John McCain And 100% Auctions

JOHN McCAIN AND 100% AUCTIONS....On Monday, John McCain outlined his climate change policy, which includes a cap-and-trade program:

We will cap emissions according to specific goals, measuring progress by reference to past carbon emissions. By the year 2012, we will seek a return to 2005 levels of emission, by 2020, a return to 1990 levels, and so on until we have achieved at least a reduction of sixty percent below 1990 levels by the year 2050.

....As part of my cap-and-trade incentives, I will also propose to include the purchase of offsets from those outside the scope of the trading system....Through the sale of offsets — and with strict standards to assure that reductions are real — our agricultural sector alone can provide as much as forty percent of the overall reductions we will require in greenhouse gas emissions....Over time, an increasing fraction of permits for emissions could be supplied by auction, yielding federal revenues that can be put to good use.

For starters, its goal of a 60% reduction in greenhouse gas emissions by 2050 is less aggressive than Barack Obama's plan, which calls for a reduction of 80%. Since the plan will probably get watered down in Congress, that's a bad place to start.

Second, there are the offsets. It's not impossible to do offsets right, but in the reality we live in they're almost certain to be used as little more than a fig leaf that gives the appearance of doing something while delaying real action on GHG reductions. Promises of "strict standards" notwithstanding, this is an area where you definitely want to see the fine print before you sign up.

Third, McCain's cap-and-trade plan initially gives away emission permits instead of auctioning them. I mentioned a few days ago that that a 100% auction of emission permits is what distinguishes a real plan from a fake one, and later that day Mike O'Hare begged to differ: "The difference between a giveaway and an auction of the same total emissions is not a difference in environmental outcome or the economic cost of getting to it; it's only a matter of whose ox is gored." That's true, but it's worth unpacking that gored ox a bit.

Environmentally speaking, it doesn't matter whether you auction permits or give them away. What matters is the cap. If you cap total emissions at 90% of current levels (and enforce it), then that's what you'll get no matter which kind of system you use. And since both systems allow permits to be traded between companies, they each provide similar levels of economic efficiency. Our ox lurks elsewhere.

Here's the difference. If you auction permits, then power plants and other GHG emitters have to buy permits to operate, and this raises their cost of doing business. This will get passed along to consumers and energy prices will go up. The revenue from the permits will go to the government, just like a tax.

If you give away permits instead, common sense suggests that since there are no additional costs to emitters, they won't raise their prices. But it turns out this isn't true. Thanks to the opportunity cost of the permits, they'll raise their prices just as much as if they'd bought the permit in an auction. (This isn't just a theory, either. That's how the European cap-and-trade system worked initially, and prices really did go up. If you want the gritty detail on why it works this way, read this paper.) So: power plants end up raising their prices, but since the emission permits are free their costs don't change. Result: a huge windfall profit for GHG emitters. Some get more and some get less, but the overall net result is lots of extra profit, with the biggest polluters getting the biggest profit.

That sounds Republican bad enough already, but it gets worse. All cap-and-trade programs increase energy prices — it's like a carbon tax. But carbon taxes are heavily regressive, and a cap-and-trade program with a permit giveaway is even worse. Not only would the resulting higher energy prices hit the poor more heavily than rich, just as they would with a carbon tax, but in addition, thanks to the windfall profits, the rich would actually benefit from increased earnings in their investment portfolios. An auction system, by contrast, (a) doesn't provide windfall profits for corporations and (b) since the federal government collects the auction fees it can use them to ameliorate the disproportionate impact on the poor. It can spend some of the money on clean energy R&D; it can spend part of the money on mass transit; and it can spend part of the money by simply giving it back to taxpayers in a way that reduces the regressive nature of the original tax.

Finally, there's a political reality here. A system that gives away permits is highly vulnerable to legislative fiddling. Just as with tax policy, it's all too easy to favor certain industries over others by doling out different permit levels, and all too easy for the whole thing to turn into yet another form of corporate welfare. It's a lot harder to do that with an auction plan, which simply sets a nationwide permit level for GHGs and then makes companies buy them in a publicly traded system. It's not impossible for legislators to game the system — it's never impossible for legislators to game the system — but it's a lot harder.

So that's that. A cap-and-trade system with a 100% auction provides revenue for green research; it reduces the regressivity of the tax hit; and it helps keep lobbyists from gaming the system. The giveaway method, conversely, is highly regressive; provides windfall profits for big polluters; and would almost certainly end up as a congressional pork barrel that eviscerated the original emission targets bit by bit by bit. It just goes to show that policy details matter. Take your pick.