nogoAs cap and trade legislation gets debated in Oregon and Washington, a worrisome lightbulb seems be going off for a number of folks. (Congressman DeFazio from Oregon, for example.) It goes like this: instead of “cap and trade” how about just “a cap without the trade?”

Under this idea, we’d meet the terms of the cap through command and control regulation. There wouldn’t be permits or a trading system (and hence no auctioning). To be sure, this will reduce emissions, which is a very good thing.

But in terms of fairness and inexpensiveness, let me be completely clear: this is a horrible idea.  

For consumers and businesses who are already struggling to pay their energy bills, cap without the trade is actually worse than the very worst form of cap and trade. Plus, it misses out on almost all of the updsides of cap and trade done right.

In the worst form of cap and trade—a “grandfathered’ system, in which the government gives out permits to polluters for free—consumers wind up paying massive windfalls to the big energy companies that get free permits. [Click here to learn why]. That’s why we favor auctioned cap and trade, since it  makes polluters pay for their permits—and the public keeps the money. Auctioned cap and trade is fair, effective, and efficient.

But if you can believe it, cap and no-trade would  actually be worse for consumers and businesses than a grandfathered system. Families would pay even more for energy, while Exxon and other big energy companies would get even bigger windfalls!

Here’s why.

  • Think Econ 101 for a second: price is determined by supply and demand. If the the supply  of something—say, fossil fuels — goes down, then the price goes up. This means that capping the amount of fossil fuels that get burned will automatically raise the price of those fuels. Consumers will face higher energy prices. 

    The way to make things right is to auction of the permission to pollute (aka, the carbon permits). If we auction off the permits the result is that the extra money from the higher energy prices will flow back to the public. In fact, the money can even be rebated directly to citizens. That’s good news.

    By contrast, if we give away the rights to pollute, the extra money from higher energy prices will go to private companies and their shareholders. That’s not so good. And cap and no-trade does exactly that: in essence, it gives away the right to pollute, even while it ensures that prices will go up.

    Actually, it’s worse than that. Because there’s no trading the pollution permits won’t get distributed “efficiently” (i.e. inexpensively) across the economy. Officials will pick and choose who gets what and how much—and their choices will probably have more to do with who’s got the best lobbyists than with genuine need. (Even if officials never made mistakes, the absence of trading would mean that companies can’t respond to changing conditions; and they’d have diminished incentive to upgrade to cleaner technologies.) The inevitable inefficiency will raise the price of carbon, which will mean even bigger windfalls for polluters and even greater harm to consumers and businesses who rely on energy.

    Look, I get it. I understand why cap and no-trade is appealing. Markets are a four-letter word right now. People are freaked out by the recent shenanigans. But there’s a pretty obvious solution: regulate the carbon markets. Subject them to commonsense oversight. I’m not saying it’s child’s play, but it’s definitely not rocket science either.

    Despite Congressman DeFazio’s displeasure with cap and trade, there is absolutely no reason to believe that cap and trade would necessarily involve “unregulated” markets. (And, no, saying the word “unregulated” over and over again doesn’t actually mean that something will in fact be unregulated.) Regulation is a choice we get to make. Let’s choose to regulate the carbon markets. Problem solved!

    In fact, one of the best ways to begin to regulate the carbon markets is to auction the permits. Auction them publicly, transparently, and frequently. In other words, do what RGGI does. And there’s been zero evidence of gaming in the RGGI carbon market.

    Even in Europe’s cap and trade program, which has hit a few bumps,there’s been no evidence of Enron-style gaming and price manipulation. In fact, the problems are mostly political in nature, as polluters jostle to get free carbon rights behind the scenes. We can fix most of Europe’s mistakes simply by auctioning the permits.

    Yes, the price of carbon in Europe has gone up and down. That’s exactly what we’d expect from a market. It’s not a sign of failure, it’s a sign that the system is working just right.

    ***

    Postscript 1: I admit it, the title of this post is an intentional exaggeration. Cap and no trade isn’t the worst idea I’ve ever heard, it’s just a bad one from a fairness perspective. The worst idea would be electing not to put a cap on carbon.

    Postscript 2: To clarify, the idea I’m objecting to in this post is a cap where the cap is met with command and control regulation. I’m not objecting to a cap where permits are auctioned but trading on the secondary market is forbidden. This form of cap, auction, and no-trade could be an okay idea, though it’s probably less good than allowing trading.

    Postcript 3: I turned down the boil on some of the writing throughout the post.