When Kerry and Boxer introduced their clean energy bill earlier this month, it contained a huge gap: it said almost nothing about the allocation of pollution allowances under the cap-and-tr… er, pollution reduction and investment program. The reason for the omission is simple: Doling out what is effectively a huge new pot of money is a subject of considerable interest to many senators, and it’s expected to help bring some recalcitrant Democrats on board. The Energy & Natural Resources Committee, under Jeff Bingaman, is holding a hearing on the subject today.

The politics around allowance allocation are interesting. The key fact to understand is that the distribution of allowances doesn’t change the overall cost or environmental effectiveness of the program (at least according to mainstream economics). Here’s how Harvard economics prof. Robert Stavins puts it:

the allocation of allowances — whether the allowances are auctioned or given out freely, and how they are freely allocated — has no impact on the equilibrium distribution of allowances (after trading), and therefore no impact on the allocation of emissions (or emissions abatement), the total magnitude of emissions, or the aggregate social costs.

Since allowance distribution doesn’t affect the overall costs of the program, you won’t get deficit hawks nagging you about it. Since it doesn’t affect the cap on carbon, you won’t get environmentalists nagging you about it. (I’ve had numerous people at bigtime green groups tell me straight-up that they don’t care how allocation goes as long as the cap is preserved.) It’s basically a special interest free-for-all, and econ-minded enviros like Stavins see that as a feature, not a bug — it is, he says, a “useful, important, and fundamentally benign mechanism.” Having free money to hand out means that “ordinary political pressures need not get in the way of developing and implementing a scientifically sound, economically rational, and politically pragmatic policy.” Translation: you can buy off everybody you need and still get the CO2 reductions you want, all with the CBO’s official stamp of deficit neutrality.

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Your honor, I object! Here’s the thing about handing out money: it may not affect long-term macroeconomic outcomes, but it does leave its recipients with more money. It may not affect how much we collectively pay, but it does affect who pays, particularly in the short-term. Resource distribution involves fundamental questions of economic fairness. Are progressive greens really happy to dismiss those issues as insignificant diversions? What would that signal to their potential allies in labor, social justice, religious, and anti-poverty groups? Distributional issues may seem like an addendum to affluent, highly educated white folks in universities, think tanks, and green NGOs, but they are central to the economic fate of today’s voters — not to mention the electoral fate of their representatives in Congress.

Happily, the politics of pollution permits are propitiously populist (yeah, I said it). Here’s why: pollution allowances handed out for free to private businesses and industries distort the carbon price signal and lead to consumers paying more than they otherwise would. In other words, many of the allocation provisions greens like least — the handouts to merchant coal generators, the LDC allocations — hurt the middle class.

This oughtta-be-legendary graph from CBO testimony tells the tale:

Waxman-Markey effect by income quintile

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On the top left is a cap-and-dividend program, where all allowances are auctioned and the revenue is returned to taxpayers via a lump-sum rebate. On the top right is 100% free allocations to polluters. As you can see, the former policy helps low and middle income brackets; the latter almost exclusively benefits the rich. The bottom is the overall effect on GDP, which is the same in either instance.

The case is also made in a paper from the Center on Budget and Policy Priorities called, appropriately enough, “Changing Climate Bill To Give More Allowances To Electric Utilities Would Likely Hurt, Not Help, Consumers.” One of the co-authors, Chad Stone, will be testifying in front of Bingaman’s committee today.

Another economist who’s done good work in this area is Dallas Burtraw of Resources for the Future, who testified to Congress earlier this year on the issue: “The increase in costs associated with the inefficient allocation to local distribution companies falls hardest on the middle range of household incomes.” His colleague Karen Palmer, another specialist in the area, is also testifying today.

The other witnesses are Tufts economist Gilbert Metcalf and MIT’s Denny Ellerman, both fans of auctioning over freely allocating permits. It’ll be interesting to see if the hearing turns into an occasion to bash the allocation scheme worked out in Waxman-Markey — which could be prelude to ENR attempting to rewrite it.

Regardless, the political take-home message is: Corporate groups like the Edison Electric Institute, which are lobbying for more free allowances, are lobbying against, not for, the interests of most taxpayers in conservative Dem states. Yet Conservative Dem senators worried about the effect of the legislation on taxpayers in their states are often the very ones lobbying for more corporate handouts. If they can be made to see that … well, it might not change anything. They get plenty of campaign contributions from dirty energy industries. But at least the fight should be joined, and the real nature of the dispute made clear: Free allowances to polluters do not contain costs for consumers, they increase them. They’re pure corporate handouts. Fighting to ensure that the poor and middle class don’t get screwed is the sine qua non of progressivism. Greens neglect this issue at their peril.

How will this crucial piece of policy architecture get worked out? It’s not quite clear yet. Boxer says the manager’s amendment of her bill is ready to go and will include a section on allowance allocations. That bill will be debated in Environment & Public Works Committee hearings next week, and likely marked up in early November. Finance chair Max Baucus has said that his committee will do a mark-up as well (they held a hearing on allowance allocation in August), but lately he’s backed off a little — it’s a toss-up whether he’ll get involved. And then there’s the Energy & Natural Resources Committee, under Jeff Bingaman, which is holding a hearing today on “the costs and benefits for energy consumers and energy prices associated with the allocation of greenhouse gas emission allowances.” That may signal that ENR wants to throw its hat in the ring as well.

Ultimately Harry Reid is going to have to pull all the bills together into something that can survive floor debate. That’ll be a tough job, and there will be considerable pressure on him to bribe the holdouts with allowances. It would be nice if progressives starting putting some pressure on him in the other direction, so he doesn’t feel entirely free to give away the store.