Carbon fee vs. Cap-n-trade

By Robert Haw

The Citizens Climate Lobby proposes a fee-and-dividend strategy using market-based financial models to reduce fossil fuel combustion and bring down CO2 emissions. Rather than rely on government regulations and subsidies, CCL advocates a Pigouvian, revenue-neutral carbon fee.

A Pigouvian fee is an assessment levied on activities that generate negative consequences. Burning fossil fuels have irrefutably negative consequences, so the idea is to assess a fee on them alone and use market forces to bend the climate-change curve downwards.

The carbon fee is proportional to the amount of carbon dioxide released during combustion. It starts out low — say $25 per ton of CO2 — and increases annually in a predictable manner — say $10 per ton per year — until the economy has de-carbonized. An ascent at this rate is necessary based on the conclusions of climate scientists.

The fee’s long term purpose is to make fossil fuels pay for the inter-generational damage they’re causing to society; its immediate goal is to make green energy competitive with fossil fuels within 10 years. The best example is gasoline. Each $1 per ton increase in the price of CO2 adds about 0.8 cents per gallon to the price of gasoline. So if the carbon fee started at $25/ton and increased $10/ton annually, gasoline would go up by 20 cents per gallon in the first year and 8 cents per gallon each year thereafter. Meanwhile biodiesel fuels would not be subject to the fee, nor would solar or wind generated energy.

The fee’s advantage is the price signal it sends to the marketplace, making renewable energy investments immediately more attractive than fossil fuels. Collaterally, a rising carbon fee decreases demand for products made from dirty energy because of higher production costs. In this way, over time, CO2 emissions will drop to zero.

The dividend part of the strategy is the charm of the proposal. The fee is collected by the federal government at the fuels’ source — the well, mine, or port-of-entry. In turn, the federal government returns 100% of the proceeds to all citizens (that’s the “dividend”), shielding them from the financial impact of the transition to clean energy. The dividend is distributed with no strings attached (similar to the oil-income rebate distributed to Alaska residents). In year 10 of the program described here, a family of four will receive a payout of roughly $4200 (Carbon Tax Center). Moreover, 65% of all households will get more money back than they pay in higher energy costs (Carbon Tax Center).

So if you don’t like paying taxes, this is an extraordinarily easy way to reduce your tax load. De-carbonize your personal economy and you’ve eliminated your carbon tax. Meanwhile the dividend check continues to roll in.

Why is Carbon Fee and Dividend better than Cap and Trade?

A cap and trade strategy limits the amount of CO2 allowed into the atmosphere. That is, CO2 emissions are capped. A legislative body (state or federal government) defines the permitted quantity of CO2 pollution and issues certificates to major polluters based on that assessment. Hence the certificates are called ‘permits’. Over time, the number of permits issued to polluters is reduced (that’s the “cap”). Note though, that businesses emitting more CO2 than allocated to them can buy additional CO2 permits from other businesses — businesses that have reduced emissions more expediently and therefore have surplus permits to sell (that’s the “trade”).

Ideally (but seldom in practice) polluters bid for CO2 permits at an auction. When certificates are auctioned they assume a value and act like currency. (The money raised from auctions can go toward clean energy programs.) Instead, in most cases certificates are handed to polluters free of charge, and freely distributed permits have an even higher relative value than the ones auctioned because they’re still tradable. For this reason, industry lobbyists worked hard to convince the European Union to grant free CO2 permits to industry. Billions of permits were given away yet Europeans haven’t profited from them by 1 euro. In California, most CO2 certificates are also given away, although a small percentage is auctioned. The price for CO2 permits in California at the end of 2013 is $14 per ton of CO2.

If permits are not auctioned, then the public does not benefit financially. Utilities and manufacturers (eventually) pass on the increased energy costs to consumers, sticking them with higher bills. Carbon traders and investors earn a profit as market makers in all cases, yet none of those profits get passed on to the public. So an advantage accrues only to an elite subset of the population under this arrangement.

There are other difficulties with cap and trade. It’s a complicated accounting process, and emissions require constant monitoring in order to enforce the cap. A carbon fee, on the other hand, is straightforward, easy to understand, easy to administer, and unnecessary to monitor. A carbon fee takes little time to set up and requires no additional bureaucracy unlike cap and trade. A carbon fee sends predictable price signals to the marketplace whereas cap and trade leads to wild swings in energy prices because of market fluctuations. Predictable prices are overwhelmingly preferred by businesses because stability enables them (and consumers) to plan long-term energy investments. Finally, in the European experience, cap and trade has not been effective so far in reducing CO2 emissions.

Much of cap and trade’s ineffectiveness in the EU lays with two reasons: lax enforcement of the cap, and CO2 offset credits. Offset credits are available to polluters in addition to CO2 permits. Polluters buy offsets so they can burn even more fossil fuel. Theoretically all the CO2 generated from this additional combustion can be negated (or offset) with offset credits. But in reality offset credits haven’t reduced CO2 emissions as advertised because: 1. offsets have been less efficient at mitigating CO2 than assumed (e.g. most seedlings in a re-forestation project die) and 2. fraud (common). One reason for fraud’s prevalence is because the referees involved in verifying the worthiness of offset mechanisms were/are hired and paid for by the offsetter – a clear conflict of the publics’ interest. (It seems that offsetters are the only parties willing to pay for referees.)

Politically, Republicans have opposed a cap because it adds government bureaucracy, while some Democrats are opposed to carbon trading because poor people pay a disproportionately high percentage of their income for energy and presume that cap and trade will treat them unfairly (unpredictable energy prices). Conversely, a revenue-neutral carbon fee returns money to the people and simultaneously removes any regressiveness inherent in an energy tax.

On balance, a rising, revenue-neutral carbon fee is the least costly and least regressive method to solve the climate crisis.



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