An account of a House hearing on auctioning permits under cap-and-trade

Last Wednesday, the House Global Warming Committee held a hearing on "auctions and revenue recycling in cap and trade," which took a close look at the advantages of auctioning (rather than giving away) pollution permits under a cap and trade system, and what might be done with the revenue. I didn’t manage to watch the hearing, but as always it has been ably summarized by the mysteriously monickered The Cunctator, publisher and editor of Hill Heat. If you’re looking for a just-the-facts account of action on Capitol Hill around climate and energy, you need to bookmark the site immediately. I’ve reprinted Hill Heat’s account of the House hearing below.

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At this morning’s House Global Warming Committee hearing on Auctions and Revenue Recycling in Cap and Trade, the witnesses presented some of the first Congressional testimony on the economic implications of a greenhouse-emissions cap and trade system such as the one proposed in Lieberman-Warner (S. 2191).

A summary of some of the analysis presented in the written testimony:

1. Power generators will raise prices the same whether allowances are given away for free or are auctioned, because the price is set by the limitation in supply (the cap)
2. Investment in energy efficiency provides greater immediate taxpayer return than technology investment
3. Because power generators are free from competition they don’t need any protection through free allowances
4. A European Commission analysis found no macroeconomic negative impact of moving their cap-and-trade system to full auction
5. Free allocation to load-serving entities is a subsidy to electricity consumption, which leads to an increase in allowance prices and requiring greater decreases from other sectors
6. The “virtual tax” a cap-and-trade system imposes can be greatly alleviated if revenues are used to reduce pre-existing taxes
7. To fully offset the costs on the electricity sector through free allocation of allowances would cost the government 2.5 to ten times the value of the economic harm to the emitters, depending on whether the free allowances are narrowly targeted (15% of sector allowances) or nationally distributed (65% of sector allowances)
8. To fully offset the costs on the poorest 20% of the American public takes about 14% of total revenues of a 100% auction system

Excerpts from the testimony related to the above points are below the jump.

Ian Bowles, Mass. Secretary of Energy & Environmental Affairs:

It is tempting to think that, if you make generators pay for the emissions they produce, it will drive electricity prices up, but if you give allowances away for free, it won’t. But it’s not true. The price impact is the same either way. . . As power generators determine the price at which it becomes economic for their plants to produce power, they have to decide whether to expend allowances in order to generate electricity, save those allowances for a time when electricity prices are higher, or sell allowances to other power producers who need to meet their compliance obligations. In any of these three scenarios, the market price of allowances becomes a component of the price of electricity.

While it is important that a federal program also give substantial new financial incentives to develop new clean energy technologies, energy efficiency gives the greatest near term return for the ratepayers.

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Peter Zapfel, European Commission Directorate General for Environment:

Because the power generation sector is not exposed to competition from outside the EU, it can fully pass on the value of carbon allowances. Full auctioning should therefore be the rule from 2013 onwards for the power sector.

In order to underpin the energy and climate package of 23 January 2008 the Commission undertook a comprehensive (regulatory) impact assessment including an economic analysis of the effects of auctioning compared to free allocation of allowances. This analysis concluded that the full auctioning of allowances has no negative macroeconomic impact and is in fact preferable to other distribution methods in terms of efficiency of the emissions trading system and the elimination of any undesirable distributional effects of free allocation.

Dallas Burtraw, Senior Fellow, Resources for the Future:

Unfortunately, free allocation to load serving entities comes with an important efficiency cost. When electricity customers do not see the increase in retail electricity prices they do not have the incentive to reduce electricity consumption. In the example we modeled it leads to a 15 percent increase in allowance price under the cap and trade program and requires greater emission reductions for the rest of the economy.. . Essentially, the free allocation to electricity customers is a subsidy to electricity consumption that is not received by users of natural gas or transportation fuels or by industry or commerce, except to the degree that they consume electricity.

Like any new regulation, climate policy imposes costs on households and firms and that cost acts like a virtual tax, reducing the real wage of workers . . . one of the most important findings in environmental economics and public finance in the last fifteen years is the recognition that the use of revenue raised through an auction (or an emissions tax), if dedicated to reducing other pre-existing taxes, can reduce this cost substantially. This so-called revenue recycling would have truly dramatic efficiency advantages compared to free distribution.

A key finding is that compensation has a significant opportunity cost, especially if the goal is to achieve full compensation. If the free allocation to achieve compensation is implemented at the federal level, we find the incremental cost of compensating for the last increment of harm in the electricity sector would cost ten times that amount in allowance value. Implemented at the regional/state level, that ratio falls, requiring the use of allowance value equal to about 4.5 times the harm.

Robert Greenstein, Executive Director of Center on Budget and Policy Priorities:

We estimate that a program designed according to the principles laid out later in this testimony, which would fully offset the impact on the poorest 20 percent of people and also provide some relief to many hard-pressed working families in the next 20 percent, could be fully funded with approximately 14 percent of the resources that would be generated by auctioning off all the allowances in a cap-and-trade system.

John Podesta, President and Chief Executive Officer, Center for American Progress, said that the federal government should pay for CCS investment:

Any cap and trade bill should also include an emission performance standard for all new coal-fired facilities equivalent to the best available carbon capture-and-store technology, and the provision of federal funds to help offset additional costs of implementing carbon capture-and-storage technology. Revenues from allowance auctions should pay for these incentives.