Pollution Politics and the Climate-Bill Giveaway

By DAVID WESSEL

President Barack Obama was emphatic during his campaign and after his election: The best way to fight climate change is to cap carbon emissions and auction off tradable permits to emit carbon.
"If you're giving away carbon permits for free, then basically you're not really pricing the thing and it doesn't work -- or people can game the system in so many ways that it's not creating the incentive structures that we're looking for," he told the Business Roundtable in March.

His budget director, Peter Orszag, was blunter: "If you didn't auction the permit, it would represent the largest corporate welfare program that has ever been enacted in the history of the United States," he told the House Budget Committee in March.
This past week, Rep. Henry Waxman's House Energy and Commerce Committee passed a climate-change bill that gives away 85% of the emission permits until 2026. President Obama applauded, calling the bill "a historic leap."
Huh?
The point of climate-change legislation is to raise the price of activities that emit carbon so consumers and businesses engage in fewer of them, and favor alternatives that contribute less to climate change. Taxing carbon is one way to do that, but it's unpopular.

Cap-and-trade became the politicians' favorite alternative because it accomplished what a carbon tax would, without an explicit tax. Auctioning off the permits, economists advised, was the most efficient way to allocate the rights; steer at least some of the money raised toward research and development and to compensate lower-income consumers for higher energy prices.
Republicans called that "a light-switch tax." Democratic old-timers warned about being "BTU'd," a reference to President Bill Clinton's ill-fated energy tax. Support for auctioning permits evaporated. Under the House bill, only 15% of the emission permits will be auctioned initially.
The rest of the permits will be given away -- 2% to oil refiners, 5% to free-standing "merchant" coal plants, 9% to regulated natural-gas distributors, and so on. Permits are valuable; recipients can sell them if they don't need them.
Orszag on the Bill
White House budget director Peter Orszag, House Budget Committee, March 3, 2009:
QUESTION: [L]et me turn to the issue you were just discussing about global warming, because I believe that the vote that we will take on this budget resolution will be the first major test of our commitment here in Congress to support President Obama in implementing an effective cap and trade or cap and invest system to place the carbon -- a price on carbon pollution, and transition to an economy that is both more energy independent are more carbon independent.
Like the testimony, the hearing that you participated in over in the Ways and Means Committee with us last September, we had another hearing on this subject in Ways and Means last week. And unfortunately the Republican reaction ranged from many old fashioned global warming deniers to those who aggressively attack any role for government regulation. I would like you to explain if you would, why you and our president recommend auctioning 100 percent of pollution allowances rather than just giving away pollute free cards to the polluters.
I believe that the revenues that you've included, and I think it's conservative; it's kind of the bottom end of the revenues through 2019 in this budget outline, is about $650 billion. How is it that the American people are better served by auctioning the revenue instead of just returning the value to the polluters who created the problem?
Peter Orszag: The reason is that if you didn't auction the permit, it would represent the largest corporate welfare program that has ever been enacted in the history of the United States. In particular, all of the evidence suggests that what would occur is the corporate profits would increase by approximately the value of the permit.
So that -- whatever that is, $600 billion, $800 billion, whatever the value is, would go in a sense almost directly into corporate profits rather than being available to fund energy efficiency investments and to provide a cushion or some compensation to American households.
That is why the president, I think, has made absolutely the right choice in saying that the permit should be auctioned.
As Europe's experiment with cap-and-trade demonstrated, giving away permits can fatten polluters' profits without protecting consumers from higher prices.
"How one gives them away, what restrictions are on that gift, makes all the difference in the world for the economic effects," said Douglas Elmendorf, director of the Congressional Budget Office. In other words, Congress will put strings on the gifts. And then things get complicated.
Giving away allowances yields windfall profits -- unless the government controls prices, as it does with electric utilities. The bill gives 30% of the permits to utilities that buy electricity from power plants and then sell that power to consumers. Congress is counting on state regulators to make utilities pass the benefits of free emission permits along to consumers.
That eliminates the windfall-profits problem, but creates another one.
Remember, if electricity prices don't rise, households won't conserve and carbon emissions won't be reduced. So emissions elsewhere in the economy will have to be reduced to meet the national cap on carbon. How? By boosting prices for carbon-heavy activities besides electricity production. Can you say "gasoline"?
Waxman defenders hope state regulators will allow electricity prices to rise so people use less, and then give a quarterly or annual rebate. But Robert Stavins, a Harvard University economist, warns: "The political instinct is not to compensate, but to insulate consumers" from price increases. That's a mistake.
Unregulated industries are different. Producers will charge what the market will bear, whether they pay for permits or get them for nothing. Congress, for good reason, worried about boosting the costs for American factories that compete with factories in countries that don't require producers to buy emission permits. The Waxman bill gives such producers 15% of the permits, and more permits if they increase production in the U.S. That reduces the temptation to move production abroad but blunts the incentive to reduce pollution.
White House Statement
On Waxman-Markey bill, May 22, 2009:
"Coupled with the announcement about setting a new national policy to both increase fuel economy and reduce greenhouse gas pollution, the legislation that passed out of House Energy and Commerce Committee is a historic leap towards providing clean energy incentives that will reduce our dependence on foreign oil and create millions of new jobs all across America. The President has been clear that if there are disparate impacts on consumers and business during the transition period, they should be compensated. Make no mistake – this bill sets aggressive emissions reductions targets and provides for a program that invests in the technologies needed to bring about a clean energy future."
Among the arguments for giving away permits, two have merit. One, allocation rules can be crafted to award free permits to protect parts of the country that otherwise would see very steep increases in energy prices from a carbon cap, such as those that rely on coal. Two, this approach may be the only politically possible way to get any cap on carbon emissions through Congress.
But there's another rub: Without the auctions, there isn't any revenue. Mr. Obama's budget proposal projected more than $75 billion a year from the auction, much of which was supposed to go to his "making work pay" tax break.
The U.S. government entered the recession with promises to pay health-care and retirement benefits far greater than its anticipated revenue. It's now borrowing heavily to resuscitate the economy and rehabilitate the financial system.
The deficit is tolerable now because the recession is so deep and foreigners so willing to lend to the U.S. at low rates. But at some point, like it or not, the federal government will need more revenue. Giving away emission permits instead of auctioning them crosses one big potential source of revenue off the list.
Write to David Wessel at capital@wsj.com