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Obama Could Sell Cap-and-trade Better

This is a tad dated, but I just went back and read over Obama's remarks to the Business Roundtable last Thursday. The portions dealing with climate policy are, if not newsworthy, at least nicely indicative of the administration's thinking on the subject. For starters, Obama isn't swayed by the argument that a recession is a horrible time to cap carbon emissions. As he points out, any cap-and-trade system passed this session wouldn't get chugging along until 2012 at the earliest, at which point we should be out of this economic crisis (if not, we've got even bigger problems). He also makes a nice pitch for long-term planning:

But if we don’t start now, if we wait until — to have the debate in 2012, and then suddenly it turns out that oil is at $150 a barrel again, and we say, oh, why is it that we didn’t start thinking about this and making some steps now to figure this out. Well, that’s what Washington does. You guys could not run your business that way. And so the notion that we are doing some long-term planning now and trying to get this town to think long term, that somehow that’s a distraction just defies every sound management practice that I’ve ever heard of.

That's a fair point—a number of utilities and energy companies have reportedly been skittish about making big investments because they're unsure what carbon regulations are sliding down the chute, exactly. Getting some certainty on that, and soon, would be helpful. Meanwhile, Obama does... only an okay job explaining why the pollution credits in any cap system ought to be auctioned rather than doled out for free:

Now, the experience of a cap and trade system thus far is that if you’re giving away carbon permits for free, then basically you’re not really pricing the thing and it doesn’t work, or people can game the system in so many ways that it’s not creating the incentive structures that we’re looking for. The flip side is, you’re right, if it’s so onerous that people can’t meet it, then it defeats the purpose — and politically we can’t get it done anyway. So we’re going to have to find a structure that arrives at that right balance.

This isn't quite right. Let's try it this way: Under any cap-and-trade regime, Congress sets an economy-wide limit on carbon emissions, and then distributes tradable rights to pollute, either through an auction, or by handing them out to companies for free, or some mix. No matter how you distribute the permits, there are only a scarce number of them, and hence, they have value. That means that you're putting a price on carbon no matter what, and fossil-fuel prices will rise no matter what. (Even utilities that receive free permits will still jack up their electricity prices, to make up for the opportunity cost of not selling their permits. That's what happened in Europe.)

So the price of coal and oil and gas will rise regardless of how you distribute the permits, and carbon emissions should come down either way. But if Congress auctions off the permits, it can use the revenue to, say, rebate money back to Americans. If Congress gives the permits away for free, though, certain companies will reap big windfall profits instead. Now, that might not be bad for a few particularly energy-intensive firms that would be especially crunched by a carbon cap—letting them pad their a bit profits might give them space to adjust. But realistically, there's going to be a lobbyist feeding frenzy to decide who gets how many free permits, so it's a lot more efficient if most or all of the permits are just auctioned off. Also, there are distributional consequences to the two approaches, as this CBO chart (via Dave Roberts) shows:

Click to enlarge if that's too small, but there on the left, you see what happens if the permits are auctioned off and the revenue is divided among Americans equally. The overall impact is actually progressive, and lower-income households come out ahead—the extra amount they pay for dirty energy is more than offset by the rebate. But if the permits are given out to companies for free, it's only wealthier Americans who benefit—they're the ones running the companies making windfall profits, after all—while everyone else gets squeezed. So this is arcane but important! Obama's explanation was decent, and I guess he didn't want to get all class-warfare-y with the Business Roundtable, but he still needs to find a compelling way to make this point.

--Bradford Plumer