Arguments for carbon fee-and-dividend over cap-and-trade

From climate scientist Jim Hansen’s _Storms of our Grandchildren_:

“Let’s discuss cap-and-trade explicitly first. Then I will provide a bottom-line proof that it cannot work. Because I have already made up my mind about the uselessness of cap-and-trade, my commentary may be slanted, but you have been warned, so you should be able to make up your own mind.
In cap-and-trade, the amount of a fossil fuel for sale is supposedly “capped.” A nominal cap is defined by selling a limited number of certificates that allow a business or speculator to buy the fuel. So the fuel costs more because you must pay for the certificate and the fuel. Congress thinks this will reduce the amount of fuel you buy—which may be true, because it will cost you more. Congress likes cap-and-trade because it thinks the public will not figure out that a cap is a tax.
How does the “trade” part factor in? Well, you don’t have to use the certificate; you can trade it or sell it to somebody else. There will be markets for these certificates on Wall Street and such places. And markets for derivatives. The biggest player is expected to be Goldman Sachs. Thousands of people will be employed in this trading business—the big boys, not guys working for five dollars an hour. Are you wondering who will provide their income? Three guesses and the first two don’t count. Yes, it’s you—sorry about that. Their profits are also added to the fuel price.
What is the advantage of cap-and-trade over fee-and-dividend, with the fee distributed to the public in equal shares? There is an advantage to cap-and-trade only for energy companies with strong lobbyists and for Congress, which would get to dole out the money collected in certificate selling, or just give away some certificates to special interests. Don’t hurry to write a letter to your congressional representative asking for a certificate to pollute—that’s not how things work in Washington. Your paragraph requesting a certificate is not likely to be included in the Waxman-Markey bill, even though at last count 1,400 pages had been added. Again, think lobbyists. Think revolving doors. People in alligator shoes write the paragraphs that actually get added. If you think I am kidding, ask yourself this: Do you believe that your representatives in Congress can write 1,400 pages themselves? It is still a free country, so you can hire your own lobbyist, but the price is kind of high. A coal company can afford someone like Dick Gephardt—can you?
Okay, I will try to be more specific about why cap-and-trade will be necessarily ineffectual. Most of these arguments are relevant to other nations as well as the United States.
First, Congress is pretending that the cap is not a tax, so it must try to keep the cap’s impact on fuel costs small. Therefore, the impact of cap-and-trade on people’s spending decisions will be small, so necessarily it will have little effect on carbon emissions. Of course that defeats the whole purpose, which is to drive out fossil fuels by raising their price, replacing them with efficiency and carbon-free energy.
The impact of cap-and-trade is made even smaller by the fact that the cap is usually not across the board at the mine. In the fee-and-dividend system, a single number, dollars per ton of carbon dioxide, is applied at the mine or port of entry. No exceptions, no freebies for anyone, all fossil fuels covered for everybody. In cap-and-trade, things are usually done in a more complicated way, which allows lobbyists and special interests to get their fingers in the pie. If the cap is not applied across the board, covering everything equally, any sector not covered will benefit from reduced fuel demand, and thus reduced fuel price. Sectors not covered then increase their fuel use.
In contrast, the fee-and-dividend approach puts a rising and substantial price on carbon. I believe that the public, if honestly informed, will accept a rise in the carbon fee rate because their monthly dividend will increase correspondingly.
Second, the cap-and-trade target level for emissions (defined by the number of permits) sets a floor on emissions. Emissions cannot go lower than this floor, because the price of permits on the market would crash, bringing down fossil fuel prices and again making it more economical for profit-maximizing businesses to burn fossil fuels than to employ energy-efficiency measures and renewable-energy technology. It would be akin to a drug dealer luring back former customers by offering free cash along with a free fix.
With fee-and-dividend, in contrast, we will reach a series of points at which various carbon-free energies and carbon-saving technologies are cheaper than fossil fuels plus their fee. As time goes on, fossil fuel use will collapse, remaining coal supplies will be left in the ground, and we will have arrived at a clean energy future. And that is our objective.
A perverse effect of the cap-and-trade floor is that altruistic actions become meaningless. Say that you are concerned about your grandchildren, so you decide to buy a high-efficiency little car. That will reduce your emissions but not the country’s or the world’s; instead it will just allow somebody else to drive a bigger SUV. Emissions will be set by the cap, not by your actions.
In contrast, the fee-and-dividend approach has no floor, so every action you take to reduce emissions helps. Indeed, your actions may also spur your neighbor to do the same. That snowballing (amplifying feedback) effect is possible with fee-and-dividend, but not with cap-and-trade.
Third, offsets cause actual emission reductions to be less than targets, because emissions covered by an offset do not count as emissions. They don’t count as emissions to the politicians, but they sure count to the planet! For example, actual reductions under the Waxman-Markey bill have been estimated to be less than half of the target, because of offsets.
Fourth, Wall Street trading of emission permits and their derivatives in the anticipated multitrillion-dollar carbon market, along with the demonstrated volatility of carbon markets, creates the danger of Wall Street failures and taxpayer-funded bailouts. In the best case, if market failures are avoided, there is the added cost of the Wall Street trading operation and the profits of insider trading. To believe that there will be no insider profits is to believe that government overseers are more clever than all the people on Wall Street and that there is the added cost of the Wall Street trading operation and the profits of insider trading. To believe that there will be no insider profits is to believe that government overseers are more clever than all the people on Wall Street and that there is no revolving door between Wall Street and Washington. Where will Wall Street profits come from? They too will come from John Q. Public via higher energy prices.
In contrast, a simple flat fee at the mine or well, with simple long division to determine the size of the monthly dividend to all legal residents, provides no role for Wall Street. Could that be the main reason that Washington so adamantly prefers cap-and-trade?
Fee-and-dividend is revenue neutral to the public, on average. Cap-and-trade is not, because we, the public, provide the profits to Wall Street and any special interests that have managed to get written into the legislation. Of course Congress will say, “We will keep the cost very low, so you will hardly notice it.” The problem is, if it’s too small for you to notice, then it is not having an effect. But maybe Congress doesn’t really care about your grandchildren.
Hold on! Or so you must be thinking. If cap-and-trade is so bad, why do environmental organizations such as the Environmental Defense Fund and the National Resources Defense Council support it? And what about Waxman and Markey, two of the strongest supporters of the environment among all members of the House of Representatives?
“I don’t doubt the motives of these people and organizations, but they have been around Washington a long time. They think they can handle this problem the way they always have, by wheeling and dealing. Environmental organizations “help” Congress in the legislative process, just as the coal and oil lobbyists do. So there are lots of “good” items in the 1,400 pages of the Waxman-Markey bill, such as support for specific renewable energies. There may be more good items than bad ones—but unfortunately the net result is ineffectual change. Indeed, the bill throws money to the polluters, propping up the coal industry with tens of billions of taxpayer dollars and locking in coal emissions for decades at great expense.
Yet these organizations say, “It is a start. We will get better legislation in the future.” It would surely require continued efforts for many decades, but we do not have many decades to straighten out the mess.
The beauty of the fee-and-dividend approach is that the carbon fee helps any carbon-free energy source, but it does not specify these sources; it lets the consumer choose. It does not cost the government anything. Whether it costs “citizens, and how much, depends on how well they reduce their carbon footprint.
A quantitative comparison of fee-and-dividend and cap-and-trade has been made by economist Charles Komanoff (www.komanoff.net/fossil/CTC_Carbon_Tax_Model.xls). If the carbon fee increases by $12.50 per ton per year, Komanoff estimates that U.S. carbon emissions in 2020 would be 28 percent lower than today. And that is without the snowballing (amplifying feedback) effect I mentioned above. By that time the fee would add just over a dollar to the price of a gallon of gasoline, but the reduction in fossil fuel use would tend to reduce the price of raw crude. The 28 percent emissions reduction compares with the Waxman-Markey bill goal of 17 percent—which is, however, fictitious because of offsets. This approach, small annual increases of the carbon fee (ten to fifteen dollars per ton per year), is essentially the bill proposed by Congressman John B. Larson, a Democrat in the U.S. House of Representatives. Except Larson proposes using the money from the fee to reduce payroll taxes, rather than to pay a dividend to legal residents. The Democratic leadership and President Obama, so far, have chosen to ignore Congressman Larson.
A final comment on cap-and-trade versus fee-and-dividend. Say an exogenous development occurs, for example, someone invents an inexpensive solar cell or an algae biofuel that works wonders. Any such invention will add to the 28 percent emissions reduction in the fee-and-dividend approach. But the 17 percent reduction under cap-and-trade will be unaffected, because the cap is a floor. Permit prices would fall, so energy prices would fall, but emission reductions would not go below the floor. Cap-and-trade is not a smart approach.
But, you may ask, was it not proven with the acid rain problem that cap-and-trade did a wonderful job of reducing emissions at “low cost? No, sorry, that is a myth—and worse. In fact, examination of the story about acid rain and power plant emissions shows the dangers in both horse-trading with polluters and the cap-and-trade floor.
Here is essentially how the acid rain “solution” worked. Acid rain was caused mainly by sulfur in coal burned at power plants. A cap was placed on sulfur emissions, and power plants had to buy permits to emit sulfur. Initially the permit price was high, so many utilities decided to stop burning high-sulfur coal and to replace it with low-sulfur coal from Wyoming. From 1990 to today, sulfur emissions have been cut in half. A smaller part of the reduction was from the addition of sulfur scrubbers to some power plants that could install them for less than the price of the sulfur permits, but the main solution was use of low-sulfur coal. Now what the dickens does that prove?
It proves that in a case where there are a finite number of point sources, and there are simple ways to reduce the emissions, and you are satisfied to just reduce the emissions by some specified fraction, then emission permits make sense. The utilities that were closest to the Wyoming coal or that needed to install scrubbers for other reasons could reduce their emissions, and so overall the cost of achieving the specified reduction of sulfur emissions was minimized. But the floor of this cap-and-trade approach prevented further reductions. Analyses have shown that the economic benefits of further reductions would have exceeded costs by a factor of twenty-five. So, in some sense, the acid rain cap-and-trade solution was an abject failure.
It is worse than that. The horse-trading that made coal companies and utilities willing to allow this cap-and-trade solution did enormous long-term damage. (What do I mean by “coal companies and utilities willing to allow”? That is the way it works in Washington. Special interests have so much power, or Congress chooses to give them so much sway, that their assent is needed.) The horse-trading was done in 1970. Senator Edmund Muskie, one of the best friends that the environment has ever had, felt it was necessary to compromise with the coal companies and utilities when the 1970 Clean Air Act was defined. So he allowed old coal-fired power plants to be “grandfathered”: they would be allowed to continue to pollute, because they would soon be retired anyhow, or so the utilities said. Like fun they would. Those old plants became cash cows once they were off the pollution hook—the business community will never let them die. Thousands of environmentalists have been fighting those plants and trying to adjust clean air regulations ever since. Yet today, in 2009, there are still 145 operating coal-fired power plants in the United States that were constructed before 1950. Two thirds of the coal fleet was constructed before the Clean Air Act of 1970 was passed.
Those people, including the leaders of our nation, who tell you that the acid rain experience shows that cap-and-trade will work for the climate problem do not know what they are talking about. The experience with coal-fired power plants does contain important lessons, though.
First, it shows that the path we start on is all-important. People who say that cap-and-trade is a good start and we will move on from there are not looking at reality. Four decades later we are still paying for an early misstep with coal-fired plants.
Second, it shows that we need a simple, across-the-board solution that covers all emissions. A fee or tax must be applied at the source. If Congress insists that it must help somebody who will be hurt by the carbon fee, such as coal miners, fine—Congress can provide for job retraining or some other compensation. But the fee on fossil fuel carbon must be uniform at the source, with no exceptions.
Finally, let me address the ultimate defense that is used for cap-and-trade: “The train has left the station. It is too late to change. President Obama has decided. The world has decided. It must be cap-and-trade, because an approach such as you are talking about would delay things too much.” That latter claim turns truth on its head, calling black “white” and white “black.” The truth is shown by empirical evidence. In February 2008, British Columbia decided to adopt a carbon tax with an equal reduction of payroll taxes. Five months later it was in place and working. This year there was an election in British Columbia in which the opposition party campaigned hard against the carbon tax. They lost. The public liked the carbon tax with a payroll tax reduction. Now both parties support it. In contrast, it took a decade to negotiate the cap-and-trade Kyoto Protocol, and many countries had to be individually bribed with concessions. The result: slow implementation and an ineffectual reduction of emissions. The Waxman-Markey bill is following a similar path…
Okay, at long last, we can address the fundamental problem. What is the backbone and framework for a solution to human-caused climate change?
The backbone must be a rising fee (tax) on carbon-based fuels, uniform across the board. No exceptions. The money must be returned to the public in a way that is direct, so they realize and trust that (averaged over the public) the money is being returned in full. Otherwise the rate will never be high enough to do the job. Returning the money to the public is the hard part in the United States. Congress prefers to keep the money for itself and divvy it out to special interests.
The framework concerns how to make an across-the-board fee on fossil fuel carbon work on a global basis, in a way that is fair, because unless there is a universal carbon fee, it will be ineffective. The backbone, I will argue, makes it relatively simple to define international arrangements—I will explain what I mean by “relatively simple” in a moment. The backbone also makes it practical to have a framework that deals with the problem of fairness between those who have caused the problem, those who are causing the problem, and those who are primarily the victims of others. The framework can also help deal with the fundamental problems of population and poverty.
Contrary to the assertion by proponents of a Kyoto-style cap-and-trade agreement, cap-and-trade is not the fastest way to an international agreement. That assertion is another case of calling black “white,” apparently under the assumption that the listener will accept it without thinking. A cap-and-trade agreement will be just as hard to achieve as was the Kyoto Protocol. Indeed, why should China, India, and the rest of the developing world accept a cap when their per-capita emissions are an order of magnitude less than America’s or Europe’s? Leaders of developing countries are making that argument more and more vocally. Even if differences are papered over to achieve a cap-and-trade agreement at upcoming international talks, the agreement is guaranteed to be ineffectual. So eventually (quickly, I hope!) it must be replaced with a more meaningful approach. Let’s define one.
The key requirement is that the United States and China agree to apply across-the-board fees to carbon-based fuels. Why would China do that? Lots of reasons. China is developing rapidly and it does not want to be saddled with the fossil fuel addiction that plagues the United States. Besides, China would be hit at least as hard as the United States by climate change. The most economically efficient way for China to limit its fossil fuel dependence, to encourage energy efficiency and carbon-free energies, is via a uniform carbon fee. The same is true for the United States. Indeed, if the United States does not take such an approach, but rather continues to throw lifelines to special interests, its economic power and standard of living will deteriorate, because such actions make the United States economy less and less efficient relative to the rest of the world.
Agreement between the United States and China comes down to negotiating the ratio of their respective carbon tax rates. In this negotiation the question of fairness will come up—the United States being more responsible for the excess carbon dioxide in the air today despite its smaller population. That negotiation will not be easy, but once both countries realize they are in the same boat and will sink or survive together, an agreement should be possible.
Europe, Japan, and most developed countries would likely agree to a status similar to that of the United States. It would not be difficult to deal with any country that refuses to levy a comparable across-the-board carbon fee. An import duty could be collected by countries importing products from any nation that does not levy such a carbon fee. The World Trade Organization already has rules permitting such duties. The duty would be based on standard estimates of the amount of fossil fuels that go into producing the imported product, with the exporting company allowed the option of demonstrating that its product is made without fossil fuels, or with a lesser amount of them. In fact, exporting countries would have a strong incentive to impose their own carbon fee, so that they could keep the revenue themselves.
As for developing nations, and the poorest nations in the world, how can they be treated fairly? They also must have a fee on their fossil fuel use or a duty applied to the products that they export. That is the only way that fossil fuels can be phased out. If these countries do not have a tax on fossil fuels, then industry will move there, as it has moved already from the West to China and India, with carbon pollution moving along with it. Fairness can be achieved by using the funds from export duties, which are likely to greatly exceed foreign aid, to improve the economic and social well-being of the developing nations.”