Thoughts on carbon cap and trade from U of I economist Don Fullerton

Thoughts on carbon cap and trade from U of I economist Don Fullerton

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If you’re already a campaigner for or against a national system of cap and trade for carbon in the U.S., today’s commentary probably won’t offer much interest to you. If, on the other hand, you’re still a little fuzzy on just what cap and trade is, and you’d be interested to know some thoughts on it from Don Fullerton, a UI economist who specializes in research on energy and environmental policy, stick around.

First, the simple definition. Under a cap and trade system, the government creates a market for carbon emissions by issuing a number of permits that matches the maximum target amount of carbon output. In order to emit carbon legally, a firm would have to hold a number of permits equal to its own quantity of carbon output, and these permits could be bought and sold in an open market. Firms that can reduce carbon emissions at a lower cost than the prevailing market price can sell their permits, and firms with higher abatement costs can buy permits.

On the plus side, according to Fullerton, such a system, properly implemented, can produce the intended result. That’s because 85 percent of U.S. carbon emissions come from operations that would fall under the regulation of such a plan.

He thinks it unwise, however, for supporters of cap and trade to suggest it could be implemented without any disruption to the economy because that raises expectations in an unhelpful way. “In the short term” Fullerton says, “prices on energy and energy-intensive goods are going to increase. There’s no way around that.”

From Fullerton’s perspective a rise in the price of fossil fuels is not sufficient reason to reject cap and trade. He points out that the costs of cutting greenhouse gas emissions through such a system are predictable, and that they can be minimized. On the other hand, the costs of doing nothing to avert climate change are much more difficult to anticipate, and they’re likely to be higher. In wealthy parts of the world such costs might include the economic burdens of coping with new conditions for agriculture and protecting coastal cities from sea-level rise. In developing countries, such costs would be borne more directly by the world’s poorest people, those millions who would suffer from drought in Africa, and those millions who would be displaced by sea-level rise in Bangladesh.

Fullerton acknowledges a point often made by opponents of cap and trade in the U.S., that higher prices on fossil fuel here have the greatest impact on the Americans who earn the least. But he counters that a cap and trade system could be made fair through tax credits or direct payments to people based on income. To provide the funding for such compensation, it would be essential that the government raise money by auctioning off the carbon permits rather than giving them away. Otherwise taxpayers wind up subsidizing energy companies.

Would implementing cap and trade wreck the economy? Fullerton points out there’s a lot of evidence that it won’t. Will it cause disruptions? Yes. In a world of higher prices for fossil fuel, some companies will lose and others will win, especially innovative companies that have already been looking ahead.

The biggest potential trouble with cap and trade, according to Fullerton, is what’s known as leakage, which is the movement of activities with high carbon costs to other countries. For that reason Fullerton thinks the U.S. should not go it alone. But for him that’s more an argument for making our first steps moderate than for taking none at all. Events leading up to the U.N. conference currently taking place in Copenhagen suggest that if the U.S. is willing to lead, other countries, including China and India may be willing to follow.

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For a fresh perspective on the U.N. climate change conference check out coverage by Adam Lentz on his blog "From Urbana to Copenhagen" [http://go.illinois.edu/copenhagen]. A native of Copenhagen who is studying in the U.S. as a Fulbright scholar, Lentz is currently working toward a double Master’s degree in the departments of Natural Resources and Environmental Sciences and Agricultural and Consumer Economics at the University of Illinois.