Waxing Waxman

I’m reading up on the Waxman-Markey cap and trade bill this morning, and I have a lot of thoughts about it. For starters, now that I’m finally tuning in, I’m a little shocked at how badly the cupboard has been raided. I know, shame on me, that’s a helluva lot of naïveté for someone who has seen first-hand what big business can do to a legislative process, but I did think Waxman would protect his turf a bit better than it appears he has.

The most important thing about domestic carbon legislation is that we have a price on carbon in the US marketplace; that we make everyone pay for the global warming externality of greenhouse gas emissions. (For those who haven’t thought about it, it’s a simple concept. If the computer on which I type this post is drawing 60 watts of electricity generated by burning coal, it’s contributing a little to global warming. If it’s drawing 60 watts generated by a wind turbine, it isn’t. By charging a price for that pollution, the market can capture the social cost of contributing to global warming, and my decision as a consumer – or, more realistically, NStar’s decision as a producer – will factor that cost in, giving lower-carbon options a competitive advantage over higher-carbon options.)

That’s the fundamental policy tool here, and this bill would get that job done, so I guess I’ll continue to be for it. But if that’s the primary goal, then the secondary goal is to give that price teeth. We can better chase the policy aim by spending some of the revenue from a cap and trade system on things like R&D and new energy infrastructure. We can also use some of the revenue to give rebates to the people who are hit hardest by higher prices as a result of the carbon price.

But to do that there has to be revenue. In principle, the “price the externality” policy tool works just as well whether you make a polluter pay for a permit up front or whether you give it to them and let them trade it. Either way, once they have the permit in hand, there is money to be made from not having to use it. The difference is that if you auction the permits at the start, revenue flows to the government that can be used for other purposes. If you just allocate the permits for free up front, no revenue, no spending on R&D and infrastructure, and no helping poor people with higher electricity bills.

There are two good reasons to allocate permits for free. The first is that some industries would experience too much of a shock from a carbon price, so you have to gradually wean them off their carbon addiction. I’m not sure about the economics, but I think that partial free allocation of permits to the electricity sector, declining over time, makes some sense. Other sectors – like steel, for example, which competes as an internationally traded commodity – have competitiveness concerns. They don’t want to all of a sudden have to compete against other producers with one hand tied behind their balance sheets. One way to deal with that problem is to allocate permits for free. (Another way would be to charge a tariff on imported steel, equal to the effect of the carbon cost. Some say that wouldn’t be legal, but I think it would be.)

The second good reason to allocate permits for free is that it’s a good way to pay a political bribe to the powerful special interests who still run this place.

The question has been how much of a bribe you have to pay to squeeze this thing through the US Congress. I thought the answer was somewhere between 25-50% of permits; 25 to 50% of permits would have to be freely allocated to deal with competitiveness and political issues, before you could cobble together enough support to auction the rest and have the carbon price. President Obama evidently thought so to, since there is a lot of revenue in his budget projections from the sale of permits under a cap and trade system.

In the first year of Waxman-Markey, though, it looks like we’re giving away 85% of the permits for free. It’s a buffet table. Environmental groups are urging Congress to scrap it and start over. I’m not sure. Remember, the primary objective is to get that price in place. But here again, we have a nice little lesson in who controls Washington. There are a lot of captains of industry who are going to have a nice new revenue stream from selling freely allocated emissions permits.

By the way, this post was supposed to be about the smart grid. We’ll get to that, hopefully.