In late June the House of Representatives approved The American Clean Energy and Security Act. If the Senate approves a similar version, this would constitute the most important American legislation on overall control of carbon-emitting gases. The main provision of the bill is a cap and trade system, to begin in 2012, which would provide allowances for emissions of carbon dioxide and other greenhouse gases. The goal of the bill is to reduce the carbon emitted by American industries to 17 % below 2005 levels by the year 2020, and to reach more than 83% below 2005 levels by 2050.
Some environmentalists have criticized the 2020 energy-reduction goal as too little and too late. However, I believe that the optimal greenhouse gas policy is to go slow initially until greater evidence on the severity of global warming becomes more apparent. The main threat to the world from global warming is an as yet unknown probability of quite severe warming that would cause considerable harm-the world could adjust at relatively little cost to a moderate degree of global warming. The additional evidence accrued during the next decade will provide more information about the likelihood of the severe warming that would merit more drastic steps. If such steps become warranted, then the rate of carbon reduction and carbon storage should be speeded up beyond that envisioned in the House bill. On the other hand, if milder versions look likely, the 2050 goal of a more than 80% reduction in carbon emissions could be relaxed.
Another reason for going slowly at first is to determine how much will be done on global warming not by EuropThese and other developing countries, along with the US, will be the major contributors to greenhouse gas emissions during the next decade. If the BRICs cannot be bribed or threatened into taking steps to reduce their carbon emissions, the US might rethink how much it wants to do. Rethinking American policy would be especially urgent if the more the US did, the greater the migration of industries from America to developing countries.
While accumulating information during the coming decade on the severity of the global warming problem, the US should greatly invest in trying to achieve breakthrough technologies in advanced carbon control and storage. The aim would be to acquire technological knowledge that could be quickly implemented without enormous cost if the evidence warranted imposing major carbon controls and storage in a short period of time. The House bill allocates about $1 billion annually to the Carbon Storage Research Corp for further research. This is probably not enough, given the possible need to act quickly and decisively to combat global warming.
Under the House bill during the first decade or so, almost all carbon allowances will be given away, mainly to companies, rather than sold to the highest bidders. Over time the fraction sold would continue to increase until the vast majority of allowances would be sold. Many economists have criticized this giving away of allowances during the next couple of decades as a missed opportunity to raise revenue for the federal government through the sale of allowances. In light of the pending massive federal deficits during the next several years, auctions might seem the best approach.
However, the political reality is that significant cap and trade legislation might not gain enough political support if the government sold energy emission allowances rather than giving the majority to the industries most affected. For energy-intensive industries are well organized politically, and they would strongly oppose a carbon tax-which is what an auction of emission allowances amounts to- since such a tax would reduce profits in these industries. On the other hand, energy-intensive industries might support, or only weakly oppose, a cap and trade system where most allowances were given to them since that system could increase their profits, or only reduce them by a little.
Economists typically assume that when a new tax, like a carbon tax, is introduced, government spending is held fixed, so that other taxes can be reduced. That assumption is often useful for analysis, but may not be realistic politically. The revenue from a new tax may be mainly used to increase government spending rather than to reduce other taxes. The case for selling emissions through auctions rather than giving them away is a lot weaker if the government wasted much of the additional revenue, or if the additional spending itself distorts behavior by households and firms. Empirically, the most common response to "new" tax sources, like a carbon tax, is a combination of reduced other taxes and greater government spending (see Becker, Gary S., and Casey B. Mulligan, "Deadweight Costs and the Size of Government." Journal of Law and Economics, October 2003). This typical response makes the case for selling cap and trade allowances considerably weaker than if government spending were held fixed after new tax revenues were collected.