Cross-posted from the Peterson Institute for International Economics.

On May 5, the Congressional Budget Office (CBO) released an issue brief titled “How Policies to Reduce Greenhouse Gas Emissions Could Affect Employment” [PDF]. With unemployment hovering stubbornly around 10 percent, the report could shape the Senate’s appetite for taking up the energy and climate change bill being drafted by Sens. Kerry, Graham, and Lieberman. Unfortunately it’s a pretty weak initial offering by Congress’s independent research shop at a time when the Hill is particularly hungry for good analysis.

I last weighed in on the “green jobs” debate in early 2009 as Congress was debating economic stimulus legislation. In that context, a number of institutions put out analyses suggesting that government spending on clean energy technology and energy efficiency would do more to create jobs than tax cuts or spending on fossil fuel sources of energy supply. The Political Economy Research Institute (PERI) and Center for American Progress (CAP), for example, argued that $100 billion of green spending would create 2 million jobs, four times more than the same amount spent in the oil industry. This analysis looked only at the gross employment effects, ignoring the net effect after raising taxes or cutting government services in future years to offset near-term deficit spending. But as there was broad consensus at the time that a good dose of Keynesian stimulus was required, spending money on windmills rather than ditch digging meant meeting economic and environmental goals simultaneously.

The same analytical approach falls short when assessing the employment impacts of comprehensive energy and climate legislation. The reason is that the investment in clean energy and energy efficiency generated through such policy is paid for with higher energy prices rather than government borrowing. And these higher energy prices work against the job creation benefits of new green investment. Identifying the net employment impact of energy and climate legislation is a daunting task.

Understanding the CBO’s approach

The May 5 issue brief does not represent independent CBO analysis on the employment impact of policies to reduce emissions, as its title suggests. Instead it reviews three outside studies, two from nonpartisan Washington think tanks-Resources for the Future (RFF) and the Brookings Institution — and one from the private consultancy Charles River Associates (CRA). Only one of these studies, the CRA analysis [PDF], evaluated a specific piece of U.S. legislation — the American Clean Energy and Security Act (ACESA) passed by the House of Representatives last June. The RFF study assesses the impact of a $10 per ton carbon tax on specific U.S. industries. The Brookings study [PDF] evaluates a range of possible greenhouse gas emission reduction scenarios. Although the studies deal with different policies and different carbon prices, the CBO attempts a cross-study comparison of the employment impacts from each study at the carbon prices the CBO projects under ACESA.

What they capture

While the three studies reviewed by the CBO assess different policies, they employ similar methodologies. All three analyze the economic and jobs impact using top-down computable general equilibrium (CGE) models. This approach effectively captures what the bottom-up methodology used by PERI, CAP, and others miss when it comes to comprehensive energy and climate policy — the impact of higher energy prices resulting from the switch to cleaner forms of energy. In CGE models, more expensive energy means lower real wages because U.S. workers have less money left over after paying for electricity, natural gas, and petroleum to buy other goods. And lower real wages prompt some workers to leave the labor market, reducing aggregate employment and further reducing consumer spending. That means lower industrial output from firms selling to U.S. consumers and lower employment in those industries. In addition, energy-intensive industries in the U.S. may be put at a disadvantage vis-à-vis their foreign competitors as a result of higher energy prices if other countries don’t adopt similar policies. This has the potential to reduce employment as well.

Counteracting these effects are the increases in employment that come from consumers switching from energy-intensive to labor-intensive products, and from firms substituting labor for capital and energy in their production of goods. All three studies forecast a net decline in employment in fossil fuel production, construction, and manufacturing, while two of the three (the Brookings and RFF reports) forecast a net increase in employment in the service sector.

What they miss

As the three studies reviewed by the CBO assess different policy scenarios, they have limited value in gauging the employment impact of a specific piece of legislation. The way revenue is collected and used under either a cap-and-trade system or a carbon tax can significantly alter the employment impact of energy and climate policy. For example, if revenue raised through pricing carbon is used to cut existing taxes that discourage employers from hiring — such as the payroll tax — then the net jobs numbers can change significantly. Carbon tax revenue or emission allowances under a cap-and-trade system can also be used to offset higher energy prices for energy-intensive industries facing international competition.