Shapiro: Economy Will Force Quick Action on Climate Change

Posted March 26, 2009 at 2:45pm

After a decade of hard work by Al Gore and legions of scientists and environmentalists, most Americans are finally and fully alert to the pressing need for serious action on climate change.

It normally could take several more years to bring the public up to speed on the economic effects of the various approaches to this problem.

But with everyone’s attention now fixed on our economic crisis, this process can be accelerated. And as President Barack Obama has suggested many times, rebuilding the economy and dealing with climate change need not be mutually exclusive, if we enact the proper policies.

The proper approach here is a straightforward one.

First, enact a carbon-based tax to move people and firms to prefer and choose less-carbon-intensive fuels and technologies. Second, as we change the relative prices of different forms of energy based on their effects on the climate, protect people’s incomes and the overall economy by returning all or virtually all of the revenues through payroll tax cuts or lump-sum payments to households.

Third, use the certainty of a substantial tax on carbon, along with additional subsidies, to promote the development of new climate-friendly fuels and technologies that can capture a new and fast-growing global market.

I recently co-authored a study that used the same modeling system as the Department of Energy to estimate the environmental and economic consequences of applying this specific approach. We found that we can effectively address climate change without harming our economy.

Over the first 20 years, our approach achieved larger reductions in greenhouse gas emissions than last year’s leading cap-and-trade proposal, Warner-Lieberman. Moreover, owing to the strategy’s revenue-recycling feature, the model found that it would have virtually no negative effects on the gross domestic product, employment or average American incomes.

Even so, many lawmakers and traditional environmental activists continue to support the approach heavily favored in Europe, a cap-and-trade system. It does have one advantage. Its cap produces certainty in emissions reductions, but does so at a large price: The cap also produces enormous new volatility in energy prices whenever demand begins to approach the cap like, for example, when the winter is colder than anticipated or the economy grows faster than expected.

The consequences of a cap not only will mean roller-coaster energy prices for consumers to an even greater degree than today; it also will undermine the incentives for businesses to develop and use less-carbon-intensive fuels and technologies, since they won’t be able to know what the price of carbon will be next month, next year or five years down the road.

The leading cap-and-trade proposals also would collect as much revenues as a carbon tax, but without recycling them in tax relief, thereby leaving most households poorer and the overall economy weaker.

Our study found that a cap-and-trade or carbon tax program sufficiently strong to put us on a sustainable emissions path would raise costs for a typical American household, over 20 years, by an average of $1,500 per year.

Again, the critical difference is that the carbon-tax-shift plan supported by Gore as well as most economists would rebate that $1,500 back to households — a feature not included in cap-and-trade proposals.

Finally, the “trading— part of these plans involves the government creating a trillion dollars or so in new financial assets (the permits), to be traded, securitized and derivatized under the same mechanisms that have brought our economy to its knees. We know that the prices of these permits will be very volatile. The prices of the permits traded under the current acid rain program here, as well as those traded in Europe’s new climate trading system, have moved up or down by an average of 15 percent to 20 percent per month (with daily shifts as great as 70 percent).

Apart from the impact of this volatility on everyone’s energy bills, it guarantees that the cap-and-trade market will attract hordes of speculators, since financial market speculation depends on rapid price changes. And volatility of this kind on a national or even global scale, especially reinforced by rampant speculation, could regularly disrupt the economy and the livelihoods of tens of millions of people.

That’s not all: Large energy companies and utilities would know about emerging shifts in demand long before the markets, producing nearly irresistible temptations for insider trading.

And after the carnage of Wall Street’s recent rounds of malfeasance, it is painfully clear that the Securities and Exchange Commission and the Justice Department simply lack the ability (and the resources) to effectively police complex, fast-moving markets involving many, many thousands or millions of trades per day.

Despite its advocates’ good intentions, cap-and-trade could put America at risk of another meltdown — one originally created and financed by the government itself.

None of these painful and difficult issues arise with a carbon tax-shift. Rather, it could enable us to effectively do our part in addressing climate change, while protecting or even enhancing our economic prospects. That’s a deal Congress cannot afford to pass up.

Dr. Robert Shapiro, chair of the U.S. Climate Task Force and head of the economic advisory firm Sonecon, was undersecretary of Commerce in the Clinton administration.