Cap And Trade: Just Another Energy Tax?

by Mike Godfrey, Tax-News.com, Washington

11 May 2009

The Senate Finance Committee on May 7 held a hearing to examine the viability of President Obama’s ‘cap and trade’ emissions trading proposals. But will environmental tax policy ever be anything more than just another means to raise revenues by stealth? The Committee’s Ranking Republican, Chuck Grassley, seems to think not.

“We are talking about a program that will raise hundreds of billions of dollars every year for the federal Treasury,” Grassley observed in his opening statement. “What’s more, the cost will be paid by every American in the form of higher prices for energy, services, and any product that takes energy to produce or transport to market.”

According to Grassley, key figures in the new administration, including President Obama himself, have acknowledged that under a cap and trade system electricity rates “would necessarily skyrocket” and that consumers, rather than firms, would ultimately bear the costs of allowances in the form of higher prices.

“If that sounds suspiciously like a federal energy tax to those of you listening, you’re right,” Grassley remarked.

President Obama intends to implement an economy-wide cap-and-trade program to reduce greenhouse gas emissions by 80% by 2050. Under this program, companies would buy rights to emit greenhouse gases from firms that use less energy and emit less carbon. This policy would require that all pollution credits be auctioned, but some firms are lobbying for some permits to be given away in the early stages of the scheme, as has happened in the European Union, to smooth the transition towards full auctioning. Obama says that the proceeds will go to investments in clean energy research and technology, and would provide rebates and other “transition relief” for families.

In the Senate, environmental initiatives are usually scrutinized by the Environment and Public Works Committee, but because this measure would, as Grassley has pointed out, raise billions for the government, the Finance Committee, which has jurisdiction over all federal taxes, has stepped in to examine whether the Treasury is the right department to design and manage an auction program.

“The work of the Finance Committee remains key to this effort, and I’m committed to finding workable solutions in cooperation with my colleagues, the business and environmental communities, and the President,” said Senator Max Baucus, Chairman of the Finance Committee.

Baucus pressed witnesses on the potential effects of a cap and trade program on the US economy and options to contain costs for both industries and consumers. Jos Delbeke, Deputy Director-General of the European Commission’s Directorate for the Environment, noted that the European Union will allocate free carbon allowances to certain carbon-intensive and trade sensitive industries during Phase III of its cap and trade program. Delbeke explained that this approach will limit auction revenues generated by the program, but will offset transition costs to industry and consumers.

The European Union is already proceeding with its own version of cap and trade, known as the Emissions Trading Scheme (ETS), although the jury is likely to be out for some time before the program’s effectiveness can be fully judged. Under the scheme, emission allowances, each representing the right to emit 1 tonne of carbon dioxide, are issued to participants and the limit is set by issuing a fixed number of allowances for each trading period. Phase I was the first trading period and covered 2005-2007. During this period, almost all allowances were allocated to participants for free. Phase II runs from 2008-2012, covering the first commitment period of the Kyoto protocol. In phase II, the EU Directive sets a limit on the maximum amount of allowances that can be auctioned of 10%.

The United Kingdom became the first EU member state to test the system having held the first auction for carbon trading allowances under the ETS in November 2008. The UK National Allocation Plan for the second phase of trading in the EU ETS sets aside 7% of the allowance cap for auctioning, amounting to approximately 85 million allowances over the phase. It has been estimated that the auctioning of carbon permits could raise as much as GBP2bn (USD3bn) in revenues for the UK government over four years, and it has been suggested that embattled Prime Minister Gordon Brown, known for his liking of raising revenue through ‘stealth taxes,’ prefers this less visible method of environmental taxation to the more populist idea of a direct windfall tax on the profits of energy companies.

Indeed, politicians around the world are learning that while environmental issues are becoming increasingly important to electorates, the idea of simply paying more taxes to curb bad behaviour with the idea of using this money to subsidize good is not much of a vote grabber. What's more, voters are sceptical that governments will spend the money on the things they promise during election campaigns. Just ask Stephen Dion, the former leader of Canada’s Liberal Party, whose much-touted ‘Green Shift’ policies were a contributory factor in the Party’s drubbing at the polls last year.

But it seems that tax and the environment are going to be inextricably linked for a long time to come.

An EU study into the area of environmental taxation last year concluded that the best approach to reducing greenhouse gas emissions is to “tax at root.”

“Putting a proper price on the emissions of, for example CO2 emissions and thereby also energy use, will give consumers and industries incentives to reduce them,” the report said. “The EU Emissions Trading Scheme is a prime example of this; indeed emissions of CO2 from nearly all electricity consumption and district heating by households are already covered by the ETS."

A new report by the UK’s Chartered Institute of Taxation, published on May 7, makes it clear that non governmental activity in this area “will simply not go away” as environmentalists and other pressure groups step up their efforts to get governments to do far more to control emissions and protect the planet. CIOT said: “One can say with some certainty that tax and other fiscal measures are expected to play an important role in tackling this worldwide problem.”

Nick Goulding CIOT President added: "The question then becomes ‘in what way will tax be deployed in achieving these environmental goals?’ Will taxes be used creatively as agents to modify and change behaviour, or imposed in a blunt manner to penalise 'bad' environmental practices, possibly using the revenue to reward the environmentally 'good'?"

At a time when many governments around the world are using any means necessary to clamber out of deep fiscal holes, one is likely to conclude that the stick will be used long before the carrot.

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