Bridges Trade BioRes Review • Volume 3 • Number 2 • October 2009

In Climate Politics, Follow the Money

by James K. Boyce

Discuss this articleShare your views with other visitors, and read what they have to say

Any policy that limits supply of fossil fuels must raise their price. The economic logic binding price to scarcity holds true, regardless of the cause of scarcity. When OPEC wants to increase the price of oil, it cuts production. If, as part of the international climate agreement that emerges from the Copenhagen conference in December, national policymakers place a cap on carbon emissions from burning fossil fuels, this too will increase the price.

The key question is: who gets the money? As the United States Congress takes up climate legislation that would cap carbon emissions, and issue permits for emissions up to that cap, this question looms large. There are three possible answers:

Windfall profits to corporations: If the permits are given free-of-charge to fossil fuel companies, they reap profits: consumers pay higher prices and shareholders get the money. This is a ‘cap-and-giveaway‘ policy.
Revenues to government: If the permits instead are auctioned to the firms, their value (which is the counterpart to the higher prices paid by the consumer) is captured by the government. If the money is used to fund public expenditures or cut taxes, the benefits to the populace will depend on these uses. This is a ‘cap-and-spend‘ policy.
Dividends to the people: If the revenue from permit auctions is returned to the public as equal per-person dividends, people with smaller-than-average carbon footprints come out ahead, receiving more than they pay in higher prices. This is a ‘cap-and-dividend‘ policy.

The stakes are enormous. A carbon cap in the United States will involve the greatest allocation of new property rights since the Homestead Act of 1862. A cap that cuts US emissions 80 percent by 2050 - the goal endorsed by climate scientists and embodied in legislation now before Congress - could generate as much as US$10 trillion over the next four decades.

Why Cap Carbon?

A cap on carbon emissions is a crucial element of any serious policy to curb global warming and promote energy efficiency and the transition to renewable energy. A carbon cap will be most efficiently administered ‘upstream’, requiring permits to be purchased by the first sellers of fossil fuels into the economy. Because the cap will reduce supply, it will raise fuel prices. The resulting market signals will spur investments by firms and households in energy efficiency and clean energy.

Costs versus Transfers

While higher prices for gasoline, heating oil, natural gas, electricity are a cost to consumers, these are not a ‘cost‘ from the standpoint of the economy as a whole. Instead, they are a transfer. Every dollar paid in higher fuel prices will be redistributed to the holders of the carbon permits. Unlike the case when oil prices rise due to market forces or supply restrictions by OPEC, a carbon cap in the United States will recycle dollars within the country. From the standpoints of both economic fairness and political durability, the key policy question is where these dollars will go.

How Does a Cap-and-Dividend Policy Work?

In a ‘cap-and-dividend‘ policy, 100 percent of the permits will be auctioned by the government, and all or most the auction revenue will be returned to the public as equal payments per person. This is what economists call a ‘feebate‘ arrangement: individuals pay fees based on their use of a scarce resource that they own in common, and the total fees collected are rebated in equal measure to all co-owners. In this case, the scarce resource is the US share of the carbon storage capacity of the atmosphere; the fee is set by the carbon footprint of the individual household; and the co-owners are the American people.

Under a cap-and-dividend policy the real incomes of low-income and middle-income families will be not only be protected but will rise.[i] Overall, about six in ten American families come out ahead in purely monetary terms - not counting the environmental benefits that are the main rationale for any carbon policy.

A transparent and efficient way to disburse dividend payments to the public is via an ATM card, similar to the cards now used by many Americans to access Social Security payments. At the ATM, people can view the auction revenue deposits into their accounts and withdraw available funds at their own convenience.

Free permits to firms would not protect consumers

It is sometimes claimed that free permit allocations to firms would eliminate or mitigate the impact of a carbon cap on consumer prices. This is not true. Elementary economics dictates that when goods become more scarce, their price goes up. A carbon cap makes fossil fuels more scarce.

In housing markets, the price of a dwelling and the rent charged by its owner do not vary depending on whether the owner purchased it or inherited it for free. In the same way, the price of gasoline will not differ if permits are auctioned to companies or handed out free-of-charge. A cap-and-giveaway policy that provides free permits to firms would simply transfer the money paid by consumers in higher fossil fuel prices to the shareholders of the firms as windfall profits.

During last year’s election campaign and in his budget proposal submitted to Congress in February, President Obama endorsed the principle that 100 percent of carbon permits should be auctioned.

With 100 percent auction there is no need for permit trading

Most permits in our society are not tradable. Driving permits, gun permits, parking permits, landfill disposal permits, and building permits cannot be traded in markets. Why should carbon permits be different?

The need for tradable permits is premised on the assumption that some or all of the permits will be given away for free rather than sold by auction. With giveaways based on some formula (like historic emissions), some firms will get more permits than they need, while others will get fewer; trading is required to redistribute them. If instead 100 percent of the permits are auctioned, say monthly or quarterly, firms can make their own real-time decisions as to how many permits they acquire. The need for permit trading disappears.

With non-tradable permits, none of the carbon revenue will be siphoned off by trading firms who need to earn a profit. In addition, non-tradable permits will safeguard the policy from the perception or reality of market manipulation by speculators or other players seeking to game the system.

Mitigating regional differences in employment impacts

Any policy to cut carbon emissions will have impacts on employment, apart from the impacts on consumers described above. In some sectors (for example, coal mining), jobs will be lost; in others (such as retrofitting of buildings and manufacturing renewable energy technologies) jobs will be created.

Insofar as investment in renewables and energy efficiency is more labour-intensive than investment in the fossil fuel sector, job gains will exceed job losses. But no automatic mechanism ensures that job creation will occur in the same communities and for the same workers who are adversely impacted by job losses.

To protect these communities and workers, a fraction of the carbon revenues initially could be allocated to the states as block grants dedicated for this purpose. In the first year of the cap-and-dividend policy, for example, 10% of permit auction revenues could be directed to block grants and the remaining 90 percent distributed to households as dividends, with the block-grant share phasing out over a 10-year horizon. As long as the proportion of revenues dedicated to this purpose is modest, the majority of families will continue to be ‘made whole‘ by the cap-and-dividend policy.

Block grants would allow the states to tailor transitional adjustment assistance policies to their own needs. In coal-mining states, for example, funds could be invested in the ecological restoration of landscapes degraded by mountaintop removal, strip mining, and disposal of mine tailings and coal ash. In manufacturing-intensive states, funds could be invested in job training and support to ‘green’ industries such as the production of wind-energy and solar-energy equipment.

Conclusion

The principal political challenge confronting any policy to curb carbon emissions is how to protect families from the impacts of higher fossil fuel prices - and how to protect the policy itself from the political fallout that otherwise will result.

What is needed is a policy in which the public not only be willing to pay higher prices at the gasoline pump and in their home heating and electricity bills, but will be positively enthusiastic about doing so, secure in the knowledge that they themselves are on the receiving end of the resulting transfers of money.

Neither a cap-and-giveaway policy in which permits are given free to firms, nor a cap-and-spend policy in which permits are auctioned and the revenues flow into the government budget, will yield this desirable result.

In short, a cap-and-dividend policy will not only address squarely the pressing problems of global warming and energy independence, but also strengthen the economic well-being of average families. By achieving these goals in a way that is fair and transparent, it will maximize the prospects for securing durable public support for a policy that weans the economy from dependence on fossil fuels.[ii]

The energy transition that is needed to avert the worst of climate change is certainly feasible. But it cannot happen overnight. This historic change will take decades, and for this reason it will require durable support. The time to launch the transition is now, but the policies that undergird it must be built to last.

James K. Boyce teaches economics at the University of Massachusetts, Amherst, where he directs the environment program at the Political Economy Research Institute. This paper originally appeared in Different Takes, No. 60, Spring 2009..

[i] See James K. Boyce and Matthew Riddle, “Cap-and-Dividend: How to Curb Global Warming While Protecting the Incomes of American Families,” Amherst, MA: Political Economy Research Institute, Working Paper No. 150, November 2007. Available at http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_101-150/WP150.pdf.

[ii] For further information, please go to www.capanddividend.org.