While most of you reading this will already know how much of a policy nerd I am, if you needed any further proof it would be my reason for supporting Barack Obama in the 2008 US Presidential election against John McCain. While I wasn’t decisively swayed one way or another by the broad policy positions on foreign affairs, economics, etc., I decided to take a closer look at the specifics of their environmental policies (which were very similar on the surface). They both proposed a cap-and-trade system of reducing emissions, but Obama promised that 100% of the emissions credits would be auctioned off, whereas McCain had in mind a system where some of the credits would be auctioned, and others allocated by Congress. As similar as they were on the surface, Obama was proposing a cap-and-trade system that works, and McCain was proposing one that doesn’t, so I shifted my support to Obama.
Fast forward to 2010, though, and the climate change bill that’s moving from Congress to the Senate is far removed from Obama’s system, with a whopping 85% of credits being allocated by Congress and only 15% to be auctioned. This doesn’t just defeat the purpose of a cap-and-trade system, but is actually worse than no bill at all. By giving congressmen the power to allocate hundreds of billions of dollars worth of credits, the bill would create a volume of pork that even the most cynical of Washington-watchers would never have thought possible. The system would be a goldmine for lobbyists, and the credits would end up mainly in the hands of the most highly polluting industries, leaving lower-polluting companies to buy them via auction, and ironically shouldering the higher costs.
There are two main reasons given for the free allocation of credits rather than auctioning. The first is that auctioning credits would cause energy prices to go up, causing extra expense for ordinary families. The logic is that, by giving energy companies free credits, they won’t increase their prices. The first problem with this is that the logic is wrong, energy companies will increase prices whether they pay for emissions credits or get them for free. The second problem is that, for a cap-and-trade system to work, energy prices have to go up, to get people to reduce their usage. If you want to counteract the extra hardship that these higher prices will cause to lower and middle income families, then do so through tax breaks or extra lump-sum payments, don’t just attempt (futilely) to keep prices low.
The second argument is that, by increasing costs for high-emissions industries, people who work in these industries will end up losing their jobs. This is true, but the approach of simply giving these industries billions of dollars worth of free credits is massively counter-productive, and completely defeats the purpose of the cap-and-trade system. Any attempt to help those people (and often entire communities) who would lose out from a cap-and-trade system should be focussed on helping the people themselves, not just bailing out the companies they work for.
The problem is that an auction-only system couldn’t credibly get through both Congress and the Senate without some big pressure from the White House. All it takes is for a single congressman or senator to propose an amendment to allocate a tiny minority of credits for free to a favoured company in order to ’save jobs’, and the floodgates open for everyone else to do the same for whatever pressure groups they have to deal with back in their home state. The promise of all that pork is what’s twisted the President’s original proposals into one where 85% of credits are auctioned. If Obama wants a climate change bill that actually works, he’ll have to make it very clear to congress that he’ll veto any bill without a fully functional cap-and-trade system where 100% of the credits are auctioned off.
Of course, this would be a hugely risky move for Obama to make. Even in its current pork-filled form, the cap-and-trade bill is having huge difficulties finding its way into law. Hence, in order to give an auction-only bill any chance of passing both houses, some fairly large carrots will be needed to get enough congressmen and senators from both parties onboard. What Obama has to keep in mind is that, by fully auctioning the credits, the money brought in will give him the opportunity for some big, and potentially very popular additions to the bill. For example, he could…
Half the federal corporate tax rates
Despite priding itself as a pro-business economy, corporate tax in the US is actually amongst the highest in the developed world, with marginal rates as high as 38% and an average effective rate of 25.2%. While successive administrations (particularly Republican ones) would have loved to reduce the tax rates to make the economy more competitive, it brings in a lot of money to the federal government (estimated at $222 billion in 2010), so reducing rates would have entailed either making big increases to other taxes, or big reductions in spending, neither of which would be particularly palatable. Obama has a big opportunity here, though. Estimates put the revenue from a fully auctioned cap-and-trade system at between $130 and $370 billion a year in the short term. Even at the lower end of this scale, he could afford to half corporate tax and still bring in $20 billion in extra revenue.
This would be hugely welcomed by the business community. For companies in the low and middle-emissions brackets, the reduction in corporate tax would far outweigh the costs of the cap-and-trade system, which would create a big, powerful lobby in favour of Obama’s auction-only bill. It could also bring a lot of Republicans on board, who would be willing to stomach the credit auctions to support the reduction in corporate tax rates.
Create a $100 billion fund to help those who lose their jobs
In the transition to a low-carbon economy, it’s an unfortunate inevitability that employment shifts from high-emitting to low-emitting industries, resulting in a difficult few years for those who lose their jobs as part of this shift. While it’s not possible to prevent job losses in any functioning scheme to reduce emissions, it is possible to make the transition as easy as possible for those who are affected by it, and Obama could promise a fund of $100 billion to help them find new, stable employment in lower-emitting sectors.
The fund could operate in a number of ways. Firstly, a lump sum could be paid out to anyone who loses their job in a high-emissions industry, to help them cover a (hopefully short) period of unemployment. The government could then also pay for retraining and education to increase employability in new industries. To help their prospects further, generous tax breaks could be given to any low/medium emitting company who hires these workers.
A further issue is that there are many towns and cities where the main source of employment is in high-emissions industry, meaning there simply aren’t enough lower-emitting businesses to take on the number of workers who lose their jobs. In this case the fund could be used to give extra tax breaks to low-emissions companies that set up in these areas, creating new sources of employment.
With a $100 billion fund spread over the first 5 years or so of the cap-and-trade system, the payments and tax breaks could be very generous and make a significant difference to the people and communities affected by this shift to low-emissions industry. Furthermore, the cost of the fund would be more than covered by the revenues from the credit auctions, even taking into account the reduction in corporate taxes, so wouldn’t increase the deficit even over the short term.
Reduce taxes for low and middle-earners to counter the increase in energy costs
Another inevitability, as explained above, of the cap-and-trade system is that energy prices go up. This is actually desirable, as it encourages people to reduce usage (or switch to lower-emission energy sources), but it can cause difficulties for those on lower incomes who spend a disproportionate level of their earnings on energy usage. The solution to this isn’t in quixotic attempts to keep prices down, but simply to reduce taxes for low and middle-earners in proportion to the increased costs. Doing so would cost in the region of $50 billion a year in lost tax revenue, but in most scenarios this would be recouped by revenue from the credit auctions.
Set long-term emissions reduction levels, and back them up with carbon bonds
With the economy still struggling, Congress (and the US public) are unlikely to be willing to stomach big cuts in emissions levels in the short term. As a result, any cap-and-trade bill capable of passing will have to stick to fairly modest reductions in emissions over the first decade or so, with the bigger reductions kicking in after that point (the Waxman bill from 2007 proposed an allocation schedule that would work quite well). To foster business confidence and prevent future administrations from simply changing the allowances at a whim, the government would have to begin issuing carbon bonds based on these proposed caps, with 10 and 20 year maturities (perhaps extending to 30 year bonds if there’s a market for them). This would greatly increase investment in low-emissions industry and technology, as companies could insure themselves against future changes to the cap-and-trade system.
By combining a fully-auctioned cap-and-trade system with the above proposals, Obama could counter the big assumption that almost all doubters have about any emissions reduction scheme; that it would inevitably harm businesses and the economy. By recycling the auction revenue into a dramatic reduction in corporate tax, the overall scheme would actually be a significant boost to the vast majority of businesses. Only the most highly polluting businesses would feel the brunt of the carbon credit costs, and instead of bailing out the polluters, a $100 billion fund would be set up to bail out the workers affected by this, and help them find new work in the growing low-emissions industries. Finally, by selling carbon bonds, the US would set itself up as by far the safest country in the world to make long-term investments in low-emissions businesses, leapfrogging countries where there is less certainty over long-term climate policy. In addition to all this, there would still be enough left from the auction revenues to reduce the budget deficit by as much as $100 billion a year.
Edit (30/03/2010): This post was originally written using the term ‘green bonds’. I’ve since changed all references to ‘carbon bonds’ instead. This is to bring the terminology closer to that used by Michael Mainelli and Jan-Peter Onstwedder in a proposal made last year, where they used the term ‘index-linked carbon bonds’ to describe effectively the same thing. The change should also remove any confusion with other uses of the term ‘green bonds’.
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