Samuelson: Let's Just Call It 'Cap and Tax'

We'll have to discard the adage "everyone talks about the weather, but no one does anything about it." In this era of global warming, it is inoperative, because the whole point of controlling greenhouse-gas emissions is to do something about the weather. This promises to be hard and perhaps futile, but there are good and bad ways of attempting it. One of the bad ways is "cap and trade." Unfortunately, it's the darling of environmental groups and their political allies.

The chief political virtue of cap-and-trade—a hugely complex scheme to reduce greenhouse gases—is its very complexity. This allows its environmental supporters to shape public perceptions in ways that are essentially deceptive. Cap-and-trade would act as a tax, but it's not described as a tax. It would directly regulate economic activity, but it is promoted as a "free market" mechanism. Finally, cap-and-trade would quickly become a bonanza for lobbyists, who would scramble to exploit the system for different industries, venture capitalists, localities and others. All the influence peddling would undermine the system's abstract advantages.

The Senate is scheduled to debate a cap-and-trade proposal this week, and although it's unlikely to pass, it will undoubtedly return because all the major presidential candidates support the concept. Cap-and-trade extends the long government tradition of proclaiming lofty goals that are, in practice, difficult or impossible to achieve. We've had "wars" against poverty, cancer and drugs to eradicate obvious societal ills, but poverty, cancer and drugs remain. President Bush called his landmark education law "No Child Left Behind" rather than the more plausible "Fewer Children Left Behind."

Carbon-based fuels (oil, coal, natural gas) provide about 85 percent of U.S. energy needs and generate most greenhouse gases. So, the simplest way to stop these emissions is to outlaw them. Naturally, that's what cap-and-trade does. Under the bill passed by the Senate Environment and Public Works Committee, companies could emit greenhouse gases only if they had annual "allowances"—quotas issued by the government. The amount of allowances would gradually decline. That's the "cap." Companies (utilities, oil refineries, steel companies) that needed extra allowances could buy them from companies that wanted to sell. That's the "trade."

Consider one version of the bill. In 2012, the cap on greenhouse gases would be 3 percent below their 2005 level and 6 percent below the level projected without any restrictions. By 2030, the cuts would be 35 percent and 44 percent, respectively. By 2050, U.S. greenhouse gases would be rapidly vanishing. Even better, their disappearance would be allegedly painless. Reviewing five economic models, the Environmental Defense Fund, an advocacy group, finds that the cuts can be achieved without "significant adverse consequences to the economy." Fuel prices would rise, but because people would use less energy, the impact on household budgets would be modest.

This is mostly make-believe. If we suppress emissions, we also suppress today's energy sources, and because the economy needs energy, we suppress the economy. The models magically assume smooth transitions. If coal is reduced, then conservation or non-fossil-fuel sources will take its place. But in the real world, if coal-fired power plants are canceled (as many were last year), wind or nuclear power don't automatically substitute. If the supply of electricity doesn't keep pace with demand, brownouts or blackouts will result. The models don't predict real-world consequences. Of course, they didn't forecast $135-a-barrel oil or the disastrous effects of corn-based ethanol on food prices.

As mandated emissions cuts go deeper, the danger of disruptions would mount. Population increases alone raise energy demand. From 2006 to 2030, the population will grow by 22 percent (to 366 million), the number of housing units by 25 percent (to 141 million) and the amount of commercial business space by 35 percent (to 101 billion square feet), projects the Energy Information Administration. The idea that higher fuel prices will be offset mostly by lower consumption is optimistic. The Congressional Budget Office estimates that a 15 percent cut in emissions from a base year would raise annual average household energy costs by almost $1,300 (in 2006 "constant" dollars), or roughly 3 percent of income for the bottom four fifths of the population.

That's how cap-and-trade would tax most Americans. As allowances become scarcer, their price would rise, and the extra cost would be passed along to customers. For the government, issuing the scarce emissions allowances would vastly expand its power. The government could sell the allowances and spend the proceeds, or it could give them away, providing a windfall to recipients. The Senate proposal does both, to the tune of about $1 trillion from 2012 to 2018. Beneficiaries would include farmers, Indian tribes, new technology companies, utilities, states and mass-transit systems. Call this "environmental pork," and it would just be a start. The program's potential to confer subsidies and preferential treatment would stimulate a lobbying frenzy. Think of today's farm programs—and multiply by 10.

Unless we find cost-effective ways of reducing the role of fossil fuels, a cap-and-trade system would ultimately break down. It wouldn't permit satisfactory economic growth. Nor would it work internationally. Developing countries, the largest source of new emissions, won't abandon fossil fuels unless there are competitive alternatives. If we're going to use price to try to stimulate those new technologies, let's at least do it honestly. Most economists think that a straightforward tax on carbon would have the same incentive effects for alternative fuels and conservation as cap-and-trade without the rigidities and uncertainties of emission limits. A tax is more visible, understandable and democratic. If environmental groups still prefer an allowance system, let's call it by its proper name: "cap and tax."