1. 1 Cap-and-Trade Done Right and Done Wrong 1 David G. Tuerck, PhD Professor and Chairman of Economics Executive Director, The Beacon Hill Institute Suffolk University, Boston Heartland Institute Third International Conference on Climate Change Economics Panel Washington DC June 2, 2009

2. 2 Questions to be Addressed Today  Is there an optimal response to global warming?  Can cap-and-trade be an optimal response?  Is Waxman-Markey* the optimal response?  Does cap-and-trade make sense as a stimulus measure? *American Clean Energy and Security Act of 2009. 2

3. 3 What “Optimal” Means Internalizing “externalities.” Maximizing the present value of “utility” (consumption).

4. 4 What “Stimulus” Means Creating jobs and investment where there is involuntary unemployment and a lack of investment demand. Nothing to do with “optimal” allocation of resources.

5. 5 What is Cap-and-Trade? Place a cap on total emissions. Give or auction emission permits to companies. Let companies that find it more costly to reduce emissions purchase emission permits from companies that find it less costly.

6. 6 Elements of an Optimal Policy Impose the correct “carbon price” or “fee.” William Nordhaus, A Question of Balance (2008): –The 2005 social (external) cost of a ton of carbon = $30. –Annual external cost per capita in U.S. = $150 (i.e., five tons of carbon per year per person). –A ton of carbon is emitted by 10,000 miles of driving. –Set fee accordingly. Choose between granting and auctioning permits.

7. 7 Cap-and-Trade Proposals LegislationYearProposed reduction in GHG emissions by 2050 Lieberman-McCain200760% below the 1990 level Kerry-Snowe200765% below the 2000 level Sanders-Boxer200780% below the 1990 level Waxman200680% below the 1990 level Feinstein200670% below the 1990 level Lieberman-Warner200770% below the 2005 level Waxman-Markey200983% below the 2005 level

8. 8 This Version of Waxman-Markey Based on the Waxman-Markey Discussion Draft.* Used by EPA for its analysis.** * http://energycommerce.house.gov/index.php?option=com_content&task=view&id=1560. **U.S. Environmental Protection Agency, “EPA Preliminary Analysis of the Waxman-Markey Discussion Draft,” April 20, 2009.

9. 9 Waxman-Markey Titles I.Clean Energy (standards, CCS*, smart grid) II.Energy Efficiency (buildings, appliances, transport) III.Reducing Global Warming Pollution (cap and trade) IV.Transitioning to a Clean Energy Economy (subsidies for transition costs) *Carbon capture and sequestration.

10. 10 Reduce GHG emissions to: – –3% below 2005 levels by 2012 – –20% below 2005 levels by 2020 – –42% below 2005 levels by 2030 – –83% below 2005 levels by 2050. Satisfy 15% of compliance by submitting allowances, pay 8% premium. Rebates for industrial sector until 70% global compliance. 10 Waxman-Markey Details

11. 11 Praise for Waxman-Markey “Increase new building efficiency by 50 percent” (Center for American Progress Action Fund). Create “millions of new jobs for Americans” (Barack Obama). Save “American consumers and businesses $465 billion annually in 2030” (Union of Concerned Scientists). “Simultaneously address the climate crisis, the economic crisis, and the national security threats that stem from our dependence on foreign oil” (Al Gore). “Restore America’s leadership of the world” (Al Gore).

12. 12 Nordhaus on Global Warming Yale economist who created the “DICE”* model: Do not: do nothing or do too much. Implement policy that charges the optimal price (or “fee”) on carbon: $27/tonne in 2005. Apply to all sectors and countries. Avoid controls, subsidies for green energy. *Dynamic Integrated Model of Climate and the Economy.

13. 13 Alternative Scenarios Benefits and Costs of CO 2 Abatement Policies Change in utility (consumption) relative to no- controls baseline % change in utility Environmental Damages Abatement Costs: PV Present Value Change in PV relative to baseline Trillions of 2005 US dollars % WORLD No controls for 250 years0.00.0022.60.0 Optimal3.40.1717.3-5.22.2 Waxman-Markey Only U.S. cuts-2.6-0.1321.1-1.53.8 OECD cuts in concert-3.4-0.1719.2-3.37.0 World cuts in concert-9.5-0.4811.5-11.120.7 U.S. ONLY No controls for 250 years0.00 4.130.00 Optimal0.620.173.17-0.960.40 Waxman-Markey Only U.S. cuts-3.42-0.953.86-0.273.85 OECD cuts in concert-3.09-0.863.51-0.613.85 World cuts in concert-1.74-0.482.10-2.033.85 Source: Based on DICE-2007 model.. Note: Assumes U.S. damages and abatement costs reflect the U.S. share of world GDP.

14. 14 Carbon Fees 21002200 202755 778677

15. 15 Effects on Fuel Costs 20072008Alternative fees Carbon fee$/tonne34.00122.00714.00 Equivalent fee on CO2$/tonne9.2733.27194.73 Increments to prices GasolineRetail price$/gal2.763.210.080.301.73 Natural gasResidential price$/'000 cu ft14.215.50.511.8210.66 Electricity: coalRetail pricec/kWh9.139.810.722.5815.07 Electricity: natural gasRetail pricec/kWh9.139.810.321.166.80 Source: Energy Information Agency. 15

16. 16 Effects on Global Temperature Relative to 1900 Global Temperature change (degrees C) 2005205021002200 No controls for 250 years0.731.813.305.30 Optimal0.731.682.763.45 Waxman-Markey: Only U.S. cuts0.731.773.125.08 OECD cuts in concert0.731.712.884.70 World cuts in concert0.731.511.722.00

17. 17 EPA Analysis of Waxman-Markey Only economic costs, not benefits. Abatement cost would rise from $22 billion in 2015 to $206-277 billion in 2050. “Allowance price” (fee) would rise from $62- 81/tonne of carbon in 2020 to $272-352/tonne in 2050.

18. 18 Waxman-Markey: A Stimulus? Cap-and-Trade cannot create stimulus for 2009-2010, given that it starts in 2012. Stimulus measures are supposed to boost spending temporarily, not fix externalities. Cap-and-trade is about long-term effort to reduce CO 2 emissions, not the creation of a stimulus. The higher cost of energy due to cap and the costlier renewables create negative stimuli.

19. 19 Waxman-Markey: A Stimulus? (Cont’d) Steer existing jobs and investment from old energy to renewable energy. Drive investment from U.S. to countries with no caps.

20. 20 Answers to the Questions Asked in Slide Number 1:  Yes, there is an optimal response to global warming.  Yes, Cap-and-Trade can be an optimal response.  No, Waxman-Markey is not an optimal response (and far from it).  No, Cap-and-Trade does not make sense as a stimulus measure.

21. 21 In Summary Nordhaus is an attempt at Cap-and-Trade done right. Waxman-Markey is Cap-and-Trade done wrong (very wrong). –Imposes carbon fees that are too high. –Pushes highest fees onto future generations. –Is not the way to do a stimulus.

22. 22 The Beacon Hill Institute at Suffolk University 22 The Beacon Hill Institute at Suffolk University in Boston focuses on federal, state and local economic policies as they affect citizens and businesses. The institute conducts research and educational programs to provide timely, concise and readable analyses that help voters, policymakers and opinion leaders understand today’s leading public policy issues. © May 2009 - Beacon Hill Institute at Suffolk University The Beacon Hill Institute Suffolk University 8 Ashburton Place Boston, MA 02108 Phone: 617-573-8750 Fax: 617-994-4279 dtuerck@beaconhill.org http://www.beaconhill.org