Opinion: Why cap and trade is a bad idea : News-Record.com : Greensboro & the Triad's most trusted source for local news and analysis

By Michael K. Wohlgenant

George Santayana's famous statement, "Those who cannot remember the past are condemned to repeat it," rings true when it comes to the effect that the proposed cap-and-trade legislation would have on taxes and the U.S. economy.

Many economists believe the effects of such legislation could be as disastrous as tax increases implemented during the Great Depression. Among others, these tax increases included the effects of the Smoot-Hawley Tariff Act in 1930, the Revenue Act of 1935 (a surtax on higher incomes and on corporate earnings), and the introduction of the Social Security payroll tax in 1937.

The Congressional Budget Office estimates that President Obama's proposed tax increase from the cap-and-trade system, which would require businesses to buy carbon dioxide (CO²) emission permits, would yield at least $80 billion per year, the effects of which would be passed on to consumers in the form of higher prices for energy, transportation and a host of other products currently using fossil fuels. The CBO estimates that such a system would cost the average household at least $1,600 per year. Because poorer households spend a larger share of their income on energy (approximately 20 percent) compared to other income groups, the burden would be greatest on low-income households.

While the purpose of the cap-and-trade legislation to reduce global CO² emissions may appear to be worthy, the ability to achieve the objective is undermined by the fact that it would apply only to those countries that adopt it. Developing countries like China would be allowed to continue to pollute without restrictions. Contrary to popular belief, the science on how much global warming is due to human activity versus natural causes is not settled. It doesn't make much sense to impose a given cut in CO² emissions if we don't have a good idea of how much it will actually reduce global warming.

In addition to having drastic effects on the economy, the cap-and-trade system could significantly increase gasoline prices in the short run, perhaps as much as 60 cents per gallon. It takes time to produce new technologies that are less dependent on fossil fuels. In the meantime, because of increased costs, domestic oil production would decline, making us more, not less, dependent on foreign oil. The increased production costs of cap and trade, causing production of fossil fuels to decline, would translate into higher gasoline, utility and other energy costs -- even more so as many of the developing economies continue to become richer and demand more fossil fuel-based energy.

In a recent Wall Street Journal column, Martin Feldstein warned that the cap-and-trade system, combined with other tax increases, could kill the present recovery. President Obama's budget already includes tax increases on those making more than $250,000 per year to pay for health reform, in addition to a number of other explicit and hidden taxes. Although some of the tax increases are not scheduled to take place immediately, households and businesses certainly recognize that such taxes will permanently reduce future income, and they will act now by reducing expenditures accordingly. As history has shown, not only from the United States during the 1930s but also Japan in the late 1990s, this is not the time for tax increases, especially of the magnitude manifested by the proposed cap-and-trade system.

Michael K. Wohlgenant is a William Neal Reynolds distinguished professor of agriculture and resource economics at N.C. State University.

dpleyden

June 5, 2009 - 8:41 am EDT

I disagree. Here are the author's arguments and why he is wrong:

* Argument 1: "Many economists believe ... [cap-and-trade] ... could be as disastrous as tax increases implemented during the Great Depression. ... Smoot-Hawley Tariff Act in 1930, the Revenue Act of 1935 ... and ... Social Security payroll tax in 1937." - In fact, most economists do not believe that the Revenue Act of 1935 and Social Security payroll tax of 1937 were disasterous. We can debate whether Social Security could have been better designed, but 70 years on, it is clear that Social Security has been a success. And the problem with Smoot-Hawley was not the fact that it was a tax, but that it was penalized international trade.

* Argument 2: "such a system would cost the average household at least $1,600 per year" with the greatest burden on low-income households - This argument misses the point. A fundamental principle of economics is that dealing efficiently with something requires that we be aware of the costs of our decisions. We are already bearing the cost of excessive carbon dioxide emissions but generally aren't aware of it. Cap-and-trade (or some other form of carbon tax) would simply make us aware of it so we can begin to deal with the problem. And the low-income households argument is specious. If we are truly concerned with low-income households, we should deal with that problem directly through more progressive taxation, better health care, better education, etc..

Argument 3: "It doesn't make much sense to impose a given cut in CO² emissions if we don't have a good idea of how much it will actually reduce global warming." - Would you not give your child acetaminophen to bring down a dangerously high fever if you didn't know how much the acetaminophen would bring the fever down? In fact, it makes a lot of sense to start now working on the problem rather than wait till it's possibly too late. This is a common sense rule that we use all the time in our personal lives and has been formalized in what is known as the Precautionary Principle.

* Argument 4: Cap-and-trade would increase energy prices (including gasoline) - This is just a variation on Argument 2. So let me repeat. We are already imposing a cost on ourselves. Cap-and-trade simply makes the cost visible so we can begin to deal with it in a rational and efficient manner.

* Argument 5: Cap-and-trade would reduce future income - Precisely the opposite is true. By making us aware of costs we are already incurring, and therefore dealing with the problem rationally and efficienty, we make our future better. If you had termites, would you do nothing because hiring an exterminator would reduce the money you have for other things?

Panacea

June 5, 2009 - 10:35 pm EDT

Brilliantly said, sir!

Andrew Brod

June 7, 2009 - 10:18 am EDT

I agree with Panacea about dpleyden's comment (hey there, dpleyden!). But two additional points. One of the biggest lessons of the SO2 cap-and-trade program that was introduced in the early 1990s (after having been proposed by the elder Bush's administration) is that industry estimates of the cost of the program were gross overstated. You heard electric utilities predict that the program would cost them over $1000 per ton of SO2 emissions. In the event, prices under the SO2 program fell to less than a tenth of that. The thing about cap-and-trade is that it forces businesses to find efficiencies, and then they do. The same innovative spirit that makes free entreprise a good deal for us all (most of the time) is what leads polluting businesses to find cost savings. So take whatever numbers industry lobbyists are throwing around now in an attempt to scare the rest of us and lop off a zero from the end.

The second point is that current concerns about cap-and-trade aren't about cap-and-trade per se, but about the way the permits or allowances are distributed. The SO2 program gave them out for free, which meant there was no net transfer from industry to government. Some businesses (those with relatively "clean" plants) made a profit by selling allowances. The initial version of the current program would have auctioned off carbon allowances, which would have led to a net flow of dollars from industry to government. Because of this, the program would have been consistent in some ways with a carbon tax (though there's an important difference between setting price via a carbon tax and setting quantity via cap-and-trade). But my understanding is that more recent proposals for cap-and-trade would revert to the SO2-style free distribution of carbon allowances. It would still enforce a per-unit incentive on polluters to reduce emissions but has the potential to attract industry support, just as the SO2 program did.

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