Cap and trade or coach and horses

Published: May 18 2009 19:47

Whether a climate change bill emerges from the US Congress this year is much in doubt. Most Republicans still oppose the very idea of reducing emissions of greenhouse gases. Democrats are less than united in their commitment to it, once forced to consider the implications. The signs are that if a bill does somehow pass, it will be ugly.
A subcommittee of the House of Representatives has taken the lead in drafting a cap-and-trade plan – the approach promised by Barack Obama – but its initial efforts give one pause.

Under cap and trade, emitters require permits and the supply of these allowances is capped at a level that reduces total emissions. So long as the cap binds, the permits have a value and the system creates a market to trade them. This ensures that cuts in emissions happen where they can be made at least cost. As a result, cap and trade is much more efficient than decreeing a uniform cut regardless of the source of emission.
The problem is not with the basic idea. A well-designed cap-and-trade scheme, though lacking the simplicity and transparency of an outright carbon tax, can do the job nearly as well. Unfortunately, Congress seems keen to take the opportunities for gaming that cap and trade presents, and increase them tenfold.
During the campaign for the presidency, Mr Obama promised that all permits would be auctioned. His first budget counts on revenues from that source to finance his “Make Work Pay” tax credits for the low-paid – to the tune of more than $600bn over 10 years. The House committee’s current proposal chooses to give 85 per cent of the permits away. The hole in Mr Obama’s long-term fiscal arithmetic just got bigger.
That is not all. Predictably, in the disbursement of this enormous windfall gain, the House proposes to reward favourites, such as regulated utilities, and punish villains, notably the oil companies. Some emitters will receive more permits in relation to their needs than others. This would create a perpetual struggle for political advantage. If you wanted to promote corruption, this would be a good way.
Still not content, the House wants to set conditions on its gifts of permits – including commitments to shield consumers from higher energy costs. Yet the whole point of this exercise is to make high-carbon energy dearer. On the drawing board is a vast and unfathomably complex new system, which fosters corruption, raises little revenue and tries to suppress the incentives that are its entire purpose. Otherwise, it all looks quite promising.
Copyright The Financial Times Limited 2009