Alternative Energy, Energy Independence and Global Warming Reduction

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We Debate: Which Is Best, a CARBON TAX or CAP-AND-TRADE?

There's movement in Congress to impose a cost on emitting greenhouse gases into the atmosphere. No less than seven bills would introduce a cap-and-trade scheme, whereas only a couple propose a tax.
     What's the difference? How would a carbon tax be applied? What does cap-and-trade mean? Which is better? This is critical legislation, and we attempt to answer those questions with arguments on both sides below.
     Decide for yourself, and then watch what Congress does (or doesn't) do.

Carbon Tax: It's Simpler
and Will Have Immediate
Effect

The carbon tax approach to reducing emissions would charge industry and other entities for greenhouse gases they emit into the atmosphere. For all six greenhouse gases, converted to their CO2 equivalents in environmental damage, a levy of $10 to $15 a metric ton is often given as an example, at least in early years.
     It is the most straightforward scheme: It says, if you continue to pollute, you pay a penalty for doing so, and the cost is likely to cause you to take steps to reduce emissions to reduce the tax — exactly the desired effect. And if that doesn’t do it, increases in the tax will.
     The money raised could be directed to research and development of clean energy technology and renewable energy alternatives to oil, or other useful purposes — even rebates to low income earners hurt by the passed-on costs.
     Under a cap-and-trade program, allowances to emit carbon dioxide could be sold or auctioned to polluters such as the power utilities to provide the inducements to cut emissions, but the Lieberman-Warner bill now working its way through Congressional committee — the cap-and-trade plan extending from 2012 to 2050 that seems to have won the most favor — would give away half of its allocations free, the other half by auction.
     What’s wrong with that? At least the utilities, cement, paper and steel companies will be paying for half, would they not?
     Only eventually, because, at first, almost all the allocations are free: 82% in the 2012 start up year would be simply given away to companies to use or trade for profit. The percentage then declines, to 27% by 2050, but for years, free permits to pollute will give industry little inducement to make any changes. The Windfall      The allocations, often referred to as credits, are bound to have tremendous value. The Congressional Budget Office estimates that emission permits could rise in value from $5 to $65 per metric ton between now and 2050; the Environmental Protection Agency (EPA) estimates $14 to $78.
     The U.S. economy currently emits 7.3 billion metric tons of greenhouse gases annually. If the cap is set at current levels for the 73% of the economy that Lieberman-Warner covers, that would lead to allocations for 5.2 billion tons. As we just saw, 82% of those would be giveaways. Splitting the difference between the early-year estimates above, that’s a handout to industry of over $40 billion in the first year alone. Using its price estimates and the sliding percentage schedule, the EPA calculates that 66 billion pollution permits valued at $1.5 trillion will be handed out free of charge under Lieberman-Warner. Too Susceptible to Gaming      Even under an auction format, there are structural flaws with cap-and-trade. Swayed by campaign contributions, Congress will more than likely set an initial cap that matches the nation’s current levels of pollution — or possibly higher, to allow industry an early-year cushion. With plenty of credits to go around, they will trade at low prices — as happened in Europe’s implementation of Kyoto. Cheaply purchased credits will undercut inducements to cut costs by making infrastructure improvements, and that will lead to a long delay before the year-to-year declining schedule of allocations forces emission reductions.
     A carbon tax, even if low at first, would at least impose a cost for emissions. Penalizing the Pacesetters      Moreover, awarding allocations equal to current emissions gives no credit to companies that have already spent heavily to cut back pollution, while at the same time rewarding the worst offenders who have resisted for decades the Clean Air mandates to install controls. That is what is assumed to have prompted TXU to announce plans in early 2007 to hurriedly build eight coal-fired plants: they wagered that pollution levels would probably be “grandfathered” by any cap-and-trade bill.
     Additionally, cap-and-trade is likely to prove vulnerable to political tampering. Lobbyists and corporate campaign contributions will constantly press for adjusting the caps and percentages as the years pass and costs rise. Trading will need to be closely regulated to thwart market manipulation. A tax, on the other hand, is highly visible and less susceptible to camouflage. The Competition Question      An argument against a carbon tax is that higher costs will make American goods less competitive. So would an auction-based cap-and-trade program, whereas Lieberman-Warner imposes no appreciable costs for years. Nevertheless, in an attempt to eliminate the cost advantages of countries that refuse to penalize emissions such as China and India, and as a concession to labor, this bill sets up a second, parallel cap-and-trade mechanism for imports. That doubles its complexity and presages a still more bloated bureaucracy.
     Much simpler would be a tax imposed at port of entry, based on the amount of emissions imputed to have been released in making the incoming goods.
     There is no point imagining that China or India might someday agree to a cap-and-trade alliance to replace this border contrivance. They would insist on a population-based carbon allowance, and America would find itself paying itself into penury to buy credits to sate its much higher per-capita energy consumption.
      Charging non-compliant nations could lead to a tariff war will be the obvious cry. Yes, it could. But it is time to realize that all such human affairs of the moment – trade pacts, costs, profits, jobs — become petty trifles when at issue is the future of planet Earth. Any scheme adopted should anticipate international application, and a carbon tax works best.
      - Stephen Wilson, PlanetWatch Editor, http://www.planetwatch.org

Cap-and-Trade: Market Incentives Will Spur Innovation

This article presents the view that a system of "cap-and-trade" would be more effective than a carbon tax as a way to bring about reductions in green house gas (GHG) emissions — primarily, but not exclusively, CO2. GHG's are products of burning carbon-based fuels which appear to be changing the heat retention characteristics of our atmosphere and risking significant damage by warming the climate.
     What is cap-and-trade? In the simplest terms, it means that an absolute upper limit on CO2 equivalent emissions is set, based on what is currently taking place, and then the limit is steadily reduced, forcing emitters to a) reduce emissions, or b) buy at market prices certificates of other entities that have provable reductions in excess of their quota, or c) suffer crippling fines. It uses market mechanisms to reduce CO2 in the quickest and cheapest manner. It is hard to implement because the starting position has to be negotiated in a political environment. Also, it needs to be adopted by virtually every country, or it loses its effect. Many prefer it over carbon tax because it cannot as easily be circumvented or changed, as can be a tax. But a tax is easier to implement.
     A key issue when introducing a cap-and-trade system is whether: a) the initial allowances should be "granted" to emitters at near their current levels of emission, giving rise to complaints of rewarding bad behavior, or b) they should be auctioned by the issuing government. The preference is the latter as it provides immediate value for allowances, generates revenue to support clean energy research and defends the government against accusations of offering "giveaways" to big polluters.
     It is important to note that either approach has the potential to be effective, and even both might work well, but if the choice must be one or the other, cap-and-trade is the better alternative. Why? The Profit IncentiveFirst, because it is likely to bring about the largest amount of GHG emissions reduction in the shortest period of time and at the least cost to the economy. When the stakes are as large as they are in this matter, issues of "fairness" and "equity" may need to take a back seat to "effectiveness". Cap-and-trade causes the easiest and least costly reductions to take place early because those who produce such reductions can sell at a profit their surplus carbon allocations to others who are having trouble meeting the reduction targets that are imposed on them.
     In a war where winning is essential, a winning policy employs the most effective available strategies and tactics, not the least expensive or the most fair and balanced. The same logic applies here. Cap and trade harnesses the forces of markets to achieve cost-effective environmental protection. Markets can achieve superior environmental protection by giving businesses both flexibility and a direct financial incentive to find faster, cheaper and more innovative ways to reduce pollution.
     Markets provide greater effectiveness than command-and-control regulation because they turn pollution reductions into marketable assets. In doing so, this system creates tangible financial rewards for environmental performance.
     Carbon caps (or taxes) need to be applied as far as possible "upstream" in the supply chain, so that carbon emitted in making gasoline, for example, is capped along with the carbon emissions potential of the gasoline itself when consumed. Europe has learned that capping carbon emissions where the energy is used, such as for an individual car, is not effective. There's Already Proof That It Works Second, cap and trade was designed, tested and proven here in the United States, as a program within the 1990 Clean Air Act Amendments. The success of this program led The Economist magazine to crown it "probably the greatest green success story of the past decade." (July 6, 2002).
A Spur to InnovationThird, because cap-and-trade gives pollution reductions a value in the marketplace, the system prompts technological and process innovations that reduce pollution down to or beyond required levels. This point is not theoretical; experience has shown these results.
     Lastly, and perhaps most importantly, a cap on carbon emissions provides a relatively predictable outcome in terms of GHG reductions, with the cost of allocations being unknown and floating with market forces, whereas a carbon tax provides known increases in costs, but allows the reduction in GHG to float with market forces. We need maximum focus on achieving specific end results, rather than concentrating on taxes and revenues. Summary      An active cap-and-trade market enables those who can reduce pollution cheaply to earn a return on their pollution reduction investment by selling extra allowances. It enables those who can’t reduce pollution as cheaply to purchase allowances at a lower cost than the cost of reducing their own emissions. It enables all participants to meet the total emissions cap cost-effectively. And it gives all emitters incentives to innovate to find the least-cost solutions for total pollution control.
      - Douglas L. Ayer, PlanetWatch Editor, http://www.planetwatch.org