Here's something I never would have predicted: When the House Energy and Commerce Committee held a hearing this morning on permit allocations, of all topics, the room was totally packed—hardly an empty seat to be found. It's not that a herd of people accidentally stumbled into the wrong room. ("Uh, sorry, we thought this was the hearing on regulating derivatives...") No, as dreary as it may sound, the question of how pollution permits are divvied up under a cap-and-trade regime has become of the hottest environmental issues of the day.
A quick refresh: Under a cap-and-trade system, the government sets an economy-wide cap on carbon-dioxide emissions by issuing a fixed number of permits for polluting carbon each year. (A stricter cap equals fewer total permits.) Those permits can than be traded, which lets the market settle on a price for emitting carbon. Polluters figure out whether it's cheaper to cut emissions or buy permits—allowing those companies that can make reductions cheaply to act first.
Once the government sets that overall cap, the big question is how to distribute the permits. The government could just auction off all the allowances, raising funds to spend as it sees fit. Or, Congress could hand the permits out to select polluters for free. Either way, because there's a firm overall cap on carbon emissions, pollution will go down. (And, as Peter Orszag has pointed out, overall fossil-fuel prices will rise by the exact same amount no matter how you distribute the permits—the main difference is who bears those costs.) So this question make no difference environmentally.
Still, many green groups have embraced a full auction, since it would let the government raise money that could be spent on tax cuts for consumers and investments in clean-energy and efficiency. A full auction would basically resemble a straight-up carbon tax. On the other hand, green groups have argued that doling out permits for free would amount to a grubby giveaway for companies, who would raise prices anyway and reap windfall profits in the process. (This is essentially what happened in the early mishap-filled stages of Europe's cap-and-trade program.)
Now, the House climate bill has been disparaged by environmentalists for giving away about 85 percent of the permits under its cap-and-trade system for free, rather than auctioning them off. But, as Henry Waxman pointed out at the hearing today—and as Harvard economist Robert Stavins has written—this auction vs. giveaway debate is somewhat misleading. Stavins found that, when you look at where the permits actually go, about 83 percent of them are used for public purposes, and only 17 percent are straight handouts to favored companies. Here are the share of permits issued between 2012 and 2050 that go to the public in one form or another:
Direct consumer rebates, 23.5%
Electricity and natural gas local distribution companies, 22.2%
Home heating oil/propane, 0.9%
Protection for low- and moderate-income households, 15.0%
Worker assistance and job training, 0.8%
States for renewable energy, efficiency, and building codes, 5.8%
Clean energy innovation centers, 1.0%
International deforestation, clean technology, and adaptation, 8.7%
Domestic adaptation, 5.0%
Note that a hefty fraction of permits go to local electricity distributors. These utilities are regulated and, in order to receive free permits, must agree to pass on the savings to ratepayers. Ensuring that they actually do this will require a wary eye, since some state regulators have a reputation for going soft on distributors. But in theory, this will help ameliorate electricity price hikes and avoid the windfall-profit problem that plagued Europe. (This is partly why the EPA's economic forecast expects the carbon cap to cost the average household just $98 to $140 per year through 2020—and that doesn't consider the bill's efficiency provisions, which could lower overall electricity bills further, even if rates rise.)
Why do it this way? Regional politics, basically. At a press conference last week, House energy staffers were asked why they took this approach instead of opting for direct assistance to consumers. The staffers argued that, if the government just auctioned off those permits and gave all Americans a straight tax cut, then ratepayers in coal-heavy states would get hit harder than ratepayers in a state with, say, more hydropower, like Washington. (They'd each get the same tax cut, but the coal-dependent consumers would see a bigger rate increase.) Under the House approach, by contrast, local distribution companies that generate more dirty power—and hence can expect bigger rate increases—get a greater number of free allowances to pass onto consumers.
This raises a follow-up question: If ratepayers are getting all this assistance to help with rate increases, doesn't that mute any incentives people might have to conserve energy? At the press conference last week, Nat Keohane, an economist with the Environmental Defense Fund, argued that utility rebates will not be tied to the amount of electricity a person actually uses. So, if my neighbor and I have the same utility, and I use less power than he does, we'll still get the exact same climate rebates on our electricity bill—giving everyone more incentive to conserve.
Now, that doesn't mean there are no controversies with the way permits are allocated. As mentioned, about 17 percent of permits are given freely to private companies (though these will be phased out over time). Here's how those allowances are split up between 2012 and 2050:
Merchant coal generators, 3.0%
Energy-intensive, trade-exposed industries, 8.0%
Carbon-capture and storage incentives, 4.1%
Clean vehicle technology standards, 1.0%
Oil refiners, 1.0%
Notice that electric utilities and coal companies get a greater share of permits than oil refiners. That means, as Geoff Styles argues at Energy Outlook, this climate bill could affect gas and diesel prices disproportionately more than electricity prices. My guess is this happened because the coal industry has plenty of Democratic champions on the energy committee, such as Virginia's Rick Boucher, who labored to make the bill more coal-friendly (look at all that money for carbon-capture research). Many of the oil industry's defenders, meanwhile, are Republicans, who didn't bother to help shape the bill.
This tension arose in the hearing today. Thomas Farrell of Dominion Power, a Virginia electric utility, told lawmakers that his trade group, the Edison Electric Institute, approved of the bill. But Steve Cousins of Alliant Oil, a small refinery in Arkansas, warned that he could be swept right out of business—in part because he saw no way to reduce his emissions with existing technology, and would have to spend money buying permits. Likewise, Tommy Hodges, speaking on behalf of the American Trucking Association, warned that the bill could raise gas prices by 70 cents per gallon and diesel prices 80 cents per gallon, kneecapping the trucking industry.
I'm not sure there's an easy lesson here, other than to note that the auction vs. giveaway debate can obscure some key subtleties, and that a bill this sprawling is bound to create winners and losers—which is why the precise allocation formula will continue to attract swarms of lobbyists. (And yes, one of the downsides of giving away permits instead of auctioning them off is that influential lawmakers will jockey for a larger chunk of free permits for their favorite industries. Read this Washington Post story for a few telling anecdotes in the House.)