McDermott's Climate Plan
Update, April 30, 2009: Please also see two follow up posts:
- The Managed-Price Approach to Cap and Trade
- Is Managed-Price Cap and Trade Different From A Carbon Tax?
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Washington's Congressman Jim McDermott just released a new climate plan, but I can't quite wrap my head around it. It gets some things right, but it may cause some relatively serious problems too.
Here’s how he described it in a recent blog post:
In brief, here’s how it would work: Producers of products and resources that emit greenhouse gases would be required to purchase a Federal Emission Permit. We establish a cap through permits that would be available in an increasingly limited supply. The price for a permit would be established by the Secretary of the Treasury and periodically calibrated to ensure that demand for the permits does not exceed an annual, national allocation.
I understand how Treasury could specify a set price for carbon permits: that’s a lot like a carbon tax. And I understand how it can specify a quantity of carbon permits: that’s essentially a carbon cap. But I’m mystified: how can Treasury specify both a supply of carbon permits and a price for each permit? In practice, that’s neither tax nor cap -- it’s more like a federal carbon ration, which carries some serious risks for consumers and for carbon policy more generally.
How is this supposed to work?
Let’s say that Treasury announces that it will sell a fixed quantity of permits at a fixed price.
If the Treasury sets the price too low, demand for permits will exceed supply. In other words, firms will want to purchase more permits than the Treasury is selling. In that case, the government will have two options: A) sell more permits than the cap allows; or B) pick and choose which firms get permits, and how many. Neither option is good.
Option A erodes the environmental integrity of the program. Option B has a tangle of problems connected to it, including the following. The firms that get picked will get cheap permits while their competitors may get nothing. The end result -- skipping over the economics of permit allocation -- is that lucky firms will reap windfall profits from consumers in the amount of the difference between the government-set price and the “real” price that would have been set by supply and demand in an open auction. In fact, such a scheme could worsen economic inequities. (Go here for more on how windfall profits happen.)
If the Treasury sets the price too high, the supply of permits will exceed demand. In other words, the government will be selling more permits, at higher prices, than folks want to purchase. That's basically just an aggressive carbon tax -- one that reduces emissions faster than the cap alone would mandate. From environmental perspective that’s okay, but it begs the question: why all the funny business with permits? Why not just set an aggressive carbon tax instead?
And if the Treasury sets the price just right? Well, I'm not so sure that will ever happen. There's really no reason to think that the Treasury can accurately forecast carbon demand and then correctly pick a price to match supply. The government has been rather bad at forecasting energy prices and demand. Even the polluting firms themselves can't do it accurately for their own industries. It seems a bit like asking Tim Geithner to forecast the price of your house in 2010.
Let's dig a bit deeper into the weeds.
