Economists: Graham-Kerry’s Sector-Specific Approach to Carbon Limits is Less Efficient

'We'll Be Getting Less CO2 Reduction for Our Dollar'

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The climate bill being drafted by U.S. Sens. John Kerry (D-Mass.) and Lindsey Graham (R-S.C.) is widely viewed as a compromise between lawmakers bent on reducing fossil fuel emissions and those who fear such reductions will cripple the domestic energy industry.

But their approach of applying different types of carbon limits to different sectors of the industry doesn’t just downplay the urgency of reducing emissions. Some economists say the sector-specific approach would be costlier to society and less efficient than an economy-wide approach that would limit emissions “upstream” from where fossil fuels enter the economy, such as at companies that supply raw energy.

In recent talks with energy industry executives and other politicians, the senators have indicated that their bill’s greenhouse gas limits will likely consist of three main programs:

    • Electric utilities would be subject to a cap-and-trade system, in which the amount of carbon-dioxide equivalent that each company can emit would be limited, but companies that emitted less than the limit could sell their leftover emissions permits, or “allowances,” to companies whose emissions would exceed the limit. The American Clean Energy and Security Act (ACES), which the U.S. House of Representatives narrowly passed last year, would establish this type of cap-and-trade system across the economy.

    • Oil would be treated differently. Oil refiners would be subject instead to a “carbon tax”: a fee on the carbon content of their fuels.

    • Industrial facilities would face no cap for several years, at which point the government would start gradually enforcing a limit on industrial emissions.

“Strictly from an economic efficiency perspective, you’re better off with either an economy-wide cap-and-trade policy or an economy-wide carbon tax,” says Michael Livermore, executive director of the Institute for Policy Integrity at New York University Law School.

Unless the carbon tax on fuel is exactly equal to the price of the permits traded between power plants — in which case it’s no different than an economy-wide cap-and-trade system — electrical companies and oil companies will have different financial incentives to offset the same quantity of emitted carbon, Livermore says.

“Someone’s going to be spending too much money to reduce pollution, and somebody else will be spending too little, so there will be waste,” Livermore points out. “We’ll be getting less CO2 reduction for our dollar.”

James K. Boyce, a professor of economics at the University of Massachusetts, Amherst, who recently testified before Congress in support of another bipartisan climate bill, submitted by Sens. Maria Cantwell (D-Wash.) and Susan Collins (R-Maine), concurs.

“You want to treat all carbon molecules the same, not distinguish between, say, carbon coming from a coal plant and carbon coming from gasoline,” says Boyce. “If you favor one, you’re doing that to please your lobbyists, but there’s an efficiency cost in doing so. And that efficiency cost gets passed along to the American public.”

The warning that a sector-specific approach enables industry cronyism is echoed by other economists.

With a targeted approach, members of Congress “can hand out special benefits to their favorite constituents and lobbyists … or they can decide who not to tax. But they simply do not know what are the most cost-effective ways to cut carbon emissions,” observes Don Fullerton, professor of finance in the Institute for Government and Public Affairs at the University of Illinois and a member of the National Bureau for Economic Research.

Fullerton agrees with Boyce and Livermore that, from an economic standpoint, the wisest option is an economy-wide plan “that applies equally to all sectors, so that everybody has incentive to cut emissions in all of the cheapest ways.” Fullerton would like to see a plan that generates revenue that can be given to low-income families to help them manage higher energy costs.

The Cantwell-Collins bill endorsed by Boyce works exactly this way. The bill applies an economy-wide cap-and-dividend system for reducing carbon emissions. Despite the similar name, cap-and-dividend is a very different strategy than cap-and-trade.

Under a cap-and-dividend approach, a limit would be placed on how much carbon-based fuel could be sold by raw energy suppliers, such as coal and oil companies, rather than the power plants who buy their products. The Department of Energy would monitor the sale of production allowances, instead of letting companies trade them freely, and ensure that a majority of the profits from those allowance sales were given to the public in equal dividends to compensate for the higher energy prices that would result from the strict cap.

Beginning in 2012, the Cantwell-Collins Bill, also known as the CLEAR Act, would charge raw energy companies between $7 and $21 for a permit to offset one ton of emitted carbon. By 2020, after steady increases, the price would be between about $12 and $32 per permit.

Livermore also prefers a cap-and-dividend approach. It reduces the largest amount of emissions for the lowest cost, he says, and it’s progressive, too:

“Under a cap-and-dividend approach, most Americans come out better off. Only Americans who lead the most carbon-intensive lifestyles come out worse off.”

The CLEAR Act, however, has been criticized for not being politically viable or strong enough to achieve its goals: reducing greenhouse-gas emissions by 20 percent below 2005 levels by 2020, and 83 percent below 2005 levels by 2050.

For instance, Severin Borenstein, a professor of business administration and public policy at University of California, Berkeley, Haas School of Business and a member of the National Bureau for Economic Research, believes a cap-and-dividend approach could provide good incentives for innovation in low-carbon technologies — if it sets the price of carbon high enough.

But Borenstein thinks the permit prices in the CLEAR Act are too low to incentivize companies to seriously reduce their emissions.

“These prices that they’re talking about for carbon, of $30 or less per ton, just are not going to substantially change economic behavior,” he says.

For every dollar in the price of a carbon permit, according to Borenstein, the price consumers pay for a gallon of gasoline only goes up by about one penny. So putting a ceiling of $32 on the price of a carbon permit, as the CLEAR Act envisions for 2020, would allow the price of gasoline to rise by no more than 30 cents.

Though Kerry, Graham and their Senate colleague Joe Lieberman (I-Conn.) haven’t yet specified how much oil companies would be taxed under their bill, or how expensive the carbon permits traded by electric utilities would be, permit prices higher than $30 are unlikely to pass the Senate, meaning a similar ceiling would be placed on the price of auto fuels.

Even when gasoline prices nearly doubled around the country recently, the spikes only caused consumption to drop only about 5 percent, according to James P. Barrett, an economist at the Environmental and Energy Study Institute, a nonpartisan research center.

“Thirty cents on a gallon of gasoline is just enough to make people notice, but not enough to make them buy more fuel-efficient cars or start carpooling,” Barrett points out.

Worse yet, according to Barrett, is the idea that industrial greenhouse-gas emitters would be exempted from caps or taxes for the first few years of the Kerry-Graham bill.

“There are some very cheap reductions to be had in that sector, but if they’re not required to do anything, that hanging fruit will be left to rot on the vine,” Barrett says. “To achieve whatever targets we’re after, we’ll have to go get reductions somewhere else, which will increase the cost of the policy.”

The decision to initially exempt industrial emitters from a cap or tax, Borenstein and Livermore agree, would waste an opportunity to foster innovation in that sector and add to the costs shouldered by the electric and auto fuel sectors.

An additional economic wart on the face of the legislation, as it has been outlined thus far, is the federal funding it would set aside for the construction of nuclear power plants.

“Like any other technology, [nuclear power] should live or die in the marketplace,” says Livermore.

Nuclear power “is not economical now, and never has been,” according to Barrett. It has only remained viable in the United States, he says, because of the 1957 Price-Anderson Act, which protects the industry from crippling insurance costs.

Rather than favor any particular low-carbon energy source, say Barrett, Borenstein and Livermore, climate legislation should divert more federal funding toward general alternative-energy research and development.

“The more I work on this," Borenstein says, "the more I think the only way we’re going to make progress on this is with breakthrough technologies, because the public as a whole is really unwilling to accept the idea of much higher energy prices."


See also:

Obama’s Energy Plan: All of the Above — Including a Price on Carbon

Cap-and-Trade, California Style: Who Gets the Money?

40-Plus Groups Launch Earth Day Revolution for Climate Action