Senators and witnesses debated the potential economic impacts of adopting a cap-and-trade program in the United States.  Billed as the “Tax Aspects of a Cap-and-Trade System,” today’s hearing before the Senate Finance Committee ended up being a discussion of the broad impacts that a cap-and-trade program would have on the US economy and on consumers.

A summary of the testimony follows:

Peter Orszag, Director of the Congressional Budget Office — A cap and trade program increases the price of carbon intensive goods and services, encouraging a demand shift in production to less carbon intensive methods. The size of the price increase depends on the stringency of the cap. Under Lieberman Warner, the Congressional Budget Office (CBO) estimates that the auction price for an allowance in 2018 would be about $35 per ton of carbon dioxide (in 2006 dollars). At the beginning of the program, in 2012, the total allowance pool would be worth $145 billion, which would rise as the cap becomes more stringent.

There is a debate going on now about whether to give away the allowances, auction them off, or some combination. Orszag testified that the distributional consequences - what effect is felt by households - does not depend on how the allowances are allocated. In other words, giving away allowances to regulated industries does not save consumers money. His analysis looked at three options: 1) auctioning allowances and giving lump sum payments to consumers, 2) auctioning allowances and reducing corporate taxes, and 3) giving away the allowances. The first option is the best for low income households, while the second provides the smallest reduction in GDP. By giving away the allowances, you end up with the regressivity of the second option and the macroeconomic costs of the first - the worst of all possible worlds.

Robert Greenstein, Executive Director, Center on Budget and Policy Priorities — A requirement to reduce emissions by 15% in 2020 (from business as usual) would cost families in the lowest income quintile about $750-$950 per year. If all of the allowances were auctioned, 14% of the revenue would fund a climate relief program mitigating all of the expenses for the bottom quintile and a portion of the expenses for the second quintile.

The best way to address these costs is through existing programs, like the Earned Income Tax Credit and electronic benefit transfer systems (e.g., food stamps delivered by debit card). This would allow the money to reach low income households without any additional bureaucracy. Income tax relief, on the other hand, would not help many low-income Americans, because they don’t pay income taxes.

Finally, Greenstein noted that a cap-and-trade program would allow the government to re-assess its current tax incentive policies. By creating a price for carbon, the economic incentives will shift, making some technologies feasible without requiring the additional support they receive today. When that occurs, the government could reallocate the incentive funding to new technologies or to other cost-mitigation strategies.

Henry Derwent, President of the International Emissions Trading Association — The EU experience shows that cap-and-trade programs are not necessarily detrimental to domestic competitiveness. Though there are complications with certain energy-intensive industries, the net effect is “considered neutral at worst” due to energy efficiency gains that create financial savings. The best approach is to offer targets for energy efficiency gains that corporations can strive for, with rebates or other incentives offered to those who meet the targets.

From the question and answer session:

Senators Salazar and Bunning offered up ideas for a “Manhattan Project” like effort to solve the problems of climate change, using revenue from allowance auctions or other parts of the budget to fund a massive effort to develop new technologies like carbon capture and storage and clean coal.

Senator Rockefeller spoke about taking the three or four biggest issues of our time, including climate change, and exempting them from the Senate’s pay-as-you-go principle, to provide massive subsidies for developing the most critical solutions. He believed that carbon capture and storage could be developed within 5 years if a team of the world’s best scientists were gathered to solve the problem.

Senator Kerry expressed a preference for the highest possible percentage of allowances being auctioned, but acknowledged the political reality that giving some away may be required in order to win passage for the bill. He also brought up the markets developed by the Clean Air Act’s sulfur dioxide program, and argued that there are parallels between that and carbon markets, despite the difference in size, to show that the adoption costs and economic losses are often over-stated in the original projections.

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