Whither climate change legislation

With both John McCain and Barack Obama onboard for cap-and-trade legislation, this year’s election bodes well for climate change progressives. It means we as a nation are joining the climate change fight no matter who wins the election.

Differences do emerge in the details, though, around such things as how stringent the caps should be, and whether the profits from trading ought to go into the government coffers as a new tax, or back to industry to fund future abatements, or to both. Of those, Obama talks the toughest game, pushing for much more aggressive caps and reductions than Kyoto calls for, and a high rate of auction. McCain, on the contrary, has pushed for more explicit multilateralism in the form of allowing linkages to Kyoto credits, more time to adjust to the caps, which are more in line with Kyoto targets, and a much lower auction rate.

First, a quick lesson: Under a cap-and-trade scheme, there are effectively three ways to make carbon credits to satisfy the cap: 1) by fiat (either allocations or auctioning of allowances by the government), 2) by industry reductions in emissions inventories to levels below their caps, or 3) by offset projects from companies that are not capped (e.g. building a wind farm instead of a coal plant). The second two actually reduce carbon emissions; fiat does not. 

So in addition to the absolute size and speed of the reductions in the caps, there are two other structural areas—how much to auction and how directly are markets linked—that we should be concerned about.

Linkage: The challenge with a unilateral approach to cap and trade is that it’s similar to going into Iraq unilaterally: It’s a bad a idea. Carbon is a global problem, and lots of separate policies aren’t likely to solve it without significant economic collateral damage. With cap and trade or taxes, if we implement separate markets or tax schemes in our country that differ from Kyoto, we’ll likely end up with different prices for carbon in California and in Texas than in China and in Europe. And since China alone now emits more carbon than the United States does (with a much faster growth rate), a U.S.-alone approach won’t solve the problem.

And if there is no way to equalize the price by simply trading credits in linked markets, the only route left for industry is to shift production out of the country with the highest price, or lose out to competitors from those markets with lower prices. If the markets are linked (meaning you can buy Chinese credits to meet California demands for example, a topic of much debate), but the local carbon regulations in California are tighter, industry has less of a need to shift production overseas, and instead could sometimes shift its carbon purchases overseas instead of shipping its labor or materials purchases (we still pay for it, but we can more easily pay for it with capital instead of shifting jobs offshore).