases.”

From here.

[NinetyWt]

@Richard_Parker

There’s just a lot of moving parts, and it isn’t clear to me what variables different studies are taking into account.

That is absolutely my problem too. As I mentioned above, it’s going to be difficult to draw a bead on this particular bill because it’s different from what these studies are based on.

Here is a link to the MIT study (big pdf). One scientist who worked on that study has said that his estimate is $800 per year, per household.

@John Reilly

The present value cost per average current household through 2050, as corrected, is about $800. Again, this estimate includes the direct effects of higher energy prices, the cost of measures to reduce energy use, the higher price of goods that are produced using energy, and impacts on wages and returns on capital. The cost per household will of course vary from our hypothetical average family depending on the household’s circumstances, though the burden on lower income households can be offset through the use of auction revenues.

From here.

[Richard_Parker]

Both the CBO and Heritage study involve the specifics of this bill.

Reading the Reilly letter, I can’t tell if that’s $800 total or $800 annual.

[NinetyWt]

@Richard_Parker

Both the CBO and Heritage study involve the specifics of this bill.

Reading the Reilly letter, I can’t tell if that’s $800 total or $800 annual.

Hmm. You’re right. It looks like he’s saying $800 total by 2050.

Ah, here is his first letter. In it he specifically says annual costs. He originally calculated $340 but changed it in the second letter to $800.

From data in the report we can calculate the economic cost in each year (percentage loss times the base welfare
level in each year), and divide this by the US population, and then multiply this amount by four to estimate the cost for a representative family of four. We further apply an economic discount rate of 4% to get the Net Present Value (NPV) cost in each year in the future. Doing this we find that the NPV cost per family of four starts at about $75 in 2015, rises to nearly $510 by 2025, and then falls to $205 by 2050. We can calculate the average annual NPV cost per family by summing over all years and dividing by the number of years, and this shows the average annual net present value cost to be about $340 - only a part of which would be actual energy bill increases.

[the_first_supraliminal]

Cap and trade benefits the giant companies at the expense of the average ones. That’s how it works in europe. A giant has many sites to average out, plus deep pockets to buy it’s way out of messy plants. The regular companies are the ones making the mods or having to sell facilities to giants.

[gonzomax]

It also allows hot spots to continue. If they have horrible conditions at one plant that would be very expensive to fix ,all they have to do is clean up a couple cheaper and easier ones to average out higher. Meanwhiles they continue to poisoni the shit out of one small area.

[athelas]

@gonzomax

It also allows hot spots to continue. If they have horrible conditions at one plant that would be very expensive to fix ,all they have to do is clean up a couple cheaper and easier ones to average out higher. Meanwhiles they continue to poisoni the shit out of one small area.

Huh, and here I was thinking we need carbon tariffs was because CO2 is global…

[Frylock]

@gonzomax

It also allows hot spots to continue. If they have horrible conditions at one plant that would be very expensive to fix ,all they have to do is clean up a couple cheaper and easier ones to average out higher. Meanwhiles they continue to poisoni the shit out of one small area.

How bad would that be, though?

As an extreme example, wouldn’t it be better if all the polution in the world were contained within a five square mile area? That one area would be hellish. But the rest of the world would be nice…

Of course you can’t really contain pollution in that way, but I’m just asking whether it’s so bad if most of the effects of pollution are concentrated in smaller areas.

[Richard_Parker]

@Frylock

How bad would that be, though?

As an extreme example, wouldn’t it be better if all the polution in the world were contained within a five square mile area? That one area would be hellish. But the rest of the world would be nice…

Of course you can’t really contain pollution in that way, but I’m just asking whether it’s so bad if most of the effects of pollution are concentrated in smaller areas.

It depends, of course, on the pollutant. CO2 is an ideal pollutant for marketable permits because hot spots aren’t a great concern as they would be with, say, particulate matter.

[Sam_Stone]

This particular bill is unbelievably bad. Not only are there many exemptions for various political constituencies, which will distort the market and create favored companies with special tax status, but it also includes a provision to place tariffs on countries that don’t implement similar schemes. Since most countries won’t do that, this bill could easily trigger trade wars.

So you have new taxes and protectionism in a bill that doesn’t a damned thing about global warming. This will work against Obama’s stimulus package and make it harder for Democrats to get support for the inevitable tax increases they’ll need for health care reform or to lower the budget deficit.

Higher taxes and trade tariffs are the absolute LAST thing you want to implement during a recession. This bill is suicidal. It’s basically putting a gun to the heads of American manufacturers for no discernable benefit - other than that it gives the government more tentacles into industry, and creates whole new reasons for companies to spend more money on lobbying - you know, campaign contributions, bribes, junkets, etc.

Who could possibly be in favor of this monstrosity?

Oh, and I forgot the 300 page amendment added to the bill AFTER it passed committee, and which no one had time to read before voting. What a farce.

[Richard_Parker]

Anything to say about the OP, Sam?

[Sam_Stone]

@Richard Parker

Anything to say about the OP, Sam?

Sure. Let me answer these questions. I’m not going to speak to the specific numbers quoted by Heritage, but we can talk about the differences between their methodology and the CBO’s.

My questions for debate are these:
[ul]
[li]Is the Heritage Foundation right that the bill will damage, rather than improve long-term GDP, given the massive investment in renewable industries represented by the program? Is their estimate of the damage reasonable?[/li][/ul]

Of course the bill will damage GDP. You can not make the GDP better by increasing energy costs, nor can you just grow GDP through ‘massively investing in renewable industries’. There is no guarantee that the return on R&D investment will be greater than one. In fact, I would say the odds are against it. There has been massive investment in renewables already, for the past several decades, and there’s no way that money has been paid back.

The assertion that money spent on ‘green’ technology will automaticaly create growth and new sources of revenue and new jobs is one of the biggest pieces of nonsense surrounding the entire environmental debate. If there was such a clear path to profitability from such research, you’d already see it. Or rather, there’s no evidence whatsoever that current levels of R&D spending are not optimum, given the risks and the current state of technology.

[ul]
[li]Similarly, is the Heritage Foundation right that energy price increases cannot be mitigated by giving allowance revenue back to businesses and consumers?[/li][/ul]

Heritage is right. As a very quick example, if you tax a business such that its products are not competitive on the world market, but give the money back to consumers, what happens? The consumers buy the product from a foreign source with lower energy costs, the factory in the States goes out of business, a lot of people go on public assistance, and the entire tax revenue from that company is now gone, and not just the tax associated with the carbon.

The bill actually admits this - this is why that midnight admendment added tarrifs - they were added to get the support of the rust-belt Senators who are afraid that it will otherwise bleed manufacturing jobs out of the country. Which it will.

But there’s another negative effect, which is that such a tax is distortionary. It favors some products over others. Companies that rely on products from others will see their costs go up. They will have to raise their prices, even if they don’t burn a lot of carbon themselves. Such distortions are similar to the effects of inflation - prices carry information about relative supply and demand and value, and distorting them makes the market less efficient until it adjusts. That’s a cost that the CBO is not considering.

And in the end, the whole point of the tax is to reduce the amount of carbon released into the atmosphere - it’s a form of rationing. Rationing has all sorts of pernicious effects.

[ul]
[li]Since cap-and-trade is a way to internalize the costs of pollution, should we really view the payment of those internalized costs as a cost to the economy as a whole? After all, someone has to pay for pollution in the form of illnesses, environmental clean-up, etc., if not the polluters themselves. [/li]
[/ul]

So long as the economy benefits from the lowered costs represented by the implicit subsidy of carbon, of course the economy as a whole will be harmed by the tax. What do you think those companies who are paying more for their energy are going to do? They’re going to raise their prices and pass them on to consumers and other businesses that rely on those products. The costs will ripple through the entire economy.

I don’t know if Heritage’s figures are correct, but there can be no doubt that the overall cost to the United States is going to be a lot higher than the basic accounting numbers the CBO uses.

[ralph124c]

Cap and Trade will be a disaste for US industry. It will provide an enormous incentive to move industry to China and India-whee pollution will continue unabated.
It will also make charlatons like Al Gore (carbon credits) enormously wealthy.
Congress has guaranteed a depression from this idiocy!:smack:

[Public_Animal_No.9]

So far everyone has only talked about one side of the story, and that is the cost of reducing CO2. There has been very little discussed about the benefits of reducing CO2. I realize not everyone agrees with the link between greenhouse gas emissions and environmental impacts (climate change), but the science does show that there are already changes occurring. Moving away from fossil fuels can have benefits other than reducing GHG emissions - lower health care costs due to reduced air pollution, lower costs associated with protecting oil supplies, and lower costs of dealing with invasive species and diseases. I’ve heard (but unfortunately can’t find the cite) that a figure of about $20/tonne of CO2 was about the break-even point for costs and benefits.

The other thing to keep in mind about any sort of mitigation strategy is that the highest cost approaches won’t come into play for probably a decade, at a minimum. We’ll definitely see more renewables (wind, solar, biomass), but there cannot be a large-scale carbon capture and storage system (the big ticket item) in place for some time, simply due to the time needed to develop the technology into something that will work on a commercial basis. The initial steps that will be taken will be more along the lines of energy efficiency (which will most likely be a net financial benefit, even ignoring any climate or health benefits) and a greater emphasis on technologies like plug-in hybrids, and combined-cycle and supercritical power plants, all of which could fall under the energy efficiency heading.

There has been far too much panic and hyperbole on both sides, in terms of end of the world scenarios and/or financial collapse. The reality will be much more mundane, and much longer term. The current energy/climate bill is definitely full of flaws, but it’s a starting point, and a very necessary one, IMHO. You can bet that it will be modified ad infinitum, whether it becomes law or not. Climate change is a long-term issue, but nearly everyone is looking at this from a short-term perspective. As we learn more about the technologies and the extent to which we need to reduce GHG emissions, there will be lots of changes to the policies and the legislation. In my view, though, most of the things that we will do initially are things that we should be doing anyway, for financial and energy security reasons. I’m well aware that there are aspects of the energy/climate bill that don’t make a lot of sense for either financial or energy security, but at this point, I think we need to work to get the framework in place and deal with the flaws later.