What's the Alternative to KGL?

Although I haven't yet seen the latest discussion draft of the "tri-partisan" energy and climate proposal of Senators Kerry, Graham and Lieberman (KGL), I've been thinking about its rumored provisions for a while. These apparently include a cap & trade system for the electricity sector, eventually expanding to include most industries, and a "carbon fee" on petroleum fuels that would be linked to the cap & trade market, along with measures to increase domestic energy production from a wide range of sources, including oil. It occurs to me that the most important question about the resulting legislation may not concern its actual contents, but what we ought to compare it to.

For all the remaining uncertainty about the risks of climate change, which this week's Economist details, the US regulatory baseline for it has already moved beyond doing nothing. Having issued its Endangerment Finding, the EPA is gearing up to regulate greenhouse gas emissions from both stationary and mobile sources. Almost any other approach to these emissions would be preferable, since regulating point sources ignores the fundamental differences between CO2 and the traditional pollutants like the oxides of nitrogen or sulfur they've been dealing with for decades. If we fail to capitalize on the helpful reality that all GHG emissions anywhere are essentially equivalent in their effect on the climate, we likely won't tackle the cheapest reductions first, and that could cost us a fortune. Yet even without some form of national greenhouse gas legislation or regulations, these emissions are already being regulated at the state level through efforts such as California's A.B. 32 and the Regional Greenhouse Gas Initiative. In that context, whatever one's assessment of the underlying science, we all have a stake in Congress passing the most practical and cost-effective greenhouse gas legislation possible. Sadly, the blatant favoritism and profligate spending of the Waxman-Markey bill that passed the House last spring disqualify it on both of these criteria.

One of the biggest challenges for KGL is ensuring that their bill doesn't end up as a bloated monstrosity like Waxman-Markey. You don't need 1,000 or more pages to define a cap & trade regime or a carbon tax, or to set up "cap & dividend", under which most of the money collected from selling emissions permits would flow back to taxpayers. (That approach has its own problems.) You do need hundreds or thousands of pages, however, to accommodate all the pork and giveaways that seem to be necessary to get any major legislation passed these days, one vote at a time. Careful scrutiny of the text of the Waxman-Markey bill suggests that there is not a majority of this Congress--or perhaps of any actual Congress we're likely to get--that sees the necessity of crafting a clear response to climate change as trumping the need to score goodies for their districts and favorite causes or constituencies. Messrs. K, G and L have their work cut out for them, finding enough support for their proposal through its primary provisions, rather than accreting dozens or hundreds of tit-for-tat favors.

Perhaps the key to a successful bi/tri-partisan bill could be found in its approach to the uses of the enormous revenues it would generate. The healthcare bill that passed the House last weekend only achieved deficit neutrality by taking a huge bite out of the revenues and savings that might otherwise have gone to bringing Medicare or Social Security back into balance, and that's not a partisan talking point. If we are indeed facing an entitlements crisis on the scale that many expect, and some form of consumption tax is on the horizon as the only viable revenue alternative to a return to the bad old days of confiscatory taxation on upper-income Americans who already pay 86% of all the federal income tax collected, then energy might be a good place to start. A fee of 25 cents per gallon--roughly equivalent to $25/ton of CO2 emitted--on gasoline, diesel and jet fuel would collect on the order of a half-trillion dollars over 10 years.

If KGL do go down the path of a carbon fee on petroleum, the biggest mistake they could make would be to follow the advice of the economists and experts who advise collecting it as far "upstream" as possible. Taxing refineries is a sure recipe for offshoring one of the few remaining basic manufacturing industries in this country that has managed to remain globally competitive, even if it has fallen on hard times recently. Likewise, taxing US oil & gas exploration and production would make them uncompetitive with foreign sources free from such burdens. Instead, since most of the emissions from the petroleum value chain occur during consumption, rather than production, the best place to apply a carbon fee--can't call it a tax--is at the gas pump. This would subject domestic and imported fuels to the same cost without having to go through gyrations to manage "leakage", only to find out later that they violate international trade rules. Best of all, the government already has the mechanism in place to collect such a fee without adding another expensive bureaucracy: Simply tack it onto the federal fuel excise tax and post the amount on every fuel dispenser whenever it changes.

In a perfect world, we'd establish a price on carbon using a simple and transparent cap & trade mechanism and return every penny collected to the public, in order to minimize the burden on the economy while shifting it in the direction of greater energy efficiency and lower emissions. In the last several years it has become abundantly clear that we don't live in that world, if we ever did. I still favor cap & trade as an efficient mechanism for price discovery, but not if its implementation comes with as much baggage as Waxman-Markey carried. I will eagerly await the details of the KGL proposal to see whether they can navigate the narrow gap between an effective, efficient approach to GHG management and the political forces seeking to feast on the bonanza it represents.