Waxman-Markey supposedly requires a large percent of the savings from free permits to be passed along to consumers. The intent is that they act as protection against price increases rather than a source of profits for large companies. Unfortunately, to the extent this works, it is likely to dampen the price signals that are supposed to help emissions. Equally unfortunately, these provisions are much harder to enforce than appears at first glance.

Let’s focus on free permits for electric utilities for a moment, and how they would affect consumer incentives for efficiency if passed along. Electricity generating companies are supposed to rebate their savings from free permits to consumers, but on some fixed basis rather than per kWh. As an example of one valid means to comply: utilities receive permits equal in value to 1 cent per kWh. They use these to continue polluting, then add 1 cent per kWh to their charges, then subtract the revenue from that on a fixed basis per electric bill. Under this system, the majority of consumers will see their electric bills stay the same or fall. Very large electricity consumers will see a slight increase, but much lower than if the full price of permits were being passed along.

Someone stuck in the  Efficient Market paradigm that modern economics has moved past will reason as follows: consumers will see a lower total electric bill than without free permits, but the marginal cost per additional kWh hour rises as much as if they did not exist. So consumers have the same marginal incentive to save as if permits were not handed out for free. Tranlated out of economic jargon, that says that buying a water saving shower head, or an energy efficient light bulb, saves exactly the same as if the free permits had not been handed out.

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The problem: as consumers, we don’t sit around making marginal utility calculations when we buy light bulbs. Someone not already motivated to buy energy sippers at current energy prices won’t be motivated by a change in allocation on their bill if that total bill does not go up.

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This is where cap-and-dividend or tax-and-dividend plans that are often contemptuously dismissed shine.  A plan that increases an electric bill $35 and give the household with the higher bill $35 in cash  (not tied to the size of the electric bill) provides almost same price signal as without the incentive. The way most of us think, the $35 check gets lumped in with the rest of our income as a not very big change. Whereas the $35 increase in our electric bill gets compared to the rest of our electric bill, not to our total income — a much bigger change.  

So, to the extent that most of savings or revenue from free permits get passed along to consumers in lower utility bills, this dampens the price signal to consumers to lower their usage.  To the extent utilities pass revenue from selling permits along to consumers, that also dampens the incentives for them to reduce emissions in order to sell permits, because they don’t stand to keep much of the profit.

To the extent free permits combined with pass-through requirements actually work as a backdoor cap-and-dividend, they undermine the incentive they are supposed to provide to reduce emissions. Whereas a real cap-and-dividend (or tax-and-dividend) combines real incentives with consumer protection by providing cash payments rather than price reductions.

That comparison shows how Waxman-Markey reduces incentives to cut emissions when savings really are passed along. But it is not as obvious as proponents think that savings will be passed through to consumers. The language certainly sounds strong to many analysts, including Joe Romm. But the pass-through programs are not detailed in the bill. Instead, there is a stringent-sounding set of requirements for rate plans which would be designed in detail by utility companies. Utilities hire some of the best lawyers and accountants outside of Hollywood and the Mafia. Analysts are over-confident when they assume utilities and other recipients of free permits won’t find loopholes that let them legally keep many of the savings or profits from those free permits.

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But suppose Waxman and Markey have done the highly improbable and designed a loophole-free set of utility requirements. How do we enforce them? Can we really count on the under-resourced EPA, whose priority is and should be reducing pollution, to devote much effort to consumer protection? Will state utility commissions, who are also underfunded and often in bed with utilities, outmatch utility lawyers, accountants, and consultants? In the end, utilities will pass along permit savings and profits to extent lawsuits force them to. Mostly this will be in settlements for pennies on the dollar. Full compliance with the law is for little people, not large regulated entities. And that applies to all recipients of free permits, not just electric utilities.

If money is really expected to be passed through to consumers, then why is it not done by auctioning the permits and writing checks to consumers in the same proportion as utility bills and gas prices will supposedly be reduced under the current legislation? Every adjustment for regional impact and income level done via lower bills could be done by adjusting the relative size of the checks. The answer is simple: under the system actually proposed, entities receiving free permits expect most of the profits and savings to stick to their paws, rather the being passed along.