First I said that we shouldn’t confuse wealth transfers with economic pain. Then I said that a $20/ton carbon price works out to a 1.4 cent/kWh rate increase. Astute readers may have noticed a disconnect. (Isn’t 1.4 cents/kWh economic pain?) Which brings me to the third and final part of this little series.

Carbon prices v. use of carbon proceeds

Let’s review the electric sector math. In 2006, the sector was responsible for some 2,784,805,000 tons of fossil fuel-derived CO2 emissions. If we had a carbon policy in place at that time charging $20/ton of emissions, electricity generators would have had to pay some $56 billion in pollution fees. Which is a big number. But, as noted previously, that works out to about 1.4 cents/kWh. A small number.

But that math was sloppy, as it violated my own insistence that we not confuse taxes and wealth transfers. After all, $56 billion only works out to a 1.4 cent rate increase to the degree that (a) it all gets passed along to consumers and (b) the government uses that $56 billion for a great big Money Fire. After all, even if you have a deeply cynical view of government and presume that only 25% of all the money government spends goes to a useful purpose, you’d still have to conclude that the total “cost” to the rate payer from that policy is just 75% x 1.4 cents, or 1 cent/kWh.

Conversely, even if you have a really charitable view of government, you probably still don’t believe that every dollar government spends accrues to the benefit of tax payer. (Salaries for certain members of Congress come to mind. Or, on a larger scale, tax breaks for domestic oil production, certain pentagon line items, etc.) The point here isn’t to be political, but simply to note that if every dollar paid to pollute goes back to DC for redistribution, both sides of the aisle would probably agree that the electricity consumer realizes less than a dollar worth of offsetting benefit.

There are many ideas about how to fix this. Cap & dividend and/or payroll tax reductions are probably the most widely noted, but those both have their flaws as well — most notably in the way that they sever cause from effect. (What after all, is the logic for providing the same $ to individuals with wildly different carbon footprints if the fundamental purpose of that $ is to provide an economic signal to reduce carbon emissions?)

Same math, with output-based standards

My personal preference, as regular readers know, is output-based standards, in which an allowance is only provided up to some level of emissions per MWh (set to something < the current 0.68 ton/MWh average, so as to create an implicit cap) and anyone who emits above that level is required to procure credits from anyone below. No federal intermediary, and no dilution of impact. If you emit a ton, you have to pay a $/ton rate that is identical the revenue realized by those who are acting to lower the CO2 intensivity of the grid. Many more details in the hyperlink above, but here’s the point on the math:

If coal plants have to buy credits from nuclear plants (or any other high/low carbon combo you’d like), the net increase in cost to the coal plant is exactly matched by a net reduction in cost to the nuke. Societally, no change in overall power prices, unless two conditions are met:

  • The allowance level is set below the current average (as it must be, to drive the overall emission down), and
  • markets are totally static (e.g., there is no shift in generation patterns as a result of the new economic paradigm).

The first item is a necessity of good policy, and always true, but the second is an impossibility given human behavior. As a result, it is almost certainly true that a properly designed output-based system with full economic participation leads to no net change in energy costs. (It might even lower them.)

That said — and as I noted before — no one can accurately model a dynamic world. So let’s just look at the math in a static world, and assume we set an output-based allowance at 0.6 tons/MWh. We’ll again assume a $20/ton pollution price, but applied only to pollution above the allowance level (and paid to those below the allowance level, pro rata to their benefit).

First, the coal industry pays less. They emitted some 2.2 billion tons of CO2 in 2006, but — since they get an allowance for the first 0.6 tons — only have to pay for 1.06 billion tons worth of pollution. So instead of seeing a $23/MWh increase in their operating cost, they see a $11/MWh increase in their operating cost. In total, that’s a $21 billion payment they have to make. Not to the government though: to zero/low carbon sources, pro rata with their carbon benefit. In other words, that’s a $21 billion stimulus package to the clean energy sector, exactly offsetting the increase in power prices that would otherwise have to be passed onto rate payers and/or divvied up in DC.

For a zero carbon source, that works out to a net reduction in their operating costs of $12/MWh. And at an aggregate level (since we are assuming a static world), the overall impact to all US rate payers is an increase in power prices by just $1.72/MWh, or 0.2 cents/kWh.

The point here is not to suggest that output-based standards are a panacea to all the world’s woes (although it’s hard to argue for any non-political reason that they aren’t miles better than everything else on offer). Rather, it’s to point out that if we insist on carbon policy that transfers wealth from the dirty to the clean, we can create massive economic incentives to lower carbon without economic pain. Why shouldn’t we set that as a goal?