This blog was written by John D. Wilson, former Deputy Director for Regulatory Policy at the Southern Alliance for Clean Energy.

Guest Blog | November 15, 2011 | Climate Change

This post provides notes and further explanation for the main post, Free market perspective already dominates the climate policy debate. Its one one of a series of posts about how the “power of free markets” may be able to help solve climate change. You can view the rest of the posts here.

Note 1 (on the equivalence of cap and trade to a carbon tax): Sebastian Rausch and his colleagues at MIT write that, “A cap and trade system with fully auctioned permits is equivalent in impact to a carbon tax where the tax rate equals the market clearing auction price.” They modeled the costs (excluding benefits) of climate change policy under such an idealized scenario. According to their model, annual household costs of climate change protection efforts over the next four decades could average $400-600 in current dollars. These and other similar studies reflect the mainstream economist view that market mechanisms are a more economically efficient means of reducing greenhouse gas emissions than command-and-control regulations.

Note 2 (on the tendency of politics to corrupt the design of cap and trade): Once this bill passed the U.S. House of Representatives in June 2009, the idealism of mainstream economists was shattered by the intrusion of politics into the “pure” cap-and-trade design. As the legislative trade-offs intensified in 2009, the perception that cap-and-trade was corrupt and inefficient became firmly established. American Enterprise Institute (AEI) Resident Scholar Kenneth P. Green concluded that special interest rent-seekers would inevitably reduce “a realistically achievable cap-and-trade scheme as about equivalent to regulation, for its damage potential.” Greg Mankiw quipped that, “Cap-and-trade = Carbon tax + Corporate welfare.”

Note 3 (on the costliness of a regulatory strategy): AEI’s Green compared regulation to “losing an arm.” In lamenting the “scorched earth” attacks on market-based mechanisms, Harvard economist Robert Stavins commented that “a plethora of standards, special-interest technology subsidies, and tax breaks — won’t do the job, and will be unnecessarily expensive.” Resources for the Future (RFF) found that an inflexible regulatory standard would be the most expensive of four policies to control greenhouse gas emissions.

Note 4 (on the limits to state leadership): In 2009, Environment America estimated that state policies in place at that time “will reduce carbon dioxide emissions by approximately 536 million metric tons by 2020. That is more global warming pollution than is currently emitted by all but eight of the world’s nations, and represents approximately 7 percent of U.S. global warming pollution in 2007.” World Resources Institute reached similar findings, suggesting that even the most aggressive (or optimistic) view of opportunities for state action indicate an opportunity for merely one-third of needed emissions reductions. Clearly, the responsibility for U.S. action has been and remains in the hands of federal officials.

Note 5 (on the debates over the impacts of carbon revenues): Most economists seem to think that revenues from a permit auction or tax should be used to reduce taxes. MIT economists reported that impacts on “welfare” (in economist parlance, economic well-being) would be minimized by offsetting carbon taxes (or permit auction revenues) with a reduction in personal income taxes.

The specific type of tax offset preferred by economists isn’t entirely clear. Economists have focused on several relatively simple methods of ensuring revenue neutrality and have not delved into the kind of complicated political compromise that would be likely in actual legislation. However, disagreements exist over whether some of those revenues should be used for other purposes, and whether such a policy change would be fair or unfair.

Free market advocates have published reports with different opinions on the use of government spending to assist with market transition. In 2008, the majority of expert panelists surveyed by the US Government Accounting Office (GAO) favored investing some revenues, particularly in “research and development (R&D) and/or deployment of low- or zero-carbon technologies.” Widely varying views on this issue persist; some suggest that increased spending on R&D to offer greater economic value than revenue-neutral (or dividend) solutions. Some “free market” advocates suggest that the federal government should “clear the field,” others argue that federal government leadership is necessary to mitigate the costs of climate action but shouldn’t be the focus.

Another area of disagreement is whether a market-based mechanism would economically advantage wealthier or poorer households. The more established perspective is that since poorer households spend a larger fraction of income on energy, a carbon tax or cap would affect them more than wealthier households. Furthermore, Gilbert Metcalf and others reported that even the personal income tax offset method would be regressive, causing more relative disadvantage to lower income households than to higher income households. However, more recent work by Metcalf and others (working out of MIT and AEI) suggest that the overall impact may be neutral or even favor lower income households. Their research also confirmed work by PERI’s James Boyce and Matthew Riddle that other methods such as a per capita lump-sum distribution of the permit auction or tax revenue would result in a progressive impact; however, this progressive impact would result in the overall economic impact to most households being worse.

As discussed, the preferences of economists and other “free market” advocates were significantly affected by the 2009-10 federal debate on climate change policy. The lack of consensus on basic perspective as to what objectives and constraints constitute a “free market” approach was evident in 2008. Even though opinions have likely changed, it seems unlikely that disagreements have softened.