8 8 Our planet’s atmosphere is a sacred public trust that belongs to all of
us, and the right to pollute it should not be given away for free.
Many of the ideas discussed so far in theoretical terms collided with reality in 2009, when Congress attempted to limit carbon pollution in the United States. Like two previous attempts, this one failed. At the same time, though less noticed, Congress also missed an opportunity to create a fund that pays dividends to all Americans. The revenue for this fund would have come from selling rights to dump carbon dioxide into our co-owned air.
The story of these failures is both political and intellectual. In this chapter, I trace the transformation of a good idea—a market-based limit on carbon pollution—into a compromised and beaten one. This transformation was driven by the familiar Washington process of rent seeking, and its story yields a number of lessons.
THE IDEA OF CAPPING FLOWS of harmful substances, and then letting markets allocate them, goes back to 1968, when a Canadian economist, the late John Dales, floated the idea in a book called Pollution, Property & Prices1 At the time, Dales wasn’t thinking about climate change; he was thinking about farmers who polluted streams with chemical runoffs. Some farmers could reduce their pollution more efficiently than others. If a declining quantity of pollution rights were issued and farmers could trade them, Dales argued, farmers themselves would find the cheapest ways to cut their pollution.
Economists, if not farmers, picked up the idea and started applying it, conceptually, to other forms of pollution. In doing this, they were influenced not just by Dales but also by Nobel Prize—winning economist Ronald Coase, who in an oft-quoted paper, “The Problem of Social Cost,” argued that property rights could solve the problem of externalities without government regulation.2 (Coase was part of the University of Chicago school of thought, which holds that markets do almost everything better than government.)
In 1990, the idea made its way into national legislation. That year’s amendments to the Clean Air Act created a cap-and-trade system to reduce sulfur dioxide emissions from coal-burning power plants, a major cause of acid rain. The total yearly volume of emissions was mandated to decline 50 percent over twenty years. Underneath the descending cap, existing power plants were given future sulfur-emission permits in proportion to their past pollution. And they were allowed to trade those permits among themselves. Plants that could cheaply reduce their emissions did so and sold their unused permits to those that couldn’t. This market-based system was supported by both Republicans and Democrats and backed by President George H. W. Bush. Utilities accepted it because they could profit by selling unused permits. Plus, in their minds, if pollution did have to be reduced, a market-based system was preferable to a regulatory one.
The sulfur cap-and-trade program was successful; emissions were reduced faster and at lower cost than expected.3 So, as concern about climate change mounted in the 1990s, environmentalists, economists, and some polluting corporations began to see cap and trade as a market-friendly way to decrease carbon emissions.
The Clinton administration injected the idea into the 1997 Kyoto Protocol, which, though never ratified by the United States, led to the European carbon trading system. Domestically, the Environmental Defense Fund and the Natural Resources Defense Council formed an alliance with utility companies—the US Climate Action Partnership, or USCAP—to push a cap-and-trade bill through Congress. They recruited Senators Joe Lieberman, a Democrat from Connecticut, and John McCain, a Republican from Arizona, to cosponsor the legislation. Wall Street spotted a potentially lucrative market for trading carbon-based securities and joined in. Former Vice President Al Gore raised and spent millions of dollars on television ads designed to win the public’s support. For a brief, shining moment, it seemed as if cap and trade was ready for prime time.
But as all this was happening—indeed, precisely because it was happening—the architecture of cap and trade began to morph. The original sulfur model had been simple. Only a few hundred power plants were covered. They all had big, easy-to-monitor smokestacks and were owned by electric utilities whose prices were regulated. Though trading of permits was allowed, it was limited. And though utilities benefited from the system, their gains were in the millions, not billions, of dollars.
Compared with carbon, however, sulfur is a minor pollutant. Carbon is the lifeblood of our economy and a source of billions of dollars in yearly profits for many corporations. Moreover, it flows into our atmosphere not just through a few giant smokestacks but also through countless flues and tailpipes. By acquiring rights to burn carbon in the future, favored companies would collectively gain hundreds of billions of dollars. On top of this, a global market in carbon-based securities would generate substantial profits for traders. Neither of these windfalls, however, is necessary for carbon capping. They occur only if the system creates them.
AT THIS POINT, IT’S USEFUL TO UNDERSTAND some details of capping systems. For a ubiquitous substance like carbon, there are four key design questions: (1) Where should the valves (which administer the caps) be located? (2) Should permits be given away or sold? (3) If they’re sold, to whom should the proceeds go? (4) Should there be privately created “offsets” that can substitute for government- or trust-issued permits?
When there are only a few hundred polluters, each of which can be easily monitored, the logical place to put valves is on each polluter’s smokestack. This was the case with sulfur. However, when there are hundreds of millions of polluters, many of them small and mobile, end-of-pipe valves can’t catch everything.
Fortunately, there’s an alternative: put the valves where the polluting substance enters our economy rather than leaves it. Think of a drip-irrigation system. Typically there’s a main water supply with a valve. Then there’s an array of thin tubes that emit drops of water next to each plant. If you want to decrease the flow of water, you can put tiny valves in every hole or crank down the big valve at the top. Clearly, it’s easier and more effective to turn down the big valve at the top.
The same is true for carbon. If carbon doesn’t enter our economy, it can’t go out. So putting a few valves upstream makes a lot more sense than putting millions of them downstream.
Actually, an upstream cap doesn’t even require physical valves. All it needs is a reporting system applied to the relatively small number of large companies (ExxonMobil, Peabody Energy, El Paso Natural Gas, et al.) that bring fossil fuels into our economy. These first sellers already track the quantities of fuel they sell—how else could they be paid?—and the fuels’ carbon content can be calculated from their sales numbers. The companies would then buy, in competitive auctions, one permit for each ton of carbon embedded in the fuels they sell. Once a year they’d “true up” with a supervising entity, much as they do when they pay taxes. If they lacked permits for carbon they sold, they’d pay stiff penalties. All this is pretty easy to do. No physical valves or monitored smokestacks are needed.
Permits to introduce carbon into our economy or atmosphere currently don’t exist; they must be created for a carbon cap to work. But these permits are valuable, and the scarcer they get, the more valuable they become. If companies got them for free, they’d reap huge unearned gains. As President Obama’s first budget director, Peter Orszag, put it, “If we don’t auction the permits, it would represent the largest corporate welfare program that has ever been enacted in the history of the United States.”4
Selling carbon permits through competitive bidding is analogous to auctioning drilling rights on public lands. It should be a no-brainer, but there’s a political disadvantage: if permits are sold, they can’t be used as political bargaining chips. Hence the congressional bias to hand out permits in exchange for support from powerful industries.
Assuming that some or all carbon permits are sold competitively, the follow-on question is how to distribute the proceeds. Here two considerations should be borne in mind. One is that the money arises from a gift we all share: our air. The second is that reducing the supply of carbon permits would raise their price, and hence the prices we pay for fossil fuels. Though wealthy households wouldn’t feel much pain, low- and middle-income households would. Their purchasing power would decline, and along with it the driving force of our economy. It thus makes sense to return permit revenue to all of us equally.
In the sulfur cap-and-trade program, the only things that can be traded are sulfur permits issued by the government. That means total pollution can’t exceed the number of permits. An equally airtight system would make sense for carbon. But airtightness isn’t always sought in Washington; in fact, our lawmakers frequently prefer loopholes. Hence the rise of carbon “offsets.”
Sometimes offsets and permits are lumped together, but they’re not the same. Offsets aren’t issued by government, and they’re not permits to pollute. Rather, they are privately created claims that a quantified reduction of greenhouse gases has been or will be achieved. And, as with all financial derivatives, there are many varieties of them.
The most familiar are the ones you can buy when you take an airplane trip. If you pay a little extra, you can theoretically offset your share of the flight’s carbon emissions. This can occur, say, if your extra payment is used to plant trees. Such voluntary acts of guilt assuagement are unrelated to carbon capping. They may or may not do any good, but at least they do no physical harm.5 The only risk they carry is that you’ll waste your money.
A much greater danger lies with offsets that are included in cap-and-trade programs. Using such offsets, polluters—while continuing to pollute—can claim that the offsets they’ve purchased result in the same reductions as would have occurred if they’d cut their own pollution. The flavor of this game is aptly captured by a British website called CheatNeutral.com. “Are you a cheater?” the site asks. “We can help you offset your indiscretions by funding someone else to be faithful.” The site calls this “cheat offsetting” and brokers deals between loyal and disloyal couples.
If you think this is mere satire, consider what actually happened under the European carbon trading system, launched in 2005 in accordance with the Kyoto Protocol. The European program allows offsets purchased internationally to be substituted for permits issued by the European Union. Over 80 percent of the offsets purchased have involved the destruction of a refrigerant byproduct, HFC-23, that’s a potent greenhouse gas. Thanks to offsets, this by-product can be worth five times as much as the refrigerant itself. Many Chinese and Indian firms—plus the brokers who bring their deals to Europe—have gotten rich by making HFC-23 for the sake of destroying it. Meanwhile, European companies that buy the offsets continue to pollute. According to the EU’s Commissioner for Climate Action, Connie Hedegaard, the offsets suffer from “a total lack of environmental integrity.”6
Of course, not all offsets are so questionable, but if the demand for offsets were to rise substantially—if, say, the United States were to accept them under a cap-and-trade regime—you can be sure that the supply of dubious ones would rise as well.7
BY NOW IT SHOULD BE CLEAR that not all carbon-capping systems are equal—their structure affects the flow of billions of tons of carbon and potentially trillions of dollars. The starkest contrast is between a downstream system that gives away permits and allows offsets, and an upstream system that auctions all permits, allows no offsets, and returns the revenue to everyone equally. For the sake of discussion, let’s call the former cap and giveaway and the latter cap and dividend. (Full disclosure: I advised members of Congress on the design of a cap-and-dividend system.)
The premise of cap and dividend is that the atmosphere belongs to everyone equally. Its central formula—from all according to their use of the atmosphere, to all in equal share—rests on that premise. But cap and dividend has other virtues: its cap doesn’t leak, and it’s good for the middle class.
Cap and dividend can be thought of as a rent-recycling system: it makes everyone pay to use our atmosphere but arranges things so that we pay ourselves as co-owners. As a result, when carbon—or, more precisely, air—prices rise, so (automatically) does the money everyone gets back. How people fare as individuals then depends on their own behavior. The more carbon they burn, directly or through the products they buy, the more they pay. But since everyone gets the same amount back, people gain if they conserve and lose if they guzzle. This creates precisely the right individual incentives. It also favors the poor, who of necessity burn the least carbon.
This rent-recycling system has political as well as economic advantages. It’s no secret that Americans hate high fuel prices. But when higher fuel prices also bring higher dividends, there’ll be a large constituency—indeed, a majority of the population—that benefits from the trade-off. As figure 8.1 shows, dividends benefit the poor and middle class, while giveaways benefit only the rich. This occurs because the rich spend more (per capita) on fossil fuels than the rest of us and own most of the stock in the corporations that would get free permits.
Figure 8.1: DISTRIBUTIONAL EFFECTS OF CARBON-CAPPING SYSTEMS8
One further virtue of cap and dividend is its transpartisan appeal. Liberals can like it because it stabilizes the climate while benefitting the poor and the middle class. Conservatives can like it because it doesn’t expand government, regulate businesses, or pick winners and losers. It simply modifies the rules by which the market operates.
THINK BACK NOW TO 2008. Barack Obama campaigns for president saying, “Generations from now, we will be able to look back and tell our children that … this was the moment when the rise of the oceans began to slow and our planet began to heal.”9 Specifically, he proposes to install a descending cap on carbon that will cut US emissions 80 percent by 2050. He also pledges to auction all permits and return 80 percent of the proceeds to the people, spending the rest on clean energy and jobs. Though the details are fuzzy, his proposal sounds a lot like cap and dividend.
Then, in 2009, with Obama in the White House and Democrats in control of both houses of Congress, the legislative process begins. Representative Henry Waxman of California joins with then-Representative Ed Markey of Massachusetts (now a senator) to draft a climate bill and get it passed. Both congressmen are longtime environmentalists. In 2008, Markey introduced a carbon-capping bill that would have auctioned 94 percent of permits and returned half the revenue to low- and moderate-income families. “The atmosphere is a sacred public trust that belongs to all of us,” he declared at the time.10 Its use shouldn’t “enrich corporate polluters at consumers’ expense.”
A year later, as lobbyists engulf Capitol Hill, Waxman and Markey decide to align with the USCAP. The architecture of their bill won’t be as Obama proposes, with 100 percent auctions and rebates to the middle class. Instead, permits will be given free to utilities and manufacturers, and polluters will be allowed to continue polluting by buying offsets. Waxman and Markey believe this is the best way to win votes, and Markey’s press secretary asks me to remove his earlier statement from my website.
Representative Chris Van Hollen of Maryland sees things differently. He heads the Democratic Congressional Campaign Committee, responsible for getting Democrats elected. He introduces a twenty-five-page cap-and-dividend bill that would auction all permits and return the revenue as equal dividends to every American with a Social Security number. For a majority of Americans, the dividends would exceed their higher energy costs, thus putting money in middle-class pockets. Van Hollen believes this will boost Democrats in swing districts.
Van Hollen’s bill languishes in the House Ways and Means Committee while the Waxman-Markey bill passes the Energy and Commerce Committee, which Waxman chairs. Waxman makes deals with coal- and farm-state congressmen, and on June 29, 2009, Speaker Nancy Pelosi rushes his bill to the floor. By now the legislation is over fourteen hundred pages long, and only a few insiders understand it. No matter. After heated debate and behind-the-scenes deals, it squeaks through the House by seven votes.
What passes is later summarized by Representative Rick Boucher, a Democrat from Virginia’s coal country, this way:
I spent two months in intense negotiations to make [the bill] acceptable for coal-fired utilities. I was able to achieve that by providing free allowances [permits], as opposed to having the allowances auctioned, and by providing two billion tons of offsets on an annual basis throughout the life of the program—so coal-fired utilities could simply pay others to reduce emissions, by planting trees, for example, and take full credit for those emission reductions.11
After Waxman’s victory in the House, the action shifts to the Senate. Again there are two bills: a USCAP measure cosponsored by Senators John Kerry and Joseph Lieberman, and a cap-and-dividend bill cosponsored by Senators Maria Cantwell and Susan Collins, the lone Republican to support carbon capping in any form. As in the House, the polluter-friendly bill gets most of the attention. But it fails to win the backing of enough Democrats or a single Republican, and it is withdrawn before coming to a vote. As it goes down, so does all climate legislation, including cap and dividend.
WHAT WENT WRONG? The postmortems offer several explanations: Obama’s lackluster leadership, the economic downturn, the Tea Party rebellion. No doubt all were factors. But the deeper problem is that inside-the-Beltway deal-making isn’t enough to pass laws that fundamentally change the US economy. Massive public pressure is needed, and that can’t happen when the legislation rewards corporations at the expense of the middle class. As Bill McKibben, the author and climate activist, put it, “We need a movement, and we need something a movement can get behind.”12
In a recent study, Harvard political scientist Theda Skocpol echoed this analysis.13 She compared what happened to carbon capping with what happened to health care reform during the same period. Both issues were contested bitterly, both pitted reformers against powerful industries, and both were cliff-hangers until their end. But health reform passed and carbon capping didn’t, and Skocpol attributes the contrary outcomes to different depths and intensities of public support.
In the climate battle, the big environmental groups, though well funded, didn’t match the grassroots intensity of their opponents. The anticapping campaign, though funded by fossil fuel companies, was fanned by the fact that in the absence of dividends, cap and trade would impose a financial burden on the middle class. It was a “light switch tax,” its critics rightly charged, and Tea Party activists angrily attacked it. The resulting furor was a major reason why no Republican senator dared to vote for cap and trade.
On the procapping side, there was no equivalent grassroots upsurge. The big environmental groups had their online petitions and sign-on letters, but these were mostly inch-deep. Neither anger nor fervor was there.
In the health-care battle, no Republican senator voted for reform, either, but on this issue the Democrats held solid. The bill they passed, while not without giveaways, made some form of health insurance available to nearly everyone, regardless of income, employment, or previous health condition. This had been a longtime demand of a well-organized and passionate coalition that included labor, civil rights groups, and churches, and they got most of what they fought for. “Policies ordinary Americans can understand,” Skocpol concludes, “policies that deliver concrete benefits to ordinary families, plus the construction of far-reaching networks of allied organizations able to push Congress—these are what it will take to pass carbon-capping legislation next time.”
Beyond these political lessons, we can draw some important pointers about system design.
Get the architecture right. Since we’ll get, at most, only one timely shot at installing a national carbon cap, we’d better do it right the first time. Carbon trading with free downstream permits and huge quantities of offsets isn’t that. At best it replaces one market malfunction—a zero price for polluting—with two others—a porous cap and heightened inequality. What it doesn’t do is assure that we’ll meet any science-based carbon target on time: the caps are too leaky and public support for them will fade once fuel prices rise noticeably. By contrast, if we cap carbon with auctioned upstream permits and dividends, and without offsets, we’ll have a leakproof system popular enough to last.
Keep it simple. Simplicity (as in the thirty-five-page Social Security Act) now seems passé in Washington; thousand page bills are the norm. That’s not because the world is more complex; it’s because lobbyists drive legislative language. So beware of any carbon-capping bill that’s longer than fifty pages—or can’t be explained in a few sentences.
Benefit the many rather than the few. Because fossil fuels are ubiquitous in our economy, any system that raises their prices will necessarily affect everyone’s pocket-books. The danger is that, because a small percentage of Americans owns most of America’s corporate stock, they’ll gain from higher carbon prices at everyone else’s expense. Any carbon-capping system should therefore be designed to benefit the many who share the atmosphere rather than the few who own polluting companies. The best way to do that is with universal dividends that rise automatically as permit prices do.
Speaking more broadly, linking nature’s well-being to that of our middle class is the key to harmonizing capitalism with nature. If that connection isn’t made, nature’s rent can’t rise very much, and markets will continue to overuse her.
THE DEFEAT OF CARBON CAPPING IN 2010 has rekindled interest in carbon taxing. As noted earlier, the idea of taxing pollution—or any activity that externalizes costs to society—was first proposed nearly a century ago by British economist Arthur Pigou. It’s akin to taxing alcohol and tobacco with the goal not of eliminating them—prohibition is the way to do that—but of discouraging them, while at the same time raising revenue for government.
Though the idea of taxing carbon has been around a long time, it hasn’t gotten far in practice. A modest carbon tax has been enacted in a few countries (Sweden, Norway, Australia) and one Canadian province (British Columbia), with modest results. The furthest the idea has gone in the United States was in 1993, when President Bill Clinton tried to win approval of a small tax on fuel energy content. A bill passed the House but was crushed in the Senate by the oil and coal industries. Since then, the idea has languished in political limbo.
Revived interest in taxing carbon is partly due to the determination of Republicans to cut personal and corporate income taxes. Of all potential revenue sources, a carbon tax strikes many conservatives as among the least objectionable. This leads some pundits to believe that a “grand bargain” is possible around a carbon tax, with liberals backing it for environmental reasons and conservatives accepting it if it allows other taxes to be cut.
Like an upstream cap with all permits auctioned, a carbon tax would be collected from the first sellers of carbon-based fuels and would be simple to administer. Consumers would pay it indirectly because the price of goods they buy would rise in proportion to the amount of carbon used to produce them.
In any plan to tax carbon, the tricky question is what to do with the revenue. One possibility—the conservative favorite—is to cut corporate and personal income taxes. Some liberals support a tax shift but would prefer to cut payroll rather than income taxes.14 Another possibility is to earmark carbon revenue for specific purposes such as investments in clean energy.
Of all the possible ways to structure a carbon tax, the most beneficial to the middle class is what climatologist James Hansen, its leading proponent, calls “fee and dividend.” A fee in this case is a tax with a friendlier name. A dividend in this instance is the same as it is under cap and dividend—an equal payment to everyone. “The only way the public will allow a continually rising carbon price is if the money goes directly back to them, so they can deal with the higher prices,” Hansen says.15
While I wholeheartedly support the dividend side of fee and dividend, I’m unconvinced that, from nature’s point of view, a fee is better than a leak-proof upstream cap. A strict quantitative limit on the amount of carbon entering our economy, with all permits auctioned and no offsets allowed (as in the Van Hollen and Cantwell bills), is by far the best way to cut carbon emissions deeply. In rejecting this mechanism, Hansen and others are reacting to cap and trade’s manifold flaws by throwing out the healthy baby with the dirty bathwater.
The fundamental problem with a carbon tax or fee, even if accompanied by dividends, is that it can’t guarantee that deep cuts in carbon use will occur. A fee is, after all, merely a signal, not a physical limit, and for highly addictive substances like alcohol, tobacco, and fossil fuels, signals aren’t enough. Moreover, a carbon tax is only one factor in the price of fossil fuels; it can easily be lost in the fluctuations of other factors. Think of the recent plunge in natural gas prices due to hydraulic fracturing. And imagine what might happen if similar breakthroughs in oil recovery or discovery occur.
Further, even if a carbon tax pushes the total price of fossil fuels upward, no one knows how high the tax needs to be to reduce emissions to a safe level. That means the only way to proceed is by trial and error. Congress would have to take a first stab, and if that didn’t do the job, as is likely, it would have to take another. This might need to happen several times. Given Congress’s present inability to do anything sensible on taxes or climate change, it seems unwise to bet the planet on Congress’s being sensible on both issues multiple times.
There’s one other problem with relying on price alone to reduce total carbon use. The oil-price shock of 1973 prodded America to improve energy efficiency but not to reduce energy consumption. This was a demonstration of the so-called Jevons Paradox, first noticed by British economist William Stanley Jevons in 1865. Jevons observed that improvements in the efficiency of coal use led to greater consumption of coal in a wide range of industries, an increase that more than offset the savings from efficiency. In the twenty-first century, it’s quite possible that more people using fossil fuels more efficiently for more purposes (such as the Internet) could still increase total use, or at least dampen the rate at which usage declines. The only way to assure a large decline in aggregate carbon use is to physically crank down the amount that flows through our economy.16
Beyond these technical arguments, there’s a deeper case for cap and dividend that has to do with the broader changes we need to make in our economic system. To make capitalism tilt toward nature and the middle class, we need new pipes with new forms of property income flowing through them. Cap and dividend would create such pipes and show they can work. A carbon tax wouldn’t.
WHILE CAP AND TRADE WAS FLOUNDERING in Washington, it was quietly making headway in California, America’s most populous state. Arnold Schwarzenegger, the Republican governor, worked closely with a Democratic legislature to pass a bill in 2006 known as the Global Warming Solutions Act, or AB 32 for short. The law committed California to return to its 1990 level of carbon emissions by 2020 and instructed the California Air Resources Board (CARB) to find the most cost-effective ways to do that. CARB hired experts, held hearings, and eventually came up with a list of measures to reach the goal. Cap and trade was one of them, and in 2013 it went into effect.
California’s cap-and-trade system is patterned after the Waxman-Markey bill that passed the US House of Representatives. It includes some auctions, but most of the initial permits are given for free to historic polluters. Offsets are also allowed.
But a funny thing happened after CARB’s initial giveaway of permits. The California Public Utilities Commission (CPUC)—an entirely different agency that regulates privately owned utilities—decided that the value of the permits given for free by CARB to utilities didn’t actually belong to them. Rather, it belonged to the people of California. So the CPUC ordered the utilities to sell the permits they’d been given and return 100 percent of the proceeds to their customers. More than that, it ordered them to pay equal “climate dividends” to their residential customers. And this is now happening.
Albeit little noticed, this is a historic development. Because of “the public nature of the atmospheric sink,” the CPUC said, utilities must distribute the atmosphere’s rent to the people. This is “consistent with the idea that the atmosphere is a commons to which all individuals have an equal claim.”17
As it turns out, California’s climate dividends aren’t perfect. They show up as twice-yearly credits on customers’ utility bills, where they’re hard to notice, rather than as cash in people’s bank accounts. (This may change in the future, the CPUC says.) And they’re not precisely one person, one share—the best the CPUC can do within its legal authority is one meter, one share.
Still, here’s the important thing: this is the first time an American government agency has declared the atmosphere a commons owned by everyone in equal share. Thomas Paine would be proud.