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Climate Change Plan B

Cap and trade has proved infeasible. But it remains critical to put a price on greenhouse gas emissions. We need to do it right this time. Let's avoid complexity and adopt a straightforward carbon charge.
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Bringing down greenhouse gas emissions with a "cap and trade" system of tradable emissions allowances seemed like a good idea. When first proposed, the prospect of setting up a carbon market to create incentives for energy efficiency and renewable power looked like a cutting-edge policy tool. But the legislative effort to pass a climate change bill has stalled. Today, cap and trade looks badly out of sync with political reality. So what is Plan B?

Before we shift policy gears, it is important to understand what went wrong with the Waxman-Markey and Boxer-Kerry bills. We owe these leaders in the Congress a great debt of gratitude for having gotten a serious climate change policy debate going, but their proposals failed to take seriously our current political and economic circumstances.

First, cap and trade turned out to be badly out-of-step with our difficult economic situation. This approach to greenhouse gas emissions control locks in the environmental target but leaves open the question of the price at which allowances will trade - and thus what the economic burden to society will be. In the wake of a deep recession, this economic uncertainty unsettled many in the Congress, including Democrats as well as Republicans.

Second, rather than auctioning off the emissions allowances and generating revenues that could be used to lower other taxes (or fund universal health care or support clean energy research and development), the current legislation gave away nearly 80% of the pollution permits - and not just for a couple of transition years but out to the 2030s. The "free" allowances were spread in many directions but the largest chunk went to coal utilities and their customers. This was said to be the political price for change - buying off those who would be hurt by putting a price on carbon. But if this were the logic, the strategy failed. The votes needed to pass legislation have not materialized.

And the allowance giveaways seemed like another example of special interests manipulating the political process for personal gain. And indeed, the loss of $800 billion in potential revenue over the next decade offered real cause for concern. But even more troubling, the allowance allocation would have blunted the incentives for behavioral change. Rather than sharpening the focus of both power producers and consumers on the need to move toward lower emissions, the free allowances would have meant that many coal-burning utilities had little reason to shift to cleaner fuels until their fossil energy (and emissions spewing) plants reached the end of their useful lives. Likewise, at the household level, consumers would have seen little change in their electric bills (after the free allowance rebates) and thus not given much thought to energy conservation.

Third, the idea of a "carbon market" seemed like a flexible and sophisticated way to harness market forces in pursuit of an important environmental goal. But in the wake of our recent economic meltdown, the idea of another esoteric and opaque market didn't sit so well. It felt like another opportunity for Wall Street bankers to make money at the expense of Main Street.

Finally, the current legislation said almost nothing about natural gas. But with half the emissions of goal per unit of electricity generated, natural gas offers the best transition strategy to a clean energy future. Moreover, in the last couple of years, vast new reserves of natural gas have been identified in the United States. The price of gas has come way down and supplies look plentiful for decades to come.

More importantly, natural gas has a proven record as a cost-effective approach to lowering greenhouse gas emissions. Only three countries met the goal of the 1992 Framework Convention on Climate Change and reduced their emissions in the year 2000 to 1990 levels. Russia hit the target, but only by collapsing its economy - not a very useful policy prescription. Both Britain and Germany cut their emissions dramatically by shutting coal mines and shifting to natural gas as the primary fuel source for power generation.

So what should climate change legislation look like? First, we must refocus on driving technology innovation. We need a policy framework that offers real incentives to develop energy efficiency, carbon-free power generation, and the infrastructure (particularly electricity storage and transmission systems) needed to support a clean energy future. Innovation is critical because the key to a winning political coalition on climate change lies in finding breakthroughs that give us more energy (not less!) at lower prices (not higher!).

In this regard, it remains critical to put a price on greenhouse gas emissions. But we need to do it right this time. Let's avoid complexity and adopt a straightforward carbon charge (or better yet, let's call it what it is: a "harm charge") of perhaps $4/ton starting in 2012 and rising $4/year for 20 years, yielding a price of $84/ton in 2032 - with all of the revenue returned to the public in the form of lower payroll taxes. Using the money raised to cut payroll taxes would broaden the base of support for climate change action since any family that did its part to reduce its own energy consumption would come out ahead. And lowering payroll taxes would also encourage businesses to hire more workers and thus provide a significant economic stimulus.

The low initial rate of the emissions harm charge would impose little economic burden. Indeed, utilities in the Northeast are already buying allowances at about $3/ton under the Regional Greenhouse Gas Initiative. And European companies are paying five times this amount under the EU Emissions Trading System.

Die-hard environmentalists will complain because this slow ramp-up will not guarantee that emissions come down on a specified schedule. But the prospect of paying much higher harm charges in the future will change investment decisions. It will mean that utilities think hard about the right fuels for the future - knowing that for most of the life of any power plants they build now, they'll be paying $80+ for each ton of carbon dioxide emissions. And anyone building a new factory, house, school, or shop will also face a new energy efficiency calculus - with investments in more efficient lighting, heating, air conditioning, windows, and insulation all paying off in a much bigger way in the years ahead. Likewise, consumers will look harder at the energy efficiency of everything they buy from cars to appliances.

The biggest impact, however, of an escalating harm charge would be the incentive created for investment in energy innovation. With a clear price signal in place, private capital would flow to companies with strong energy technology pipelines. The promise of a huge payday for breakthroughs that contribute to a clean energy future will engage entrepreneurs across the country and the world in finding ways to bring down the costs and improve the reliability of power generation from the wind, sun, geothermal wells, second-generation biofuels, waves, tides, and other alternative sources.

And we shouldn't leave nuclear power out of this technology development race. If the waste disposal and safety issues can be addressed and power plant designs structured to keep costs down, nuclear energy might well turn out to be the winning bet. Likewise, we should let those who envision an energy future based on oil, coal, and natural gas compete. Their technology challenge will be to demonstrate that carbon capture and storage can be done cost effectively.

Remember that energy is a $6 trillion dollars per year sector of our global economy so the stakes are high. But with a clear price signal and an open playing field, we can engage the creative spirits and inventive minds across society in the mega-challenge of creating a clean energy future that will not only address climate change but drive economic progress and global prosperity.

Dan Esty directs the Yale Center for Environmental Law Policy. He served for a number of years as a top official at the US Environmental Protection Agency and more recently as an energy and environment advisor to the Obama campaign and as a member of the Presidential Transition Team. He is the author or editor of nine books including the recent prizewinning Green to Gold: How Smart Companies Use Environmental Strategy to Innovate, Create Value, and Build Competitive Advantage.

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