This week, the Senate debated the Lieberman-Warner Climate Security Act that seeks to establish a cap-and-trade program for reducing carbon emissions from the electricity, transportation, and manufacturing industries. Its likelihood of passing is remote and prospects for overturning a veto threatened by President Bush are even more farfetched. However, it is worth considering the soundness of the proposal due to the virtual certainty of having a president (Sen. Barack Obama or Sen. John McCain) in January 2009 who favors reducing carbon emissions at least in principle.
Under the Lieberman-Warner Act, most industrial carbon emitters (comprising 86% of U.S. emissions) would need permits in order to emit carbon. If they produced more carbon than their permits allowed, they would have to buy permits from other emitters, creating an incentive to minimize emissions. If the bill were made law, 80% of carbon allowances would initially be distributed for free, with 20% of them auctioned off. Over time a gradually increasing percentage would be auctioned off. The total amount distributed would be based on 2005 levels and would decline 2% per year between 2010 and 2050. As the number of permits declined, they would become more expensive and the new effective price of carbon should force emissions to drop. The backers of the proposal maintain that it would reduce emissions about 70% from current levels by 2050 (although many consider this inadequate).
The advantage of cap-and-trade is that it can ensure in theory that only a sustainable amount of carbon is emitted. A tax, on the other hand, doesn't set an actual cap, although the incentives to reduce emissions would be equally strong. The main disadvantages of cap-and-trade are its administrative challenges and vulnerability to political pressures and corruption. Europe's cap-and-trade program established three years ago has suffered from problems such as cheating by certain corporations obtaining more emissions credits than they should have. Carbon emissions have actually increased in Europe since the implementation of cap-and-trade.
The flawed method of implementation in Europe is present in Sen. McCain's global warming plan. McCain proposes giving away the emissions credits initially, which will not create incentives for the biggest emitters to reduce their emissions faster. Giving the credits away free of charge also would open up the possibility of the influence of special interests to creep into the process of distributing the credits. Sen. Obama's plan proposes auctioning off credits at the program's onset, which is much sounder policy according to Former Labor Secretary Robert Reich.
There is also the question of what to do with any revenues generated by permit auctions or by carbon taxes. Lieberman-Warner proposes placing revenues from carbon permits into a public-private entity known as a Climate Change Credit Corporation. This will finance other greenhouse gas reducing activities such as researching alternative energies, improving fuel efficiency, and insulating homes and businesses. But there is evidence this could be subject to abuse, as many of the biggest carbon-emitting corporations are lobbying to obtain funding to develop their own private pollution-reducing technologies. On the other hand, both cap-and-trade and carbon taxes will likely increase energy costs in the short-run and disproportionately impact the poor and middle-class. An alternative is to return the proceeds of the carbon permits to these groups which will render the policy revenue-neutral.
Al Gore, along with many environmental groups and economists, has supported creating a more straight-forward carbon tax. This will lead to more predictable energy prices over the long-term on which environmentally responsible economic decisions can be based. But, of course, proposing "new taxes" of any kind is politically difficult, even if they're imposed on something as environmentally devastating as unregulated carbon dioxide.
A case can be made for either carbon-reducing scheme, but the bottom line is that tax policy will in some form have to play a key role in any method chosen to address the climate crisis.