Viewpoint #1: Cap and Trade is very different from an Externality Tax and can be treacherous

03 Dec Viewpoint #1: Cap and Trade is very different from an Externality Tax and can be treacherous

Green Position on Cap & Trade is No!
Here is the content of an advertisement that I plan to run in the Seattle Times on Sunday, August 9, 2009.
Cantwell and Murray should nix it….The Green Position on Cap & Trade is No!

The devil is in the details, goes the cliché…

Cap & Trade has details enough to make a Hedge Fund jealous. One of the details that terrifies me, a detail that could destroy the world’s remaining forests along with its remaining biodiversity, involves carbon offset credits. Under Cap & Trade a polluter will be allowed to continue to pollute as long as they save a forest. But the definition of saving a forest has been written, as if by the devil himself, to include destroying it and turning it into a commercial plantation. It’s refreshing to have leadership that cares about the sad state of the Earth, but we must not let our shared sense of urgency serve as an excuse for adopting flawed ‘cures’ that are even worse than the disease.

-Ed Newbold Wildlife Artist

End Seattle Times ad copy

So much for the ad. I’m thinking it’s important, since I decided to run this ad, to lay out in an essay why I oppose Cap and Trade, or specifically the Waxman-Markey Climate bill:

What’s Cap and Trade about?

Cap and Trade is often called a “Market-based solution,” both by oponents and proponents, but that’s really a mischaracterization.

Let’s look at an example of a true “market-based solution,” the tax on tobacco cigarettes. Here’s how it works:

The government, deciding that cigarettes are bad for people’s health, including those who don’t smoke, levies a tax on the consumption of cigarettes. It tries to set the tax below the rate which would generate a vigorous black market, and it tries to find and prosecute any vendor who isn’t paying the tax. In the scheme of things, it’s all very simple, and it works fine. This tax makes the smoking of tobacco more expensive and therefore rarer. It allows people to decide how many cigarettes they want to smoke, but doesn’t allow them to avoid the tax. Let’s say the tax happens to be enough to lead to a decline in smoking of 10%.

This tax is an “externality tax,” i.e., a tax on something that has a negative effect on others not accounted for in any market transaction.

[singlepic id=18 w=400 h=300 float=left]Under a Cap & Trade regime, cigarettes like these shown would be much cheaper because they wouldn’t be taxed. You’d need a permit to buy them, and that might cost a lot or a little, depending on many things.

Now suppose the Government wants to reduce smoking but instead of the straightforward approach, it chooses do do this with a “Cap and Trade” program for smoking. The first step of implementation is for the government to determine who is smoking how many cigarettes. It then grants and/or auctions them the right to buy and thus smoke those cigarettes. However, it is trying to reduce smoking, so the government must estimate current use, and “cap” it at some level below that, we’ll say 90% of base levels. Smokers get the right to smoke 9 cigarettes for every ten they smoked last year. For some, forgoing that 10th cigarette is easy, even the 9th one as well, and those smokers are allowed to sell their unused rights to other smokers who don’t want to reduce or want to smoke even more than last year.

In this example in which Cap & Trade is hypothesized to have worked perfectly, the overall result was very similar to the tax, but notice that Government’s job was more complex, more psychologically intervening, more controlling, and much more expensive. And notice that a brand new “market” is created that is not created in the first scenario, where people simply absorbed a higher price signal for tobacco.

The fact that Cap & Trade creates a market that didn’t exist before, combined with the comfort many large Corporations have with it (the late Enron Corporation had hoped to trade Carbon offsets) has strangley influenced mainstream observers plus activists from both the political Right and Left to see Cap & Trade as a “Market” or “Market-based” solution.

Notice that to the extent that the government granted the rights to smoke cigarettes rather than sold them, some folks who were about to quit anyway became suddenly enriched by government, rewarded mightily for having been cigarette smokers, as they now can sell their smoking credits on the Smoking Credits Market. Nothing remotely like this happened under the tax.

(In my original description of the program I said it grants and/or auctions the smoking rights, but the difference is crucial. If the rights are auctioned, Cap and Trade could concievably make some minimal amount of sense. Under Waxman Markey, 85% to all of the permits will be simply handed out, so we will continue to proceed in this analogy with a free-permit system).

Also notice that since the program began, all smokers have been elevated above the rest of us. They aren’t just smokers anymore, but newly minted property-owners: holders of special tradable and likely valuable Government rights to smoke cigarettes.

Now lets think about the value of this windfall for the smoker who isn’t going to use his or her permits. Because the government is reducing the total amount of smoking allowable, by 10%, the windfall has real value. If the government gives out as many or more permits to smoke as people want, the permits will have little or no value (they still may be sellable on the “futures” market). But if government aggressively limits smoking, say by 30%, the permits will shoot way up in value and so will the windfall income of people who are gifted with these rights to smoke and in a position to sell.

But wait, this is going to be a “Hybrid” Cap and Trade program. Since citizens are dying from tobacco all over the country and in other parts of the world, let’s create another option to add to the market, “smoking offsets.” If smokers contribute money to a program either in the US or in another country to convince people to quit smoking, they can avoid having to reduce their own smoking. These “offsets” can now be bought and sold along with other smoking credits by anyone, and can be bundled.

Some people believe that some of the “offset” programs to reduce smoking are ineffective, or in some cases nonexistent, corrupt, or counter-productive, so a governmental panel is set up to examine these issues and grant accreditation to offset programs deemed to be real. Independent anti-smoking activists not connected to the mainstream anti-smoking organizations that are helping design the program accuse some on the panel of having ties to the Tobacco industry.

Now the government’s role, with the “Hybrid” Cap and Trade on cigarettes, has become yet more complex. It must evaluate smoking cessation programs here and abroad for their effectiveness. Are the 5000 people who someone says gave up smoking in Seattle or the Philippines real? Did they really quit? Did they really quit because of the program or would they have probably quit anyway? Are they going to stay quit? Is there an age escalator where 5000 new young people have just taken up smoking, effectively replacing the 5000 older folks who just quit?

The Companies which develop and sell smoking offsets must also develop social monitoriing research instruments to try to answer these questions, many of which are so esoteric that they might thoroughly stump a scientist. The monitoring must be continued indefinitely into the future, since some social, natural or national trauma might suddenly cause many former graduates of anti-smoking programs to resume smoking. The monitoring takes time and money that the staff and managers of the anti-smoking program would rather spend on the ground to make their programs work, or repatriate as profit.

But despite these issues, the hybrid Smoking Cap and Trade Program (SCTP) is up and running, and now we can expect the Government to progressively reduce the Cap, if all works according to plan.

While achieving roughly similar results as a tax on cigarettes in this (unlikely) scenario in which everything worked perfectly for it, the SCTP still cost taxpayers massively more. Thus health programs that would have been underwritten by the simple tax on cigarettes had to go unfunded. Certain players in the drama were enriched completely irrationally. It also reduced individual freedom massively more–which matters to some, and it pitted the individual against the government massively more by using government fiat rather than a simple price signal to instigate change, thus possibly creating the underlying psycho-social infrastructure that leads to social alienation and rebellion.

But really, this was all hypothetical. Cap and Trade as applied to Carbon emissions in practice would be much worse than in this sanitized analogy.

Why Cap-&-Trade Carbon, but tax Cigarettes?

Cap & Trade of individual smoking would be so complicated as to be untenable, but that’s only part of the reason a simple tax is chosen for cigarettes while we are on the verge of adopting a Cap & Trade program for Carbon. Cigarette smoking has declined in the US, (thankfully) to the point smokers are a small minority of the population. A very logical tax on them does not create a huge political problem for legislators. Not so Carbon users, since that category includes nearly everyone. Cap & Trade, if done according to plan, will cost the Carbon user money (if the cap is set lower than the market would set carbon use) but it has the tremendous political advantage of a last name of “Trade” rather than “Tax.” (Trade= good Tax= bad). Large Corporations either love Cap and Trade or at least water down their opposition they would have to a Carbon Tax because there is something in it for them: valuable Carbon emission permits. Meanwhile, many very good, smart, and very well-intentioned people who care about the planet support Cap & Trade of Carbon, that’s non-negotiable. But are they making a worse-than-Faustian bargain? I think so.

Not only will Cap & Trade fail to reduce Carbon use, it will result in the speeding-up of the destruction of the remaining worldwide forest. Furthermore, Cap & Trade is fundamentally arrogant in it’s assumptions about the world. Finally, Cap & Trade will undermine approaches to saving the forest that are working now, and undermine approaches to reducing carbon that can work much better than Cap & Trade.

Cap & Trade will not succeed in reducing Carbon use

Cap and Trade will fail or at best not be very good at reducing Carbon use. Why? Let’s go back to the cigarette analogy. How did the government determine how much smoking was occurring at baseline? Government used research, questionaires and public data and their own monitoring devices. One method was to ask smokers how much they smoked in the previous year. The smokers, knowing a crackdown was on its way, answered the questionaires on the high side. It wasn’t always a case of lying, as often they weren’t sure exactly how much they smoked since they had not installed their own methods of counting their cigarette use, and they didn’t want to err on the low side.

Because of a tendency to count high by both the smokers and the bureaucrats who fear rebellion if the crackdown is too onerous, the first set of permits issued actually allows for MORE smoking than baseline. A vigorous market fails to develop for permits since only a few people don’t have enough already, but some permits are bought and sold and some smokers become rich(er) selling them.

This is essentially analagous to what is happening in Europe in the Carbon market where Carbon Cap and Trading has already gotten underway and Carbon use has increased while producers of dirty energy have recieved massive windfall income.

But it’s worse than it looks. In the entire span between when Cap and Trade first hit the political radar and it’s implementation, a perverse incentive has been at work. The smoker’s incentive during this time has been to smoke as much as possible, because, as everyone knows, the smoking permits will be doled out based on baseline smoking amounts, and eventually the permits will be worth a lot of money.

But once the permits are issued, a new perverse incentive takes hold. A shot has now been fired across the bow of all smokers: The Games have Begun! Organize and Fight for your newly acquired permit (property) rights. Find ways to define them in your favor. If you want more, work to find and jump through loopholes in the system. It’s time to start gaming Cap & Trade, and it’s not hard–it’s probably a lot easier to game the system than to reduce your smoking!

Cap and Trade is supposed to work because the Government will incrementally take away the permits it has so kindly doled out. But things are different than before the program started.

Before John Doe was just a smoker. Now he’s not only a smoker, he’s an owner of property, a holder of tradeable permits that grant him the right to buy cigarettes, and when he says you can’t, or shouldn’t, take away his permits, he’s not just blowing smoke! he has much stronger legal and political ground to stand on than he did as a simple smoker.

In the US Constitution it says that the government may not take or confiscate private property. The imagined ease of ratcheting down the “Cap” is up against this simple fact. Every decrease in the cap is fought hard in the political arena, in the Courts and in the court of public opinion.

The legality of reducing the cap is questioned and the plaintiffs who argue against reductions now have a much stronger argument than they ever had before. The government is now confiscating their property every time it reduces the Cap.

Regardless of whether they prevail in this line of legal argumentation, every Cap reduction becomes a battle royale.

Luckily, we have a laboratory example. In Europe, Carbon use rose for the first three years of Cap and Trade and has declined since not because of Cap and Trade but because of the recession. Here’s how the Wall Street Journal put it on June 26, 2009:

Given the system’s inherent flaws, it comes as little surprise that the ETS didn’t quite work as intended. According to European Commission figures, emissions from the 27 member states rose by 1.9% in the first three years of the regime. Following criticism, the caps for the period to 2012 were reduced for the majority of member states, but only to a little lower than actual emissions in 2005, and the evidence is that the recession is having a much more direct impact on emissions than the trading scheme (incidentally putting a lot of low-priced permits on the market).

Notice that the job demanded of government by Cap & Trade involves predictive abilities which neither government nor anyone else has. When Government in Europe failed to foresee the recession that would reduce the demand for Carbon permits, that resulted in flooding the market with “low priced permits.” Any energy producer who wants to keep liberally using coal and just game the system should just be on the lookout to buy these cheap permits up whenever they come on the market: changing might never be necessary.

But here’s the Real Nightmare of Cap & Trade: it will facilitate the destruction of the world’s remaining forests

So far, any reader who has waded through to this point may conclude that my only problem with Cap & Trade is that it may be ineffective and idiosyncratic in its rewards, cost a lot and be complicated. But the reality is so much worse than that. Cap & Trade will do real harm. The Carbon offset credits will create a nightmare for the world’s remaining forests.

In the smoking analogy, recall that smokers who wanted to smoke more cigarettes could always buy “offsets.” Offsets were purchased when smokers buy into an official program from somewhere around the world designed to reduce smoking. With Cap & Trade, polluters can buy similar credits from programs designed to increase the Carbon storage of vegetation on the land.

Here’s how the Nature Conservancy, which sadly supports Cap & Trade, expresses enthusiasm for this idea on their website:

Linking Emerging Markets
By including strong provisions to allow participants in a U.S. cap-and-trade system to access international forest carbon credits , U.S. climate policy will create incentives for developing countries to limit their greenhouse gas emissions.

Access to U.S. greenhouse gas markets is strong motivation for participation by emerging economies. Linking our carbon markets to developing nations through policies to reduce emissions from deforestation and degradation is a triple-win proposition. It has the potential to

unleash tens of billions of dollars to save the world’s forests and their biodiversity;
help contain the costs of U.S. climate policy for U.S. companies ; and
improve the quality of life for local communities around the world.
However, developing countries will need to put in place key building blocks — such as monitoring systems, and capable enforcement institutions — that will enable them to participate successfully in carbon market activities.

Global Solutions
With conservation projects around the world informing our decisions and policy positions, The Nature Conservancy believes that international action is essential to meet the climate challenge and U.S. leadership is integral to motivating other countries to engage in solutions.

International engagement and linkages increase economic efficiency by increasing the capacity for emission reductions from a diversity of sectors and nations, further encouraging broad political engagement.

But is the Nature Conservancy’s optimism warranted? Read on.

But first read another offset proponent, Dr. Bill Chameides, Dean of Duke’s Nicholas School of the Environment, defending offsets in the Huffington Post:

“Two Prime Reasons Offsets Have Gotten a Bum Rap
Quality of voluntary offsets currently available. Even though we don’t have a cap-and-trade system for carbon in the United States, a pretty healthy market of voluntary offsets has sprung up. The problem is that there are no standards for these offsets. Some may be real, others not so much. And it’s those bad ones that have given offsets a bad name. But just because there are bad offsets in our voluntary market, it does not follow that there will be bad offsets in a regulated carbon market.

“Misunderstanding of climate system. Many people have a hard time accepting that one can emit CO2 from a power plant in Ohio and offset those emissions by capturing methane on a North Carolina hog farm. Or that a New Jersey driver can offset her emissions by paying a California farmer to store carbon on his farm.

“In fact these scenarios work just fine. When it comes to greenhouse gases, the atmosphere doesn’t care where the gases come from; it only cares how much of the gases are in the atmosphere. Offsetting emissions is the same as never emitting the greenhouse gas in the first place.

Now let’s learn a bit more about offsets from reporter Jessica Leber, of E & E (Energy and the Environment) Publishing:

Half would be sourced domestically and half abroad, although the most recent Waxman-Markey substitute allows that international credits could reach three-quarters of the total in the likely chance that the U.S.-based market falls short.

But, as some are quick to note, offsets are tricky business. The agency is tasked with setting provisions to verify and enforce those reductions, both in the United States and, even harder, abroad. EPA is also to determine what constitutes a “permanent” emission cut that is “additional,” or wouldn’t have otherwise occurred without a carbon price.

Some consider it an unattainable mandate. “It’s impossible to ensure,” said Environment America’s federal global warming director, Emily Figdor. Others, most notably a number of major environmental groups and businesses that have signed onto the U.S. Climate Action Partnership, have backed offsets that come with rigorous standards.

For regulated industries, they are among the most important components of the bill. Without international offsets, the Waxman-Markey cap-and-trade program could nearly double in cost, EPA estimates.

And although several previous cap-and-trade bills outlined specific projects and sectors, such as forestry and agriculture, that would qualify as offsets, the Waxman-Markey substitute instead would give EPA, advised by an independent nine-member Offsets Integrity Advisory Board, authority to decide which will make the cut.

Much will hang on an advisory board
The latitude left to EPA is largely on purpose. Jake Schmidt, international climate policy director for the Natural Resources Defense Council, said that the move takes a lot of the politics out of the current offsets debate.

But sectors looking to participate in a potentially lucrative market are wrangling to get more specific language back into the bill ( ClimateWire , May 20). Rep. Zack Space (D-Ohio), for example, is working with Chairman Waxman to incorporate some certainty for the agricultural community in the offset market into the bill, according to his spokesman.

Others are happy about Congress’ hands-off approach and for provisions requiring the agency periodically review its own rules. “The best aspect of the quality controls is that the bill leaves the technical decisions to the scientists,” said Figdor.

The result, however, could be to push the political struggle down the chain to the selection and activities of the new advisory board, which the bill’s language indicates could have substantial influence on EPA’s decisions, said Michael Wara, a law professor at Stanford University.

“Everyone who is regulated or is selling offsets wants as much in as possible. This is the cost-control money, and these people are going to be the gatekeepers,” he said.

Conservative regulations could control the supply
At minimum, EPA will have a delicate balancing act on its hands. It could take a conservative approach, limiting itself to projects that unambiguously meet the stringent criteria, but that would likely reduce the offset supply, especially early on in the program, several experts in offset projects and markets said.

One reason is the substantial gray area in deciding whether emissions reductions are additional, especially on the international side and in state-controlled economies like China’s, said Wara. That could play out the extent to which EPA approves already-existing projects for the program, an important source for the initial market supply.

For example, the Obama administration could potentially certify some credits from the United Nations’ Clean Development Mechanism, a program that has been fraught with controversies over questionable projects, said Alexia Kelly, a senior associate in the World Resources Institute’s climate and energy program, although she questioned whether there would be the “political appetite” to do so.

Perhaps most significantly, the bill gives EPA, the State Department and the U.S. Agency for International Development the power to work out sector-by-sector baseline emissions thresholds with foreign countries, under which projects could qualify for offsets in the U.S. market. “It’s sort of like a cap-and-trade with training wheels,” said Wara.

On the U.S. side, EPA will likely look toward existing programs like the Regional Greenhouse Gas Initiative and the Climate Action Reserve, which has been busy building regulatory quality protocols to approve projects based on sector-wide standards for landfills, livestock and forests.

Today, however, RGGI has not yet approved any offset projects. The Climate Action Reserve recently issued its millionth offset credit, which would still be a small drop in the bucket for an economywide program.

Gary Gero, the Climate Action Reserve’s president, is confident that the program could scale up significantly before cap and trade takes effect, and that its standardized methodologies allow for quick approval. He has been urging EPA to adopt its model or even to contract out the process to the Climate Action Reserve itself.

The agency itself already has some experience supervising offsets through voluntary programs and protocols, such as its Climate Leaders program. Those, however, are far less stringent than a regulatory program would be, said Kelly.

Regardless of the overall approach, many agreed that the need for speed is troublesome. Should the bill pass, EPA would have two years after its passage to get regulations into effect and provide an initial supply to the market.

“Look at everything they have to do to approve even a sector of offsets. They are going to be under a lot of pressure to rush, particularly if they are understaffed,” said Victor Flatt, a University of Houston law professor and a scholar with the Center for Progressive Reform. Brownstein said it would be difficult for EPA to get a real head start until the legislation passes, since it currently lacks the mandate, funding and staff.

Will a forest fire cause ‘havoc’ in financial markets?
Flatt worried that the offset program could run into not only environmental trouble but also financial trouble if EPA makes early missteps in approving projects. He’s essentially concerned about “toxic offsets.”

The bill already incorporates an insurance plan on the international side, a buffer that requires five foreign-bought offset credits for every four emissions allowances awarded, leaving one to a common pool. For domestic offsets, the substitute bill removed this wiggle room, said Flatt. The only insurance is a requirement that carbon sequestration projects reimburse EPA if the project “reverses,” or releases its captured emissions.

If a tree in an offset program, for example, is intentionally logged, the bill requires that project developer pay back the offset credit. But if the loss is “unintentional,” say, through a forest fire, the project owner only returns half the cost to EPA.

This one provision, said Flatt, has the potential to cause havoc in emissions financial markets. “To the extent that they can, EPA really needs to have some way to make sure they are made whole again.”

Why I’m Terrified

Other readers may or may not be terrified, but I am terrified after reading this discussion. WHY?

Waxman-Markey will take areas in the Third World where land costs are low, either because of low population, poverty, or because they are “owned” by indigenous people who don’t hold formal title to the land, and overlay this land with one yardstick and one yardstick only: how much Carbon can you sequester for us? as measured by United States bureaucrats.

It’s no accident that there is no mention of biodiversity here, no distinction between native forests and commercial plantations, and no concern for the people who will inevitably be forced off this land as the Carbon Offset Market suddenly makes it worth much more than it is now. There’s no interest in these subjects that reduces back to Cap & Trade.

Indeed, REDD (acronym for Reducing Emissions from Deforestation and Degradation: ) is likely to be the bureaucratic “middleman” involved in accrediting Carbon Offsets under Waxman-Markey, and REDD has had no problem with calling a commercial plantation a forest.

It should therefore be expected that the vast majority of all offset projects will involve commercial pantations, since it’s easier for a transnational corporation to get rent from a plantation than a native forest, and it needs rent from the land to supplement the money it gets from selling the offsets.

Cap & Trade will therefore create a new incentive–above and beyond normal market forces–to cut down native forests and plant non-native trees like eucalyptus, and pine, even in the future special trees bio-engineered to sequester carbon more quickly. These tree-plantations will replace native flora on land that will suddenly surge in value because of the new international market for carbon offsets.

Kiss the native forests good by.

Charles Komanoff, writing in Grist, says of Cap & Trade, ” …there’s less here than meets the eye. For as the inconvenient details of cap-and-trade schemes start to surface, USCAP (US Climate Action Partnership, a coalition of Corporations and big Environmental organizations pushing Cap & Trade-EN) is looking less and less like a CO2 control lobby and more like a corporate club seeking to cash in on the rising clamor against free carbon spewing.

Seattle Climate activist Duff Badgley says, “REDD opens the door to wholesale butchering of our forests by pushing tree plantations. and he quotes Susan Austin, Tasmanian climate campaigner asserting “…This means that a country can convert a natural forest to a plantation or a palm-oil tree crop, and as far as the climate treaty is concerned the tree crop is still a forest, and deforestation (or the permanent removal of the forest) has not occurred.”

This will be no small matter: “Now add the $1 trillion in market-based REDD money predicted by 2019. You get rampant biofuel plantations and vast logging tree farms decimating what remains of our natural forests—and the creatures they harbor,” concludes Badgley.