Slicing and dicing to gain support for cap-and-trade

May 12, 2009

John Kemp Great Debate— John Kemp is a Reuters columnist. The views expressed are his own —

House of Representatives Energy and Commerce Committee Chairman Henry Waxman will this week publish a full text of proposed climate change legislation, including details of a cap-and-trade scheme for regulating and pricing emissions of greenhouse gases.

Press reports suggest the Waxman bill will give away as many as 75 percent of the permits free to power utilities, coal-producers and other industrial users in the first stage of the plan to defuse opposition and buy support from congressional Democrats representing industrial and coal-producing states.

Free allocations would be phased out eventually, but only after a lengthy transition period that could last as long as 10-15 years.

Free allocations will undermine the immediate impact — and demonstrate the depth of opposition — to cap and trade but the real question is whether any transition to full permit auctions is automatic or requires further congressional action.

Commentators have focused on the budgetary implications of giving away permits for free. The president’s own budget plan anticipates revenues of $646 billion from permit auctions over 8 years from fiscal 2012 to fiscal 2019. The White House has already “spent” these revenues on tax breaks for low-income families as well as energy research and development.

Critics allege that giving away permits for free will blow a hole in the budget calculations and lead to even worse deficits over the next decade.

This is wrong. The White House included revenues from permit sales in its budget plan for symbolic reasons — to show it was committed to implementing cap-and-trade; it would spend the political capital needed to get legislation through Congress; to showcase the benefits auctions could bring; and to show how low-income groups could be protected against the impact of rising permit and energy prices by redistributing the proceeds.

But officials have been careful not to rely on the anticipated revenues too heavily. The president’s plan allocates the money to discrete tax breaks and research spending rather than general government revenues. If the permit revenues do not materialize, the tax breaks and research funding will be cancelled, and there will be no implications for the deficit.


Instead, the decision to give away most permits for free demonstrates that the shallow political consensus surrounding climate change and emissions pricing is forcing even supporters to take a very cautious approach to the issue.

Giving away 75 percent of the permits and phasing in a full auction system over a decade or more will limit the program’s effectiveness early on. But it is probably the only way to build support from Democrats in the industrial Midwest and Appalachian coal states needed for a House of Representatives majority and a 60-vote super-majority in the Senate.

More importantly, the administration wants to get agreement on the principle of cap-and-trade so that it can start building the necessary infrastructure (an inventory of emissions sources, supplementary regulations, and permit exchanges).

Once the infrastructure is in place, free allocations can be gradually reduced and the permit system can be tightened over time. Crucially, once trading starts, it will create vested interests among traders and permit owners, making it almost impossible to reverse or relax the scheme. So even a small-scale limited program will benefit from a ratchet effect.

The administration and its supporters in Congress are employing “salami tactics” — slicing a big controversial decision on which it may not have sufficient support into lots of small steps which are not objectionable in themselves but which, taken together, will eventually accomplish the same goal.


In another sign of increasing political sensitivity, the Wall Street Journal reported the administration is consulting on how to rebrand its cap-and-trade program to lessen opposition from voters and legislators.

Until recently, advocates of emissions control favored cap-and-trade rather than an emissions tax because it was seen as more “market-friendly” and obscured the impact of raising the cost of both permits and energy paid by consumers.

For political reasons, cap-and-trade has been favored even though research by the non-partisan Congressional Budget Office suggested a tax would be a better choice because it is more straightforward and offers the certainty about emissions costs that utilities and other heavy energy users need to make long-term investment plans.

But as voter awareness of how cap-and-trade will work and will increase energy prices has grown, popular support has eroded. According ecoAmerica President Robert Perkowitz, interviewed in the WSJ, less than half the respondents in a voter survey said they would support a cap-and-trade policy. So the administration is keen to rebrand the process.


When the full bill is published, the focus will be on the number of permits given away free in the first stage. The real interest, however, is how quickly the free permit allocations will be replaced with permit sales and whether the transition is automatic or will require further congressional action.

Environmental groups will support a fairly substantial allocation of free permits in the first phase to get the bill through Congress, provided there is a clear timetable for moving to a full auction system and the transition is automatic and not subject to further congressional votes. In contrast, coal producers and power utilities will lobby hard to ensure Congress must vote again before free allocations are reduced and the trading program is tightened further.

Crucial points to watch out for:

(1) Whether the actual text of the legislation sets out a timetable for withdrawing free permit allocations in binding language, or whether a move to full auctions is set out in a non-binding “sense of Congress”.

(2) If the legislation mandates a transition to full auctions in binding language, is it conditional on further congressional approval or automatic?

(3) If the phase out of free permits is conditional, does it require positive action by Congress (legislators would have to vote in favor of reducing free allocations, something which could be hard to achieve) or negative approval (free allocations reduce automatically unless Congress specifically votes to block the reduction, which would be equally difficult)? Positive approval would make a full auction system hard to achieve. Negative approval would make it hard to block.


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Australia’s FINSIA will shortly be publishing my findings on global investment and spending needs in Cleantech, simply to cover likely oil capacity depletion losses to 2025. This is a minimum of about 25 Mbd (million barrels/day) new or replacement capacity needed from non-oil sources. Climate change imperatives make this a no choice of Alternate & renewable energy sources.

My cost analysis come to a minimum of around USD 750 Bn per year in 2009 dollar terms. In turn this makes the consideration of multilateral frameworks and part-financing measures both urgent and necessary. I will be interested in hearing from anybody working on this subject area.

Posted by Andrew MCKILLOP | Report as abusive

You have cut to the chase again John. The economy is first and foremost in peoples minds. The consequences of not reducing fossil fuel emissions are not immediate giving the perception to many that we still have time to act in the future. We have probably passed the tipping point. There a really possibility that habitat destruction due to climate change can derail any economic recovery we can muster. It would appear that in regards to the environment and the economy we are not very good stewards of either.

Posted by Anubis | Report as abusive

Anyone read the account of the siege of Troy and the Trogon Horse. The horse was given to Troy as a gift to put the Trogons off their guard and get Greek solders inside the fortifications of Troy.
I think you are pointing out the “Trogon Horse” of 2009.

Posted by Craig Coal | Report as abusive

When folks talk about not knowing where the Gigatons of carbon go when it enters the atmosphere I think they forget their elementary education. CO2 is absorbed by plants, the oceans, the ground and rain.
I would believe the Cap-and-trade was anything more than just another way to tax the working folks of the world if it included a plan to bring water to the world’s waste lands for the purpose of planting more trees and other plants. Such a plan would bring about many benefits including: Providing a sink for the CO2 in the atmosphere, providing a source of more food for the underfeed nations of the world and creating millions of jobs and businesses throughout the world.
The proponents of global warming wring their hands over the ice caps melting and the sea levels rising; why not use solar, wind, nuclear or cold fusion to beat global warming to the punch by desalting sea water and pumping it inland to water the deserts of Asia, Africa, Australia, North and South America. This would make more sense than just wringing our hands and raising the cost of living for some unseen objective.

Posted by Craig Coal | Report as abusive

To see the importance of “compensating” the coal fired electric utilities by handing out “free permits”, take a look at this new paper. n_5_7_09.pdf

We document that in 2007, U.S congressional representatives from poor, conservative, high carbon areas were the least likely to vote in favor anti-carbon legislation. To entice a majority to vote in favor of anti-carbon legislation, some explicit incentive will have to be offered. The question is whether this is simply a geographic transfer of $ from “green” areas such as California to “brown” areas such as Missouri or will such income transfers also have efficiency effects as incentives to “go green” will be distorted?

Posted by Matthew Kahn | Report as abusive

There is absolutely a way to both mitigate global climate change and bolster the economy. It’s called a revenue-neutral carbon tax and it significantly reduces emissions, incentivizes green R&D AND returns the revenue to the people. I just hope Congress catches on before it’s too late.

Posted by CTF | Report as abusive

I would say one should really have a great belief in the US political system to even approach it with such an idea as cap and trade. It’s a huge country that have lobbies and interest groups for just about everything in the world. Once the true costs of cap and trade become evident, a huge mess will be produced. The truth is that taxes may be way more effective way to do what the cap and trade intends to achieve, but they go against the deeply ingrained American habit of constantly looking for free lunches. The end result of the cap and trade will be that the taxpayers will end paying more for the program that will achieve much less even though compared to doing nothing the cap and trade is still better.

Posted by Nobody | Report as abusive