Cap and Trade: What It Will Cost You

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Last Updated Jul 22, 2009 3:07 PM EDT

The energy bill now winding its way through Congress is an unprecedented attempt to put a limit and a price tag on carbon emissions, with the intention of stemming the tide of global warming. But if you're trying to get a read on how much it'll end up costing you, you might well be confused.

In the months before the American Clean Energy and Security Act passed the House of Representatives on June 26, numbers had flown every which way. The bill sets a nationwide, declining limit on greenhouse-gas emissions that some claimed would raise the average household’s energy bill by $3,100 per year. Others said it wouldn’t cost the consumer much, if anything — a view buttressed just days before the vote when the Congressional Budget Office released a forecast putting the increase at $175 annually by 2020.

So which is it?

The centerpiece of the bill — also known as Waxman-Markey after its co-sponsors, Democratic congressmen Henry Waxman and Edward Markey — is a cap-and-trade system. Companies will have to keep their carbon dioxide emissions within an initial allowance or face a fine. Those that release less than the permitted cap can trade (i.e., sell) their credit to those that go over. Companies can also invest in or buy offsets from, say, a landowner who obtains carbon credits after planting trees. The goal of the bill? A 17 percent reduction in greenhouse-gas emissions from 2005 levels by 2020, a 42 percent reduction by 2030, and an 83 percent reduction by 2050.

Provisions in the groundbreaking bill aim to prevent higher energy costs from being passed on to consumers. To what extent they make sense is up for debate, as is the bill’s effectiveness against global climate change. A similar cap-and-trade policy for sulfur dioxide emissions has successfully reduced acid rain in the U.S. over the last 12 years, although carbon emissions are much more pervasive and complex phenomena.

What About My Bills?

In April, House leader John Boehner, among other Republican opponents of the bill, slammed the proposal as a heavy tax on consumers. To arrive at that $3,100 figure, they took the study’s projected revenues in 2015 from the auctioning of allowances — $366 billion — and simply divided it by the number of households in the country, assuming that households would eventually end up footing the bill.

But that calculation assumed that revenue generated by the program is the full “cost” and that none of the money would flow back to the public and into the economy. In fact, revenue from the auction of 15 percent of the carbon allotments will assist low- and moderate-income consumers in the form of tax reductions. The rest of us should get a break, too. Most of the allowances given to the electricity sector and the natural-gas sector will go to local distribution companies (LDCs), the folks who send the bills to you. The details are a bit ill-defined for now, but the LDCs are supposed to sell their allowances into an allowance marketplace where the buyers will include any large industrial emitter of carbon dioxide, such as electric utilities, oil refiners, and iron and steel manufacturers. They will then distribute the revenue to customers — that includes businesses — as refunds within monthly bills.

When you factor in these rebates and tax breaks, the net cost per household will be closer to $800 per year over the full lifetime of the policy through 2050, says John Reilly, who was the lead author on a study of cap and trade at Massachusetts Institute of Technology and is an associate director at the school’s Joint Program on the Science and Policy of Global Change. This amount would be lower in the earlier years of the program when emissions reductions targets are less aggressive. The CBO’s lower figure of $175 per household reflects the fact that the CBO looked at the program’s estimated costs just in 2020 rather than over its entire lifetime, and also factored in projected economic growth between 2010 and 2020.

The Pain Factor

But in the end, keeping costs from hitting utility bills might not be such a great thing if it doesn’t motivate all of us — consumers and businesses — to reduce energy consumption. When gas is expensive (and here it’s worth noting that the added cost per gallon of gas in 2020 would amount to about 20 cents under the plan), people drive less and they decide not buy gas-guzzling SUVs. Will our energy bills become painful enough to demand conservation?

Muting energy-price increases will surely reduce the incentive to conserve. Consider your utility bill: The refund will hit the fixed portion of utility bills, the charges for transmission lines, distribution, and so on. The volumetric charge — the usage part — will reflect the added cost. The notion is that those who use less electricity will come out that much more ahead. But if the overall bill isn’t rising that much, will Americans be motivated to conserve? And when one considers the obvious fact that businesses large and small also use electricity, and that they’ll get breaks too, to what extent will the policy encourage society-wide conservation and efficiency?

The emission targets themselves are problematic as well. The 2030 target of a 42 percent reduction in emissions is an ambitious one. Will companies get their act together now so they can handle that target? Given the country’s history of wavering about climate change, it’s a valid concern. “The bill as it’s structured now is a lazy stroll to 2020,” says Mark Cooper, director of research at the Consumer Federation of America. “But then it’s a frantic race to meet the 2030 target.” If large polluters such as the utilities start responding now, we can avoid that frantic race. If not, Cooper argues, they’ll need to catch up quickly by investing in research and development and new technology to lower their emissions — and you’d see much bigger increases in your energy bill years down the line.

Opponents of cap and trade say that’s what happened in Europe. The European Union’s system, which began in 2005 and is now in its second three-year phase, got off to a rocky start, mostly because the EU lacked solid data on emissions. Initially, the cap was set too high, and so the price of carbon eventually fell to zero, effectively voiding companies’ incentive to cut emissions. In addition, nothing in the EU’s original plan prevented some companies from passing on to consumers the full cost of their efforts to reduce carbon emissions. Germans, for example, experienced a 25 percent rise in electricity prices. Now that the system has been tweaked, however, Europe seems on track to cut emissions over 11 percent from 1990 levels by 2012.

Cap and Trade, American Style

Waxman-Markey isn’t making the same mistakes. The stronger federal union in the U.S. and the oversight of the Environmental Protection Agency mean the full cost is unlikely to be passed to consumers. The 50 state public-utility commissions, which regulate the local distribution companies, have a good history of trying to keep rates down and should make sure the LDCs follow through with the refunds to consumers, according to A. Denny Ellerman, a senior lecturer at MIT and an expert in emissions-trading systems. “Anyone who argues that the EPA isn’t going to enforce this is ignoring American law and all the experience we’ve had in this kind of program,” he says, referring to the country’s past success dealing with acid rain.

Cap and trade worked then on a much more modest scale to curb sulfur dioxide pollution caused by emissions from power plants (by 2007, sulfur dioxide emissions had declined 50 percent from 1980 levels since the start of the program in 1995). Unlike most other plans that proposed a tax on carbon emissions, Waxman-Markey sets a legal limit on carbon emissions. But compromise has also watered down the bill’s emission targets. The Union of Concerned Scientists favors a cap-and-trade policy but says the CO2 targets need to be pegged to 2000 levels, rather than 2005 levels as they are now, “to avoid some of the worst, irreversible consequences of global warming.”

So while the good news is that the pain to U.S. consumers will probably not be all that great, that’s also the bad news. “In the next 20 years, cap and trade is not going to fundamentally transform the American energy system,” says Ellerman, who nonetheless supports Waxman-Markey as a way of gradually changing behavior. “It’s going to change consumption patterns and how manufacturers and producers make things, but the United States is still going to look pretty much like it looks today.” To many, that’s precisely the problem.

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