The Flawed Logic of the Cap-and-Trade Debate

Two prominent — and iconoclastic — environmentalists argue that current efforts to tax or cap carbon emissions are doomed to failure and that the answer lies not in making dirty energy expensive but in making clean energy cheap.

In early May, anxiety among climate activists about the fate of cap-and-trade legislation erupted into a full-throated roar with the release of a scathing open letter by Dr. James Hansen. In it, the NASA scientist called a bill by Representatives Henry Waxman and Ed Markey a “temple of doom,” savaging it for being complex, corrupt, and “a minor tweak to business-as-usual.” Hansen called for a carbon tax in its place, one that would establish a “substantial and rising price on carbon emissions.”

Hansen was right about Waxman-Markey. It will do little to reduce U.S. emissions, will transfer billions to incumbent energy interests in the form of free pollution permits, and will send billions more to timber, agriculture, and other interests, here and abroad, in the form of dubious “offsets.” But Hansen’s analysis of why climate legislation has gone so terribly off the rails is wrong.

Hansen argues that the problem has to do with the mechanism by which Waxman-Markey would establish a carbon price — a cap-and-trade system. In this, Hansen is joined by many other greens and economists, who argue that cap-and-trade is a cumbersome and economically inefficient means of establishing a carbon price, one that is particularly vulnerable to manipulation by polluters and politicians.

No government in the world has been willing to place a high price on carbon.

On the other side of this debate stand many business interests, some prominent climate scientists, and green groups like the Environmental Defense Fund and the Natural Resources Defense Council. They argue thatcap-and-trade is a superior approach, because it guarantees certainty of actual emissions reductions, and a more pragmatic one, because it does not require politicians to vote for a new tax on pollution. They say taxes are just as prone to manipulation by politicians and polluters and that simple carbon taxes exist only in the ivory tower equations of academic economists, not in the real, rough-and-tumble world of politics and legislating.

The truth is, however, that neither of these approaches will lead to significant reductions in carbon emissions, and for a basic reason: Both Hansen and those he criticizes focus on pollution regulation and pricing to make fossil fuels more expensive, rather than on innovation to make clean energy cheap. This approach ignores the history of technological breakthroughs, which has primarily been driven by public investment. And public investment in clean energy is what is needed today, because no effort to achieve deep reductions in carbon emissions, domestic or international, will succeed as long as low-carbon energy technologies cost vastly more than current fossil fuel-based energy.

The Power of Positive Thinking

For more than a decade, the cap vs. tax debate has taken on a ritual quality, with carbon tax advocates conveniently ignoring the reality that the reason that capping and trading carbon has been so ineffectual has been the unwillingness of politicians to establish a high price on carbon. Similarly, cap-and-trade advocates have ignored the fairly obvious fact that carbon caps are not binding and provide no certainty of reductions if policies substantially limit the maximum amount that emitters will be required to pay to reduce greenhouse gases.

Ironically, both sides share the same pollution paradigm, which views the massive transformation of the global energy economy as fundamentally the same as past pollution battles over acid rain and air pollution. In fact, the debate pits one central objective of that paradigm, the establishment of strict pollution caps, against another, making industries pay to pollute.

But the debate between carbon tax and cap-and-trade proponents is a false one. The problem is that no government in the world so far has been willing to establish and sustain a high price on carbon, whether through taxes or caps. This is due to at least four substantial and interlinked issues: the political power of incumbent energy interests, low consumer tolerance for high energy prices, the economic impacts that substantially raising energy prices will have on key energy-intensive sectors of the economy, and — most importantly — the substantial price gap that continues to exist between fossil fuels and clean-energy alternatives.

Yet so powerful has been the mental model imposed by the pollution paradigm that neither party to the tax vs. cap debate has much acknowledged either the ways in which the climate crisis differs from past environmental problems or the larger socio-political context in which any climate policy must function. Clean energy technologies cost much more than fossil fuels. Binding caps requiring deep and rapid reductions in carbon emissions must allow carbon prices to rise to whatever level they must (read: very high) in order to comply with the cap. As a result, no society has been willing to establish high carbon prices, regardless of the mechanism.

Environmentalists must look to low carbon prices to fund public sector research into clean energy.

The serial failures of the European Emissions Trading System, the recent rollback of emissions reduction commitments in Australia, and the looming passage of the Waxman-Markey legislation in the United States are evidence not that carbon trading is the “temple of doom,” but rather that most political economies are highly resistant to high carbon prices. Yet when confronted with this reality, proponents of traditional cap-and-trade or tax schemes have had three responses. The first has been to produce a blizzard of economic models that downplay the economic impacts of high carbon prices. But even when these models show that long-term benefits outweigh the costs, someone will still have to pay in the short-term, and those interests — whether consumers or industries — are well-represented in the U.S. Congress.

Others, such as Peter Barnes of CapandDividend.Org, have proposed refunding to consumers all revenues generated by auctioning pollution allowances, under the assumption that doing so would blunt consumer opposition to high carbon prices and the energy price increases they bring. But there is no evidence that rebates would have this effect. Moreover, the strategy would do nothing to soften the impacts on regional economies and energy intensive industries.

Another strategy, prominently championed by author Bill McKibben, argues that it will be necessary to build a much more powerful movement to mandate the deeper emissions reductions and higher carbon prices needed to stabilize the climate. But there is strong evidence that as long as such a movement is predicated on deeply cutting carbon emissions, no matter the cost, such a political tipping point is unlikely to arrive — at least not before climate catastrophe is so close at hand that substantial mitigation actions will be largely beside the point.

All three strategies have been offered with the best of intentions, but have allowed greens and others to ignore the ways in which economic and political realities constrain carbon pricing. Greens have sunk enormous political and intellectual capital into an emissions reduction framework that simply can’t succeed — at least as long as the price gap between fossil fuels and clean alternatives remains large and so requires the maintenance of high carbon prices to close. This is what we identified in 2007 as “global warming’s Gordian Knot”: price carbon too high and provoke political backlash that results in the evisceration of emissions caps and other policies to reduce emissions; price it too low, and you don’t have a sufficiently high price to drive the innovation and technology investment necessary to make the transition to clean energy alternatives.

For this reason, we argue that environmentalists must shift from looking to high carbon prices to drive private sector energy innovation to using low carbon prices to fund public sector research, development, and deployment of clean energy technologies.

Far better to set a low carbon price and implement a simple and transparent program.

Rather than focusing on emissions reduction targets and timetables, a new framework will establish price declines in the real, unsubsidized costs of clean energy technologies as the explicit objective of climate and energy policy. Rather than attempting to establish high carbon prices globally in order to create sufficient incentives for private interests to invest in energy technology innovation, this new framework focuses on establishing very modest and politically sustainable carbon prices in developed economies to fund very large public investments in technology innovation and to help bring competitive technologies to market. Rather than viewing private interests and markets as the primary driver of technology innovation, this framework recognizes public investment as the most effective method of driving technology innovation. Rather than insisting that developed economies “go first” by achieving symbolic but largely irrelevant emissions reductions, the new framework sees developed economies as critical laboratories that will finance and invent the low-cost technologies that will make deep global emissions reductions possible.

The serial contortions of cap-and-trade programs around the world result from the political necessity of containing the costs and price impacts while maintaining the fiction that strict pollution caps are being enforced. Offsets promise cheaper reductions somewhere else. The liberal distribution of free pollution allowances to energy interests and industry promises to ameliorate the impacts of high carbon prices. The various schemes to borrow allowances from future compliance periods promise to keep carbon prices from rising too high. When all is said and done, what we get is a program where costs are intentionally opaque, implementation is corrupt, and benefits are few. Little wonder that Rep. Rick Boucher (D-VA), who represents a coal-dependent state, recently told reporters that he expected cap-and-trade legislation to “create the opportunity for increasing coal production.”

Far better to accept that the price for carbon won’t be high and implement a simple and transparent program to establish a stable and low price. Such an approach is compatible with either a carbon tax or cap-and-auction with hard price caps and floors. Because the impacts of the price on end users, consumers, and businesses are small, this approach does not require figuring out how to refund the proceeds to consumers, buy off impacted industries, or flood the market with cheap offsets, which is what Rep. Waxman and Rep. Markey have spent the last month doing. And this approach allows all the revenues generated by the program — $30 billion or more annually, even with a low carbon price — to be dedicated to the development and deployment of clean energy technologies and infrastructure.

This approach will not offer certainty of emissions reductions. But neither will carbon taxes or cap-and-trade, as Europe has proven. What it will do is explicitly direct climate and energy policy toward the single variable that holds the key, both politically and economically, to achieving deep reductions in global carbon emissions: the broad availability of low-cost, low-carbon energy technologies.

The End of the Pollution Paradigm

The Waxman-Markey cap-and-trade legislation represents the final absurd expression of the failed pollution paradigm that has defined climate policy for over a decade. The long obsession with pollution caps, targets, and timetables has produced legislation that, in the name of reducing greenhouse gas emissions by 20 percent by 2020, will allow regulated industries to emit as much as a third more carbon in 2012 than they did in 2005 and close to 10 percent more in 2020.

This program will have little, if any, impact on U.S. emissions. But it will allow President Obama to arrive in Copenhagen next fall touting a mandatory U.S. program to cap and reduce its carbon emissions, thereby returning the U.S. to the community of good global citizens that have made such commitments without discernibly altering the actual trajectory of their growing emissions. What all share with the United States is an unwillingness to establish carbon prices high enough to drive significant emissions reductions.

Meanwhile, soaring rhetoric from greens and Democrats about the importance of bold public investments to build a clean energy economy has proven empty. The Waxman-Markey bill would, under the rosiest of scenarios, invest just $9 billion annually in technology innovation, defined broadly, compared to a whopping $41 billion to buy off utilities and heavy industries and $19 billion for offsets. If the price of carbon dioxide is $5 to $10 per ton — a level Waxman-Markey supporters like the Center for American Progress’s Joe Romm acknowledge it could be in the early years of the program — there would initially be just $3 billion to $6 billion for energy technology and just $250 million to $500 million for R&D. Those levels are only a five to ten percent increase over current energy R&D spending, and one-thirtieth or one-sixtieth of the $15 billion annually in new clean energy R&D investment President Obama has consistently promised. In the end, greens supporting this bill have chosen weak caps, riddled with loopholes and giveaways, over serious investment in clean energy technologies.

For the rest of us, including the many greens who now see the writing on the wall in Congress, the time has come to question whether the long effort to establish high carbon prices and strict carbon caps has finally run its course. It is time that we get serious about how to achieve deep reductions in emissions with the low carbon price we will get rather than the high carbon price we may wish for.

This may not be the choice that many greens would like, but the alternative is another decade of attempting to implement policy predicated on high carbon prices without the necessary price signal for those policies to have any chance of succeeding. If this choice were not clear already, the impending cap-and-trade legislation likely to pass the U.S. House this summer should leave no further doubt.

Correction, May 21, 2009: An earlier version of this article incorrectly stated the position of Joe Romm, of the Center for American Progress, on the expected auction price of carbon dioxide under a proposed cap-and-trade system. Romm has written that the price of one ton of carbon dioxide will initially be low — roughly $5 to $10 — before rising to no more than $15 a ton in 2020.