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Cap and Trade-offs

The Obama Administration has initiated plans to address climate change by introducing an economy-wide program to reduce the greenhouse gas …

The Obama Administration has initiated plans to address climate change by introducing an economy-wide program to reduce the greenhouse gas emissions that contribute to global warming by some 14 percent from 2005 levels by 2020, and by 83 percent by 2050. To do this the federal government plans to introduce a cap-and-trade program that will limit greenhouse gas emissions and create a business cost for carbon beginning in 2012.

The House Energy and Commerce Committee proposed a series of cap and trade measures culminating in the Waxman-Markey bill designed to contain global warming by reducing carbon dioxide and other greenhouse gas emissions. The cap-and-trade plan at the core of the bill would do this by limiting severely the amount of energy derived from the three carbon-dioxide producing fuels — coal, oil, and natural gas.  Currently, over four fifths of U. S. energy comes from these three fuels simply because they are the least expensive and most abundantly available fuels.  

A cap-and-trade system restricts output and raises prices for carbon-intensive products. This in turn affects the broader economy by permanently increasing relative prices for carbon-intensive products; and lowering real earnings for workers and owners of capital.

This begs the question what is the economic impact of such a scheme and will the benefits be worth it? Someone would have to pay for all the solar panels, biofuels and wind turbines in a de-carbonized energy world. The International Energy Agency estimates that halving global emissions by 2050 would cost $45 trillion. That is $45 trillion above the cost of fossil fuel energy that would not be spent to create wealth. This would take a big bite out of global prosperity. There is a great deal reported about the so-called “consensus” on climate science. Can there be any doubt that the economic consensus is that reducing emissions reduces economic growth.

According to a study commissioned by the Investor Responsibility Research Center (IRRC), Carbon Risks and Opportunities the impact of carbon risks to the S&P 500 are far from trivial.  If a market price of $28.241 were applied to each ton of CO2 emitted by companies trying to offset carbon costs, the total would be over $92.8 billion. This equates to over 1 percent of revenue from S&P 500 companies in 2007, and over 5.5 percent of combined EBITDA. The report identifies utilities, basic resources, food & beverage, chemicals and oil & gas as the sectors most affected.  Financial risk from carbon costs is greatest in utilities where EBITDA at a company level could fall by 2 percent to 117 percent. Exposure to carbon costs varies significantly with carbon costs amounting to less than 1 percent of EBITDA for 203 companies, while 71 companies could see earnings fall by 10 percent or more, according the report.

The total cost of mitigation would be reach 1percent of global GDP annually by 2050.  Although the report’s authors assert that “costs are growing the longer action is delayed if governments and industry fail to cut greenhouse gas emissions,” and argue that “Climate change could wipe 5 percent to 20 percent off annual world GDP in the long term,” they do not say how they arrived at such an estimate if no action is taken.


Source: Tax Foundation Input-Output Model.

On the other side there are definite costs to our economy if we proceed as the government intends. Tax Foundation adjunct scholar Andrew Chamberlain, author of the working paper, “Who Pays for Climate Policy? New Estimates of the Household Burden and Economic Impact of a U.S. Cap-and-Trade System,” points out that cap-and-trade would not represent a “tax free” way to reduce greenhouse gas emissions. The Tax Foundation study shows that a cap-and-trade system designed to reduce greenhouse gas emissions by 15 percent would place an annual burden of $144.8 billion on American households. (See table). The average annual household burden would be $1,218, which would be approximately 2 percent of the average household income. Although carbon emission permits under a cap-and-trade system would be purchased first by energy companies, the costs are ultimately paid by American consumers. In addition, depending on how the system is structured such a scheme could reduce employment by 965,000 jobs, decrease household earnings by $37.8 billion, and economic output by $136 billion per year.


Source: Tax Foundation Input-Output Model.

In the long run, cap and trade causes prices throughout the economy to rise by an amount roughly equal to the value of outstanding carbon allowances. The reason is simple: cap and trade introduces artificial scarcity in the market for carbon-intensive products, which is reflected in the price of tradable allowances. Requiring companies to hold these carbon allowances permanently raise their costs of production.  As firms adjust to these costs increases, the burden of holding the allowances is ultimately passed forward to consumers in the form of higher prices throughout the economy.

There is also the question of whether such a huge undertaking will achieve its stated purpose of reducing greenhouse emissions. Given that China produces the equivalent of a new coal-fired electricity generating plant each week and has no intention of placing a carbon tax on its growth, is the U.S. deluding itself in thinking that curbing its own emissions in this costly way will command other countries to follow its lead?  Or is our current policy course committing the U.S.  to an enormous wealth transfer to that country? More importantly will CO2 emissions grow globally as world production shifts from relatively to less efficient facilities in China, India and other parts of the world?

The problem is that the costs of cutting carbon come to $20 per ton, yet the benefits add up to only $2 a ton. Cutting emissions has a feel-good factor-the wealthy put up solar panels to burnish their image-but does little to solve global warming.

“President Obama touts the supposed economic benefits – green jobs and prosperity – that will accompany his regulatory regime, “ observes Max Schulz, senior fellow at The Manhattan Institute. “ It is true that, due to government policies that mandate the use of renewable energy, jobs will be created to build wind turbines and install solar panels. But the far higher energy costs throughout the economy associated with these unreliable energy sources will kill jobs and make Americans poorer.”

Perhaps the time has come to call a time-out and take a measured view. Certainly with a trillion and a half stimulus plan that promises to raise deficits as far as the eye can see this is no time to saddle our economy with another tax from which our enfeebled economy may find it difficult to recover.  Environmentalists do their cause no service by hyping the effects over climate change.  The Danish social scientist Bjorn Lomberg who believe the effects of warming are real, has scolded the more strident pundits in the media by making claims that the science cannot possible support.  For example,  Al Gore famously depicted how a sea-level rise of 20ft (six meters) would almost completely flood Florida, New York, Holland, Bangladesh, and Shanghai, even though the United Nations says that such a thing will not even happen, estimating that sea levels will rise 20 times less than that.

“Such exaggerations do plenty of harm,” Lomberg believes. “Worrying excessively about global warming means that we worry less about other things, where we could do so much more good. We focus, for example, on global warming’s impact on malaria – which will be to put slightly more people at risk in 100 years – instead of tackling the half a billion people suffering from malaria today with prevention and treatment policies that are much cheaper and dramatically more effective than carbon reduction would be.”

Exaggeration also wears out the public’s willingness to tackle the problem. If the world is doomed, why do anything?  School children in Washington are reportedly traumatized that if action isn’t taken polar bears will become extinct. Never mind that the polar bear population since 1940 has quintupled–despite disappearing summer Arctic ice. (In the first part of the current interglacial period, glaciers were almost entirely absent in the northern hemisphere, and the Arctic was probably ice-free for 1,000 years.)  

A record 54 percent of American voters now believe the news media make global warming appear worse than it really is. A majority are coming to believe that global warming is not even caused by humans. In the U. K., 60 percent doubt that it is man-made.  If the issue is as momentous as its adherents claim then it is too important to rush into without proper consideration of the costs vs. benefits received. Even if man is the cause of climate change, we burden our economy with ever greater penalties in pursuit of a poorly understood objective without regard for the cost.

About J.P. Donlon

J.P. Donlon
J.P. Donlon is Editor Emeritus of Chief Executive magazine.