An Energy Bill with a Catch

Yesterday, a monumental energy bill was passed in the House. While liberals and conservatives are shouting out praise or disapproval, respectively, few have looked past party lines to gauge the real effects of the bill.

The bill is attempting to achieve one main objective which is a 17% reduction in economy-wide greenhouse gas emissions by 2020. The proposed strategy is a cap-and-trade system with large amounts of domestic and international carbon offsetting opportunities. There are provisions in the bill which will assist and mitigate the primary objective such as renewable energy requirements on utilities, energy efficiency incentives for consumers and businesses, grants for green jobs, and research and development on carbon sequestering technologies.

Though I support a bill to mitigate use of carbon-producing technologies, I cannot say with confidence that this bill will be able to achieve that. A system of cap-and-trade can be effective but is easily sabotaged with offset credits. The theory behind cap-and-trade (in this case) is that the government will set a limit on CO2 emissions that can be released into the air and then issue permits to businesses to pollute in the specified range. This provides economic incentives to businesses to reduce emissions for whom it is inexpensive to adopt cleaner air technologies. These businesses can then sell their permits to businesses that cannot easily adopt clean air technologies. So far so good. But then the offsets begin. This allows a business to pollute above their permit allowance so long as they invest in carbon offsetting activities. These carbon offsetting activities could be planting trees in Brazil to encouraging US farmers to adopt energy saving farming practices. Businesses will then invest in the offsets until the cost of offsetting reaches the cost of buying permits. The problem is that offsets reverse any intention and effect that capping has - i.e. it is the purpose of the cap to reduce emissions but offsets allow firms to pollute past the cap as long as they pay for it.


Economically, this makes sense. Those who pollute must pay. But the goal of the bill clearly specifies a 17% decrease in greenhouse gas emissions by 2020. If the goal is a reduction, then offsets will not help. If the goal instead is to increase the cost of polluting to reduce consumption, then cap-and-trade with offsets is the right system. it might seem that in both cases the reduction in emissions is realized, but in the first system, without offsets, the amount of emissions is set and final, while the with the offsets, the amount of emissions will depend on a multitude of factors such as firm's cost structures, elasticity of demand for that firms products, elasticity of supply of that firm, etc. And this is where it becomes complicated.

Further, though I have not done the research, it seems a bit far fetched to me that planting forests in South America will offset emissions released in the US. On average, maybe this is true, but this isn't statistics where the average rules. This is our air and I want the air I breath in the US to be clean, not clean "on average."

TGR: Efficient Allocation System?

What's a TGR? Read Martin Feldstein's article in the WSJ.

Tradable Gasoline Rights are a great idea because they essentially solve the Tragedy of the Commons that is our ozone layer. By assigning the right to pollute we can internalize the marginal cost of CO2 emissions. The government would effectively set a cap (just like cap and trade) so that our consumption would be limited. This would be the mechanism for setting a market price that internalizes the societal harm of excessive gas consumption. Instead, if we were to implement a gas tax, we could to get to the same consumption but calculating the correct tax would be difficult or near impossible. TGR offers a simple solution to this difficult calculation. Further, many say a gas tax would be easier but a tax doesn’t limit quantity which is the objective of TGR. A tax would be effective if the sole objective were collecting higher government revenues and inflating the price of gas as to justify research and development on alternative energy technologies.

The best part about TGR versus tax is that TGR would be a progressive policy, i.e. it would tax those that use higher quantities more whereas a gas tax is regressive (all sales taxes are) and would essentially tax the poor proportionally more than the rich.

With a system of TGR there is an externality that arises which could be detrimental to society; that is the urban migration externality. If people are given the choice to sell or use their TGR, many would chose to sell and use less gas which might mean moving to more urban residences. China and many upcoming third world nations have major problems due to urban overcrowding where the city grew faster than the planners could keep up with which leaves poor sewage, water, and electricity structures.

Another problem with this system would be the rationing. I feel that getting the rationing correct isn’t necessarily the problem because the market will naturally reallocate the TGR to the people who value them the most but rather the share that are for businesses versus individuals. I have heard the suggestion that TGR should only be given to individuals where businesses would have to buy TGR which would create high incentives for businesses to invest in energy efficient technologies. This would also eliminate any political lobbying for higher allocations of TGR to certain industries.

I am not sure if my assumption that the market will allocate responsibly is valid and therefore, I feel that either the market will prevail or rationing correctly will be an integral part of a TGR system working. And this all goes back to Hobbes who said that if transaction costs are high (i.e. calculating allocations to each individual or household) then you have to get it right the first time. This is the major hurdle with a system of TGR.

The good thing with a TGR system there is little opportunity for a black market to start simply because a TGR would not be a tangible asset and the ability to transfer a TGR between individuals would be only possible within the electronic system – although we must give credit to all those hackers that find a way around most cyber-barriers.

Then the next hurdle is: how do you deal with mass transit? Would a part of a TGR be taken for every bus ride you take? Would it matter on the length of the ride? Would the price of the TGR just be passed onto the consumer via a bus ticket and the transit authority would get rationed TGR? This might make for a very volatile bus fare.