I share Senator Murkowski’s concern that we find a climate solution that triggers a strong investment in clean technologies and reduces CO2 emissions at the lowest possible cost. I believe that a properly designed cap-and-trade system does exactly that.

Congress’s interest in cap-and-trade stems from the success of federal, state and local trading programs that have been in place since the 1980s. These programs overall are well known for reducing emissions much faster and more cheaply than command and control programs. I agree with Senator Murkowski that time is short. That’s why I think we are wise to build off the proven track record of cap-and-trade rather revisit unproven options.

To be clear, however, cap-and-trade alone is not the solution to effectively accomplishing our energy and climate goals. Our success will rely on a set of actions that include a price on carbon emissions, domestic oil and gas resource development, alternative energy development including nuclear, reduced reliance on fossil fuels, investment in and development of clean technologies, and incentives for developing countries to lower emissions.

Focusing on cap and trade; there are four key advantages to a cap-and-trade program, two of which speak to Senator Murkowski’s important concerns regarding affordable energy, a strong economy and the deployment of clean technologies.

First - certainty: A cap-and-trade program provides the kind of regulatory certainty critical to businesses and industry. It sets long-term and near-term environmental targets. This allows companies like Shell to begin planning how we will reduce emissions to reach those targets most efficiently. The more time we have to plan against certain targets, the more innovative and cost effective we can be in meeting those goals.

By contrast, a carbon tax is largely a guess at a CO2 price that Congress thinks will effectively reduce emissions. If the tax isn’t high enough, emissions are not reduced and Congress has to increase the tax. If the tax is too steep, the economy suffers and Congress has to decrease the tax. In a cap-and-trade program, the free market drives the carbon price, and as such, the carbon price reflects the inevitable growth and contraction of the economy. With a carbon tax, Congress may have to rush in to lower a tax during a recession or raise it during economic growth. Congress fiddling with tax levels makes it tough for businesses to plan strategies and choose technologies, not to mention it’s an inefficient use of Congress’ time when other pressing issues face the nation. More troubling, however, is the notion that reaching critical environmental goals becomes time consuming guesswork on an issue we can ill afford to waste time in addressing.

Second – lower cost: Lower cost is an inherent attribute of a cap-and-trade system. Fundamental in a cap-and-trade system is the flexibility for covered entities to choose the lowest cost pathway to compliance while still guaranteeing that an environmental target is met. A carbon tax can’t do that. Shell continues to advocate for a cap-and-trade system because we believe it reduces emissions at the lowest possible cost to consumers and the economy.

Third – innovation: I share Sen. Murkowski’s urgency regarding the development and deployment of clean technologies. Global deployment of key climate technologies is critical to achieving our environmental goals. And while government investment in these technologies is critical, government spending alone probably won’t be enough to stimulate the level of investment needed to commercialize known technologies and stimulate investment in new yet unknown technologies.

Shell is particularly focused on the development, demonstration and deployment of carbon, capture and storage (CCS.) We believe global deployment of commercial-scale CCS by 2030 is necessary to meet the steep 2050 environmental targets. One commercial-scale CCS project is expected to cost in excess of a billion dollars. Hundreds of such projects are needed around the world. USCAP calls for 72GW of such projects in the United States alone (equivalent to 72 large power plants.)

Governments need to select the policies that encourage businesses to invest their capital in clean technologies – technologies that will stimulate the economy and create jobs now and well into the future. An emissions cap creates the incentive and the trade reduces the cost of compliance sufficiently to maximize investment.

Fourth, a cap-and-trade program provides the capability for linkage with other nation’s trading systems to establish a globally compatible carbon markets. This is important because climate change is a global issue and linking carbon markets through cap and trade can not only reduce the cost of achieving environmental goals but establish a globally recognized carbon price important to stimulating action on reducing GHG emissions and the investment in technologies needed to do so. To this end, I believe it’s particularly important that we plan towards the development of a North American trading scheme, ultimately joining efforts with our closest trading partners to reduce emissions at the lowest possible cost to all three of our economies and strengthening our existing trade ties.

The upcoming United Nations Climate Change Conference in Copenhagen is good opportunity to look for tangible progress in developing a global carbon market as a way of putting a price on greenhouse gas emissions.

The world needs diverse energy supplies and with energy demand continuing to grow, we should focus on legislative efforts that help us produce the diverse energy supply we need, while pursuing a CO2 reduction pathway. Call me an optimist, but I think it’s possible to do both.

Senator Murkowski raises the right question - whether cap and trade is the best policy. The answer is no -- there are much better options than cap and trade. A good example is a sector approach that tailors a combination of incentives, and possibly mandates, coupled with technology development that is tailored to reflect the characteristics of each industry. A workable climate/energy policy should put a priority on the removal of barriers to accelerating usage of “existing” energy efficient products and technology. Common sense policies like removing barriers to greater use of highly energy efficient CHP and recycled energy should be a top priority. Policies that accelerate capital stock turnover are the key to not only quickly reducing GHG emissions, but improving productivity, exports and jobs. And, by the way, these are the policies that are desired by manufacturing companies around the world – not cap and trade. A critical question that should be asked first is “does the policy increase or decrease capital investment?” For the manufacturing sector, cap and trade, at least in the versions expressed within proposed legislation, encourages companies to either delay capital spending or to increase capital spending in other countries. Cap and trade adds so much uncertainty that it makes the U.S. a poor place to invest relative to other countries. Cap and trade makes each increment of increased production more expensive – hardly a model for long-term economic growth. 99% of all manufacturing CEOs will tell you that international competitiveness concerns cannot be satisfied through legislation. Our competition, the global manufacturing sector, is too smart and nimble to be boxed in by U.S. legislation. And then there is the issue of reciprocity...

Kevin Knobloch is away. Lexi Shultz, Deputy Director of the Union of Concerned Scientists’ Climate Program is the author of this response.

In response to Senator Murkowski’s follow-up, I’d like to point out that adopting a number of clean energy policies along with an emissions cap is the right strategy to maximize emissions reductions and deliver energy and gas cost savings to American households and businesses.

The Union of Concerned Scientists’ 2030 Blueprint found that an emissions cap plus a suite of complementary energy and transportation policies -- such as energy efficiency standards, renewable electricity standards and clean car standards -- would help meet a cap set at 56 percent below 2005 levels by 2030 while saving consumers and businesses $1.7 trillion in energy and transportation costs. The study also found that this policy suite delivered bigger savings than a cap-and-trade program on its own.

Policies targeting efficiency and renewable energy work. They have a long track-record of delivering savings to consumers, creating jobs, driving down emissions and improving public health. California’s energy efficiency standards have kept electricity costs in the state down over the past several decades, even as its economy has greatly expanded. Money saved on electricity was invested in other areas of the state’s economy, generating an estimated 1.5 million jobs. And twenty-nine other states and the District of Columbia have adopted renewable electricity standards that are a key driver in the recent record growth of the U.S. renewable energy industry. A strong national renewable electricity standard can build on these state efforts, helping the industry overcome market and institutional barriers while creating additional jobs and driving economic development. Meanwhile, new car and truck standards from the Obama administration will cut emissions by the equivalent of taking 32 million of today’s cars and trucks off the road while saving consumers $26 billion in 2020 alone (based on a gas price of $2.25 per gallon).

The American Council for an Energy Efficiency Economy found that by 2030, energy efficiency provisions in Waxman-Markey could create more than 600,000 jobs and deliver nearly $500 in annual household savings — all while reducing nationwide carbon emissions 8.6 percent.

Efficiency and renewable energy policies aren’t an added complication; they are necessary pieces of the puzzle. Yes, it’s a big puzzle. But climate change is the transcendent issues of our time – affecting our health, our environment, national security and the way we use energy. Big, complicated problems need big, ambitious solutions.

From the rising seas lapping at the coasts of Florida to the wind-battered shores of Shishmaref, Alaska, Americans are demanding action to address dangerous climate change caused by our dependence on coal and oil. We must rise to this challenge with every tool at our disposal. Switching to a clean energy economy will save us from the worst effects of climate change and make our country stronger, healthier and more prosperous.

There are three elephants in this room. And all three indicate that Senator Murkowski is onto something big.

The developing countries (elephant one) have not been mentioned once. Yet until July, the key argument for a U.S. cap was its ability to lead China and India into a global system and thereby cap global emissions. That agenda has failed. In fact, as I’ll explain, it has backfired.

Also not mentioned, the U.S. negotiating strategy for Copenhagen shows the same bias Senator Murkowski notes for domestic policy. U.S. negotiators never mention a carbon tax, only carbon caps. But of all the reasons explained in the posts below, only one can explain the U.S. aversion to carbon taxes in other countries. So that one common reason is likely the real answer to Senator Murkowski’s question.

Finally the two most prestigious U.S. economists to focus on climate policy go unmentioned—they are elephant number three. Not only have their views gone unmentioned in this room, but also in every environmentalist’s blog and academic paper arguing for cap and trade that I have had the pleasure to read in the last few years, and these number in the hundreds. There is something unhealthy about a debate that so assiduously ignores the most brilliant advocates of a carbon tax, both of whom are striving for a strong climate policy.

The most telling clue to the solution of the Murkowski mystery is elephant number two, our lopsided negotiating strategy. The same people who have argued strenuously against a carbon tax for twenty years are in control of the U.S. negotiating strategy that so carefully avoids offering China and India the option of a carbon tax. Is this because “tax” is a four letter word in India and China? Hardly. Instead, “caps” insult the populations of Indian and China, and caps have been ruled off the table by them with great vehemence for fifteen years. In fact China is even now considering carbon taxes in spite of their dismissal by U.S. negotiators.

So, to shift the focus of the Senator’s question for a moment, why has “only one idea, a carbon cap-and-trading scheme,” received significant attention by our negotiating team? Given the dire consequences of this mistake and the early warning from Joseph Stigilitz that a cap stood no chance and that a carbon tax avoided the problems of a cap, this presents an even greater mystery.

None of the tactical or political reasons given in these posts apply to negotiations, so what remains is the one real difference between a cap and a tax. Both put a price on carbon, and both have their effect only through that carbon price. So, the real difference is that a carbon tax is a pure market approach that simply prices carbon—no more and no less (as first elucidated by Pigou in 1922).

But cap-and-trade includes a huge dollop of command-and-control tossed on top of a carbon tax. I’ll wager this difference also solves the Murkowski mystery. Only cap and trade is considered because only cap and trade has a cap. That’s why the environmentalists and “card-carrying environmental economists,” like Robert Stavins, have stuck by cap and trade for twenty years. As Stavins told us in 1988, “Permits are preferable in many cases, as they can start with a firm decision as to how much pollution is the limit.” In 2008 he listed “three criteria that stand out.” The first was “environmental effectiveness,” which “considers the certainty with which a policy will achieve emission or other targets.” He concluded “a cap-and-trade system can achieve emission targets with high certainty because emission guarantees are built into the policy.” He believes that only a cap, and not a tax, can achieve his first criteria for climate policy.

That is why a tax has always been ruled out by those now guiding U.S. policy. It passes economic muster by pricing carbon, but it does not pass environmental muster because it does not command compliance with the ultimate control—the cap on emissions.

This also explains why economists usually prefer a tax. They cannot approve of the economic implications of a cap. First, it implies that for emissions below the cap, emission reduction has no value. Second, it implies that when emissions are above the cap, we are willing to pay any price to reduce emissions. Normal economics is highly skeptical when it comes to such rigid black-and-white judgments, especially when they fly in the face of all the findings of the U.N.’s IPCC concerning uncertainty. Harvard economist Richard N. Cooper seems incredulous, noting that “well-ordered societies do not generally attach infinite economic value to any single objective.” (See page 19.)

With these clues from the second elephant, it becomes clear why the other two elephants have not been mentioned. Even though, as Senator Murkowski notes, the primary goal of national climate policy should be to achieve an effective global policy, that can no longer be mentioned when defending caps, because failure on this front has now been admitted by our chief negotiator, Todd Stern. (“We’re not talking a national cap for China.”). China and India are not having caps, and that means caps cannot “achieve emission targets with high certainty” in the only context that really matters, global emissions.

In fact, the distaste for caps by developing countries has driven them to Nationally Appropriate Mitigation Actions (NAMAs), which are now all the rage but which are, unfortunately, the antithesis of carbon pricing. Environmental economists should be upset by this because they really do see carbon pricing as important.

The two most prestigious U.S. economists working on climate policy cannot be mentioned because one of them, Joseph Stiglitz, predicted the failure of caps as a global policy years ago and for exactly the right reasons. The other economist, William Nordhaus, explained why caps would likely be disastrous as a global system. No one can question Stiglitz’s seriousness about climate change. And Nordhaus has run his climate-change-policy model, DICE since 1990 ("Mankind is playing dice with the natural environment”). Both economists focus on developing countries as the main reason caps will not work as a global policy. And only a global policy can meet this challenge.

So to answer Senator Murkowski, we never did decide cap-and-trade was most effective—not if “we” includes the top U.S. economists, the favorite climate scientist of environmentalists, the inventors of cap and trade, or the majority of the economics profession. But if “we” means the driving forces behind current policy, the answer is that they decided in the late 1980’s, and it’s time to rethink.

But what about the claim that cap-and-trade is the best domestic policy, and a carbon tax would be a disaster like Clinton’s BTU tax? First, the Waxman-Markey bill did just a hair worse in the house than the BTU tax did. Second, the only people who still don’t know that a cap is a tax are pro-environment and not allergic to a tax. But what makes a carbon tax unpopular is that the pro-cap establishment refuses to advocate the economically prescribed, fully-refunded tax of the type invented by Pigou in 1922 to curb pollution. Notably, President Obama’s proposal came closest to the full refunding recommended by economics.

Give all the money back, and those who tar caps and taxes as too expensive will have a very hard time indeed. The problem is that most of those who favor caps would want an expensive tax, that like the Waxman-Markey cap, pays many constituencies for political support and funds a plethora of green programs.

Although cap and trade is simply a variable carbon tax that adjusts to make emissions hit a target, those unpredictable tax-rate adjustments have two important consequences. First, they mean the same average tax will accomplish less if imposed by a cap, because fluctuations cause investment delays. Second, since our best hope of a global carbon price is for developing countries to adopt carbon taxes, a fluctuating permit price cannot align with, for example, a steady carbon tax in China. This creates boarder adjustment problems. Matching carbon taxes would best protect American competitiveness.

As the week wraps up, I’ve been asked to post a few concluding comments on this thread. I’d like to start by thanking the National Journal for this opportunity and all of the experts who submitted responses.

While my intention was not to endorse one approach to climate policy over another, I do think it has been valuable to broaden the conversation and re-examine some proposals that are now habitually left out of it. Again, I believe it’s important to act quickly on climate change – but it’s more important to find the right policy. Whenever the slower pace of action in the Senate affords us the chance to review our options, as it has right now, we’d be remiss not to take full advantage.

From this week’s discussion, it’s clear that this topic generates quite a bit of interest – and disagreement – even among experts. Some believe cap and trade is the right path forward; some think it is exactly the opposite; and some are willing to try it out for lack of a better option. All of these viewpoints are thoughtful and carefully considered. Taken together, they’re the latest sign that we haven’t reached consensus on a particular policy, and that a considerable amount of additional work will be required to get to that point.

With so many involved in this ongoing debate, and so much at stake in its outcome, I’d like to outline a few priorities that I believe can help us move forward on climate policy.

First, the Senate should emphasize meticulous debate of climate policy over hasty passage. While just one bill was given an opportunity to move through the House, there are many senators who feel strongly about climate change and who have a history of introducing measures to address it. Before all is said and done, I believe a number of different proposals – in addition to the bill offered by Sens. Kerry and Boxer – will be put on the table. We should consider each of them on their merits, even if that means spending a bit more time on this issue than some would like.

An essential part of that process will be senators’ ability and commitment to weigh in on all aspects of proposed legislation. In the House, the only question up for debate seemed to be who would receive free allowances. In the Senate, I suspect we will not only have a conversation about who gets them, but whether allowances should be given away for free at all. Remember, the president has endorsed the latter approach, with a full auction, and he will have final say on the enactment or veto of any legislation that makes its way to his desk.

Many other matters will need to be addressed, and I posted a comment partway through the week about one that is particularly important to me. The main argument for cap and trade is that it will create a market in which economically efficient and environmentally compliant decisions can be made. Despite this, the sweeping measures introduced so far this year display a clear lack of faith in cap and trade’s ability to function on its own. What other explanation is there for provisions that require efficiency requirements for food warmers and light bulbs, programs that dictate how and where to plant shade trees, and performance standards for emitters that are already covered under the cap and therefore required to participate in the carbon market?

If a given policy purports to address climate change, it should be allowed to do just that. In the face of legislative action on climate policy, we should take additional layers of regulation – which may only prove duplicative, inefficient, or counterproductive – off the table. We should pre-empt the climate-related use of the Endangered Species Act, EPA greenhouse gas regulations under the Clean Air Act, and the variety of state and regional programs that could work against our ultimate goal of establishing a global, not local, approach.

I also believe the Senate will take a serious look at our ability to encourage, require, or otherwise force international action on greenhouse gas emission reductions. We know for a fact that the United States, acting alone, can do relatively little to mitigate climate change. And as much as I want to believe that leading by example will result in global progress, history has shown that’s not often the case. Our nation has made tremendous progress on everything from civil rights and labor standards to education and water quality in years past, but those advances have not always been met with similar progress throughout the rest of the world.

It’s often said that global climate change is a global challenge that requires nothing short of a global solution, which is why the Copenhagen negotiations are so incredibly important. I’m troubled by recent efforts to manage expectations going into these talks, and even more troubled by accusations that many of my Senate colleagues would not support ratification of a binding global treaty. To the contrary, I think many who are concerned about the impact that unilateral action could have on American competitiveness want nothing more than to vote for an inclusive and binding international treaty. Perhaps inconveniently for some, while the Senate ultimately votes on the ratification of treaties, the task of negotiating their contents is very explicitly in the hands of the Executive branch.

Finally, to those who suggest time has run out to pass climate legislation this year, I simply disagree. If a measure capable of garnering 60 or more votes is put together, I suspect we would be on the Senate floor debating it in very short order. The difficulty is making it to that point – as always, the devil is in the details. I remain convinced that the threat of economically damaging regulations from the EPA should not and will not compel the Senate to accept a bill that is more stringent than the unpopular measure passed by the House. We need to recognize that consensus will not be forged through measures drafted to appeal to a specific constituency – or through criticisms meant to narrowly appeal to some other constituency – and proceed accordingly.

I was one of many Republicans to co-sponsor cap-and-trade legislation in the last Congress, and sincerely hope the members of the Senate can come together and reach agreement on climate policy. We know this will be difficult, but simply communicating our views – especially in a positive and thoughtful manner as we did here this week – will only help us build momentum going forward.

Sen. Murkowski raises a legitimate question when she asks whether a cap-and-trade system for greenhouse gas emissions should be the only option in the coming Senate debate on climate change.

Of course it shouldn't be. Policymakers should always ask themselves if there is another way to achieve the same goal more cheaply and effectively.

And the senator is right to imply that cap-and-trade did become prematurely a point of almost religious doctrine among environmentalists. Cap-and-trade need not have become the "only" option.

And yet, for all that one is hard pressed to see what other truly adequate strategy Sen. Murkowski might embrace for meeting the massive challenge posed by climate change.

After all, any plausible response to climate change, as I wrote recently at The New Republic's Avenue blog, needs to achieve two essential goals. First, any climate program needs to greatly limit near-term emissions and get industry and consumers to accelerate the deployment of existing clean technologies. And second, it needs to pour--starting now--some $20 to $30 billion per year into clean energy R&D aimed at overcoming the market failures that depress energy innovation and producing the radical scientific and technological breakthroughs needed to deliver the massive 80-percent greenhouse-gas emissions cuts necessary by mid-century.

In light of all that, I appreciate Sen. Murkowski's search for new approaches, but wonder what policies she has in mind that would answer to the needs of the hour.

Would she prefer the imposition of a steep carbon tax, with a huge chunk of the revenues dedicated to clean energy innovation pursuits? I'm with her if she does. But somehow I doubt that approach would meet her approval.

Would she prefer draconian "pollution" rules to reduce emissions and the annual appropriation of $25 or $30 billion a year in new money to catalyze the clean energy R&D we need? Somehow I doubt the senator would embrace a huge new federal R&D program and vote for it year after year.

In short, it's easy to share Sen. Murkowski's doubts about the hyper-complicated, inelegant Rube Goldberg contraption that is cap-and-trade. And she's right to be frustrated by the absence of serious alternative regimes. But in the end it's really quite difficult to think of another system or array of them that would deliver flexible, comprehensive regulation to depress emissions while generating massive long-term revenue year after year that can applied to game-changing innovation investments.

The Alliance to Save Energy is neutral on the question of whether to reduce the cost to society of greenhouse gas (GHG) emissions through a cap-and-trade program, a tax or another policy. But it’s not clear how we can or should “set politics aside” in choosing among such policies. The realities are first, that we must act quickly and meaningfully if we are to avoid calamity (which sounds like too trite a word for what could happen as the Earth warms!); and second, that a cap-and-trade program is the only meaningful climate policy that has been well-vetted by Congress, and is it already a long way down the legislative road, giving it an opportunity to be enacted into law in time to provide real help in staving off the consequences of global warming.

And, cap-and-trade is not a bad way to go. The climate legislation passed in the House and being considered in the Senate would provide certainty on GHG emissions levels while containing abatement costs through various mechanisms, including strategic reserve allowances, offsets and energy efficiency programs. According to the U.S. Environmental Protection Agency, House-passed energy efficiency measures would actually reduce household energy bills, relative to business-as-usual projections, by about 7 percent in 2025 – an average saving of about $144 per household!

While we absolutely need a massive investment in clean energy, and especially energy efficiency, that is no substitute for an economy-wide policy to reduce GHG emissions and their impacts. The two strategies will work best hand-in-hand, as energy efficiency will help to contain the costs of abating emissions under a GHG emissions reduction program. Moreover, it is unlikely that energy efficiency will ever receive the level of investment that is economically efficient without a climate policy.

Cap-and-trade provides allowance value that can be used to ease the transition to a low-carbon economy, especially for households and industries that have become heavily reliant on low-cost coal. While we can argue over how much assistance should be provided, the political fact of the matter is that we will never get a climate policy without providing transition assistance. Rather than focus on how we can avoid “unfairly” helping the beneficiaries of cheap coal, many of us have decided it is more productive to focus on how to make all of us better off.

If there are meaningful policies besides a cap-and-trade program that could gain the support of 60 Senators and a majority in the House and could be enacted in time to provide a chance of reducing GHG emissions by 80% by 2050, we’re all ears. If not, then we view such discussions as a way for opponents of meaningful climate policy to further delay action. Cap-and-trade will not be perfect – nor likely would any other such overarching policy – but it is far superior to protracted debate and inaction.

I would like to comment briefly on Senator Murkowski's second message in this conversation, which begins "Both the Waxman-Markey and Kerry-Boxer climate bills..." and concludes "... it's a threshold question."

In this second message, the Senator's key message is that it is important not to load down a carbon pricing policy -- such as a cap-and-trade system -- with lots of additional, regulatory policies "which could reduce the efficiency of a carbon market." I completely agree.

As I have written about elsewhere, the supplemental regulatory parts of the Waxman-Markey bill (and for that matter, the developing Senate legislation) will -- to a large degree -- accomplish little or nothing additonal for the environment (under the cap-and-trade umbrella), and simply drive up aggregate costs by re-locating emissions-reduction efforts from the cost-effective pattern established by the unconstrained carbon market.

Some may argue that this is a reason to oppose Waxman-Markey and Kerry-Boxer, but this would be throwing out the baby with the bath water. Instead, the Senator's insightful comments should -- in my view -- be taken as a call to keep our eyes on the prize (reducing CO2 and other GHG emissions), focus on the carbon market, and streamline these legislative approaches.

Energy is – literally – the capacity to work. The availability of affordable and abundant energy is inextricably linked to our ability to grow our economy and enhance both our economic and environmental prosperity – prosperity made possible by the very sources of abundant, affordable energy that cap-and-trade seeks to make more expensive and less available. Indeed, the cap-and-trade plan, by its supporters own admission, is intentionally designed to increase the price of 85 percent of the energy that fuels the American economy and makes life as we know it possible. Increasing the price of energy not only limits our capacity to do work and put more Americans to work producing American products, it necessarily increases the price of just about everything else we use and consume on daily basis – computers, cell phones, makeup, toothpaste, food, clothing, medicine, you name it.

So what exactly is the goal of cap-and-trade? Is it really all about the environment? Because throughout our history, as we have increasingly and more efficiently used the very sources of energy cap-and-trade seeks to make more expensive and less available, we have increased our wealth and productivity, all the while improving our environment.

Is it all designed to potentially reduce global temperatures by less than one tenth of one degree Fahrenheit by 2050, as the government’s own models estimate? Is it to unilaterally destroy the U.S.’s ability to compete in the global economy, while hoping China and our other competitors around the world “follow our example?” Or is it all about creating a massive, unprecedented new source of government revenue (tax) to fund a rapidly expanding, big federal government and its never-ending list of new and existing government-run programs?

Perhaps the goal (or ultimate result) of cap-and-trade, as a recent IER study concluded, is to create a massive transfer of wealth from the poorest Americans among us to the wealthiest? Maybe our Congressional leaders simply want to follow Spain’s model, a model in which the government spend hundreds of billions of taxpayer dollars on unsustainable, temporary, government make-work jobs – at the expense of more than twice as many real, well-paying private sector jobs – in hopes that it will lead to yet another economy-killing bubble? Or is it just another, albeit far worse, example of the government attempting to pick winners and losers (or more accurately, simply picking losers)?

If those are our goals, then yes, cap-and-trade is the way to go. But if we are truly interested in protecting our environment for future generations, history tells us that limiting our use of energy is exactly the wrong direction to take. The availability of affordable and abundant energy is inextricably linked to our capacity to do work and grow our economy, which is, in turn, inextricably linked to a cleaner environment.

As Senator Murkowski points out, there could be more than one route to the country’s goal of reducing greenhouse gas emissions, and a robust discussion of all possible options is in the best interest of finding the best ideas.

Forest products manufacturers believe the following principles should guide policymakers when they evaluate the alternatives for encouraging greenhouse gas reductions. Three of these key principles include:

· Competitiveness matters. Climate change policies should strengthen the competitiveness of the forest products industry and the U.S. Economy. The U.S. forest products industry is facing growing competition from other high-emitting countries such as China and Indonesia, which have lower energy costs and lower forestry, labor and environmental standards. Imposing a carbon regulation on U.S. manufacturing without requiring equal actions from other high-emitting countries will weaken American competitiveness.

· Be reasonable. Climate change legislation should ensure reasonable emission allowance prices, adequate allocations, and realistic compliance timelines to address higher energy prices from a lower carbon economy. Energy is the third-largest manufacturing cost for the pulp and paper industry. If the industry has to pay high energy costs resulting from a carbon regulation, it must receive an adequate allocation of allowances in order to compete in the world economy since we cannot simply pass on higher energy costs and remain competitive.

· Forest products are part of the solution. Climate change legislation should recognize the forest products industry’s important role in fighting climate change. Forests and the paper and wood products that come from them offset 10 percent of annual US carbon dioxide emissions and should be eligible for offset credits. Also, climate change legislation should encourage increased recycling and recognize recycling projects as eligible carbon offset project types. Paper recycling reuses a renewable resource that sequesters carbon and helps reduce greenhouse gas emissions through avoided methane emissions and the reduced energy required to make a number of paper products.

Regardless of the end policies that Congress and the President enact, reflecting these principles is essential if we want the forest products industry — almost one million green jobs generating 6 percent of U.S. manufacturing GDP and the leading industrial producer of carbon-neutral renewable energy — to continue to be viable in the U.S. Accomplishing that goal requires policymakers to make any climate policy as low cost as possible by allowing maximum flexibility on key issues like timeframes, allocations and offsets, and harmonizing timelines with available technology. Doing so will allow the forest products industry—the original green jobs provider—to continue to contribute to a sustainable future for our country.

Senator Murkowski suggests that long pieces of legislation are not necessarily bad. I would like to sugges that legislation addressing complex subjects tends to be so complex that unintended consequences are inevitable. In my opinion, taking bite size pieces and addressing them well is a much better way to go.

Many of the comments try to build a case for cap and trade being preferable to a carbon tax. That case does not withstand close scrutiny because the virtue of fixing the outcome does not guarantee that it will be achieved as the EU trading system and Kyoto prove. Resources for the Future published a paper in the early 2000s that concluded that a carbon tax was 5 times more cost-effective than a cap and trade system.

The comment that we have tried a carbon tax --the Clinton BTU--and failed miserably is not an accurate rendition of history. The petroleum industry which led the opposition to the BTU tax did so because it discrminated against oil and had a bias toward coal. If it had not been structured as it was, the Petroleum Industry would not have fought it.

A carbon tax which is used to reduce a more distorting tax--the payroll tax for example--is strongly favored by most economists who have addressed the subject.

For all the different options that Congress has explored, there’s a reason we keep coming back to cap and trade. Experience tells us that emissions trading systems deliver what they are set up to do.

Congress must put a price on carbon in order to effectively control greenhouse gas emissions. To do this, it can mandate a specific price on carbon, via a tax; or set a carbon emissions limit—a cap—and enable businesses to trade allowances to discharge emissions.

A carbon tax is not as simple as it may sound. There is little evidence to suggest that the government could accurately set the tax to deliver the right level of emissions reductions. There is even less chance that Congress would be willing to raise the tax regularly in order to keep emission levels falling. Efforts to ensure regional fairness would create a lot of complexity and opportunities for loopholes. You would have to love the IRS code to believe a tax would be fair and simple.

That’s why we believe the most effective way to control greenhouse gases is through a cap and trade mechanism designed to guarantee steady emissions reductions, encourage innovation, and ensure a measure of fairness to low income consumers and coal dependent regions.

Cap-and-trade programs are not new; they have been a proven staple of environmental regulation for decades. The acid rain program in the United States employs a sulfur emissions cap and trade system that successfully produced a 50 percent cut in emissions - at much lower cost and greater efficiency than predicted. Three US regions are already implementing successfully, or designing, cap and trade programs for CO2. Australia’s Parliament is currently debating a cap and trade system and will likely vote on one in the lead-up to Copenhagen. Japan’s new government also announced it will introduce cap and trade to help implement its 25% below 1990 by 2020 target.

The European Union also has a fully-functional cap-and-trade program. During its pilot phase, the EU trading system was over-supplied with allowances, reducing the price signal to the market and reducing its effectiveness. The current and future phases have increased the amount of permits auctioned, which has led to a much smoother system. The point is that the experience in pilot phase doesn’t mean that cap-and-trade is fundamentally flawed, as some have suggested. Europe has in fact stuck with cap and trade due to its cost-effectiveness and environmental certainty.

Both the Waxman-Markey and Kerry-Boxer climate bills would do much more than put a price on greenhouse gas emissions. Only about 200 of Waxman-Markey’s 1,428 pages are devoted to creating a carbon market; the rest would impose an unprecedented series of new federal programs, standards and requirements. The Kerry-Boxer proposal puts the Senate on the same track.

A long bill is not necessarily a bad bill, and some ideas, such as the creation of a Clean Energy Deployment Administration, are worth pursuing as complementary policies. But this year’s climate bills stand in stark contrast to those introduced last Congress when none were longer than 350 pages, and almost all were less than 130 pages.

I’m concerned that we risk a counterproductive proliferation of policies and requirements that could reduce the efficiency of a carbon market and increase the cost of energy. If Congress adopts a carbon price approach to reducing greenhouse gas emissions, we should give it room to work and fully pre-empt other existing approaches to climate change mitigation. We should do so because a “belt-and-suspenders” approach is not necessary if we have faith in a legislative solution’s ability to reduce emissions. This issue should not be treated as a point of negotiation, it’s a threshold question.

Politically, passing anything with the word “tax” in it is difficult. But many believe a “carbon tax” is the most efficient, fairest, and easiest way to attempt reducing carbon through a market-based system. NARUC endorses a market-based approach to control CO2 emissions. We have not specifically thrown our support behind cap-and-trade, though we have offered a set of principles Congress should consider to protect consumers if it were going to implement such a system.

Any cap-and-trade system must be workable, flexible, and adaptable. It must provide the right structure so that consumers are not overly burdened and investments can be made to lower the cost of compliance over time. Unfortunately language we’ve seen in both House and Senate climate bills may create unintended outcomes that frustrate the smooth implementation of the allocation process and the use of allowance values.

Here is the problem: In an attempt to keep electricity rates from skyrocketing in the early years, House and Senate lawmakers imposed numerous conditions on the regulatory treatment of no-cost allowance values distributed to rate-regulated Local Distribution Companies (LDCs). While NARUC has long advocated for the allocation of any free allowances within the electricity sector only to LDCs, the prescriptive language in both House and Senate bills may likely complicate the distribution of the benefits of these assets.

In a cap-and-trade system, the LDC serves as a proxy for their consumers. Because they are rate-regulated, any benefit an LDC receives from no-cost allowances—e.g revenues from allowance sales or reduced compliance costs—would be captured for their consumers through longstanding State regulatory procedures. State commissions have gained significant experience in addressing similar regulatory issues through the successful Acid Rain trading program.

Although the House and Senate bills recognize the value of this regulatory process, they also impose detailed requirements that unnecessarily complicate the rate-setting entity’s ability to protect consumers and share any allowance proceeds. Language in both bills requires that allowance benefits be shared “ratably” among and within consumer classes. Language also appears to direct State commissions to provide cash rebates to industrial and residential consumers if the cap-and-trade system results in higher electricity bills.

On top of that, the bills seem to place the Environmental Protection Agency in the role of overseeing retail ratemaking decisions nationwide through new authority to require and approve LDC plans for distributing allowance proceeds.

These conditions not only prevent State commissions from determining how best to protect consumers, but it also risks making the cap-and-trade system unworkable. Instead of benefiting consumers, ambiguous language in both bills guarantees litigation on both the federal and State level. Consumers risk seeing their benefits held up in court as lawyers debate congressional intent. The end result could well be years of litigation instead of true progress on clean energy programs.

NARUC recognizes the need for some kind of federal oversight over these programs, given the amount of money that is at stake. But ambiguous and overly prescriptive intervention makes the whole system far less predictable. State commissions and other rate-setting entities are legally obligated to assure just and reasonable rates. They are accountable to their constituents and already have processes in place that address these concerns.

As the Senate begins its work on cap-and-trade legislation, it should keep in mind that the system has to be workable and flexible. There should be enough oversight to keep all parties honest, but enough flexibility to foster innovation and investment in clean energy programs that will benefit all customer classes.

NARUC stands ready to help in any way it can. We support a market-based, economy wide system for reducing carbon emissions, and we look forward to working with Senators Boxer, Kerry, and the rest of the Senate as this issue moves ahead.

At what point did we decide… good question. It certainly didn’t happen overnight. It took about 20 years, and it makes many of us feel old. We did not arrive here without a serious look at carbon taxes – in fact, we took a major detour toward taxes that failed miserably. Here is a quick recap:

Congress first began considering an emissions trading model for climate change in 1989, right as the acid rain law neared final passage. It isn’t new. This first proposed legislation, introduced that year by Reps. Jim Cooper and the late Mike Synar, proposed capping power sector emissions and allowing offsets for compliance. In the 1992 Energy Policy Act, Congress rejected their full-blown emissions trading proposal in favor of a voluntary registry, the “1605 (b)” greenhouse gas reduction reporting program at DOE. Given the early state of those climate policy debates, it was no surprise when the bipartisan majority felt that we should give voluntary measures a fair chance to work before considering mandatory controls. As we look back 20 years, voluntary measures were a fine place to start – but they failed to solve the problem.

Then came the detour. In 1993, President Clinton proposed a BTU tax as part of his climate and budget policies. It didn’t turn out well. By the time it emerged from the legislative process, the tax rate was so low and riddled with loopholes that it barely effected emissions at all. But it effected several Members of Congress who supported it: it contributed to several Democratic losses in the mid-term elections of 1994 and contributed the phrase “to be BTUed” to the political lexicon.

The BTU tax offered several important lessons:

First, the politics of carbon taxes are horrible – far worse than cap and trade.

Second, a carbon tax will not be simple or easy. It begs some of the same questions as emissions trading – who will bear the responsibility – and how hard will they be hit? Who will get exemptions, credits and alternative tax rates? How will the revenues be used? But it adds the more fundamental question of how to set the tax levels right so that they produce the desired pollution reduction? And when you’re done, it won’t perform. It will have loopholes, complex exemptions and endless opportunities for confusion – or manipulation – that prevent companies from cleaning up their act, literally.

Third and most importantly, taxes are an inferior environmental policy, because they attempt to control emissions indirectly through the fiscal measures rather than direct emissions limits. Don’t be fooled: setting the tax at the right level is not a trivial task. On something this important, we aren’t likely to simply trust the IRS to set it at the “right” level. The odds of setting the tax at precisely the right level through our rough-and-tumble legislative process are extremely low. Either the tax will be set too low, which will mean we miss the intended environmental goal (as with the BTU tax), or it will be set too high and cause undue economic harm.

In contrast, a cap addresses the real pollution goal, no more and no less. And the “trade” provisions will deliver the cost effectiveness goal. The “trade” provisions need to tap into cost containment measures, like offsets, banking and borrowing – to ensure that we get the biggest bang for the buck. These approaches will allow us to take advantage of “where” and “when” flexibilities, which economists like Dr. Richard Richels and Dr. Jae Edmunds have cited since the 1990s as the most cost-effective course.

We know how to do emissions trading right. American invented emissions trading for solving air pollution problems. The acid rain law is the proof. It works better than any other clean air program in existence. America's energy industry cut SO2 emissions by more than 40 percent between 1990 and 2007, reaching the 2010 target three years early at just a quarter of the originally predicted cost. That is unparalleled success. We can do the same on climate change.

Like other commentators, I applaud the Senator’s question. I think it’s wise to think through every option before reaching a conclusion. But I’m jaded enough to believe that many tax proponents really just want another delay.

The consensus around the cap and trade model this year is profound. Most environmental organizations support it, and a large swath of business supports it. Certainly the pending Senate legislation is imperfect – but the focus should be on improving and amending, not ditching it. Senators should seize the momentum and adopt carbon trading legislation soon. So that we can start improving and rebuilding our energy infrastructure for a new century.

Congress certainly shouldn’t abandon the great progress it has already made in the House when it passed comprehensive climate and energy legislation. The Senate needs to follow suit and deliver a bill before the international climate treaty negotiations in December.

The most effective way to address climate change is through a suite of policies and cap-and-trade is among the most important components. Other key elements include energy efficiency and renewable electricity standards, funding for research and development, and clean technology deployment. Fortunately, auctioning emissions allowances under a cap-and-trade system can raise revenue for many clean technology investments, as the success of the Northeast Regional Greenhouse Gas Initiative (pdf) has demonstrated.

A cap-and-trade system can ensure that we meet a science-based emissions reduction target while letting the market set an appropriate price on carbon. By contrast, an economy-wide carbon tax would ensure a price for carbon, but wouldn’t guarantee a given emissions reduction target. Additionally, the price of carbon in a cap-and-trade program adjusts with changing economic conditions, allowing businesses to make decisions based on their real-world emissions. A carbon tax would not offer entities that need to reduce emissions the same flexibility.

The cap-and-trade system in the House-passed bill and the Senate’s Clean Energy Jobs and American Power Act offers additional flexibility for polluters. Under both bills, there would be strong oversight for the carbon market, a strategic reserve of allowances that can be introduced to the market to lower carbon prices, and allowances set aside to benefit consumers. The plan’s smart design is part of the reason the Congressional Budget Office said the cost of the House bill would be low for consumers – less than a postage stamp a day. And that analysis didn’t even count the money people will save through increased energy efficiency.

Such success wouldn’t be unprecedented for cap-and-trade. The first such system, implemented under the 1990 acid rain amendments to the Clean Air Act, was wildly successful. The Economist called it “probably the greatest green success story of the past decade.” That program not only reduced acid rain pollution below the levels required, but did so at a cost that was less than a third of what was projected by the Environmental Protection Agency in 1990.

Geoengineering, meanwhile, is no substitute for reducing emissions now. With the cost of inaction so high we can’t afford to gamble with possibilities that may not work. Meanwhile, the message from climate scientists is getting ever more urgent and we know that we have the technology we need – energy efficiency, wind turbines, fuel-efficient cars – to get started on reducing emissions today.

Senator Murkowski’s constituents know how dangerous climate change is and how it’s affecting us now. The recent United States Global Change Research Program report from scientists at 13 federal agencies identified Alaska as one of the most at-risk areas for climate change. If we are to secure an international climate deal that protects Alaska as well as the rest of the world from climate change, the Senate needs to move forward with a bill now.

Why seek a different approach when cap-and-trade is not only proven to work, but supported by so many Americans? The system has already been used to dramatically lower acid rain pollution at only a fraction of the cost to consumers that was originally predicted. And 71% of American voters support the American Clean Energy and Security Act that passed the House in June.

Americans know we face interconnected economic, energy and climate crises. That's why they support comprehensive solutions like American Clean Energy and Security Act that passed the House and the Clean Energy Jobs Act in the Senate. Each bill would that cap global warming pollution and invest any revenue into protecting consumers, developing clean energy technology, and safeguarding our natural resources from the impacts of global warming. And with each passing day as we hear more dire climate science and see more energy prices go up, the urgency only heightens.

It's an especially urgent threat to Sen. Murkowski's home of Alaska, which has been called the poster state of global warming. Winter temperatures have already risen 6 degrees. Sea ice that protects coastal villages from winter storms forms a week later than it used to. Forests are under siege from wildfires and insects. Melting permafrost is shifting foundations of homes and drying up lakes. The state's best-known animal, the polar bear, is seeing its habitat literally melt away and is the first land animal to be listed as a threatened species under the Endangered Species Act because of global warming.

Cap and trade has become something of a yogic mantra for many in Washington and elsewhere who do not want to think about other options. There are many other options.

One of the most important is to give proper incentives to companies via tax breaks, investment incentives and more to help drive them toward greater energy efficiency and less carbon effluent production.

Take for example your typical gas or coal electric generating plant. About 85 percent of the fuel used is wasted in heat that goes up into the atmosphere at the plant, losses on transmission lines and other losses. If you are going to follow these losses to the typical electric light bulb used in the US then about 97 percent of all fuel used to produce the electricity to make that light bulb work goes up in heat and other losses. The typical light bulb produces more heat than light.This is sort of like the debate on the energy-environment connections in Washington and elsewhere,

There are many technological, behavioral and other options that could reduce this energy waste. Giving the right incentives to industry and the general public could go a long way to reducing the energy waste and, hence, reducing the environmental problems from the production and use of such energy.

Similar things could be said for the typical transport vehicle in the US. These are massively wasteful, built on the concept of the heavier is better and safer, and environmentally not a smart way of doing things. Light-weighting of transport vehicles, greater movement toward trains (and building more extensive and smarter train systems), and reconfiguring the energy equations in transport vehicles to use the heat and friction wasted toward usable energy could go a large distance toward solving some of our energy and environment problems.

The greatest potential source of energy is in greater efficiency. Greater efficiency in energy use leads to less environmental degradation per unit of end-use services and goods. In plain English that means if we use the energy smarter we also help the environment and may reduce some of the global climate change that so many scientists expect to occur.

Why none of these other options has been seriously considered is baffling to me. All we seem to hear about is cap-and-trade. It may be that this seems like a more understandable solution, and a faster solution, than inventions, innovations, and positive behavioral change. By behavioral change I am not talking about social engineering, but bringing companies and people to first realize that the energy-environment addictions we have are not just for oil.

The biggest and most damaging energy-environment addiction is the addiction to waste. We are the world champions of energy waste. It is astonishing that this is not at the very top of the agenda.

Cap and trade is also a lot more complex and has a lot more implications than some may think. Let’s look at the term itself. What are we capping? Are we capping carbon production? That is the way most see it. Maybe we should be capping energy waste. Who determines the cap? Are they the scientists and other experts who have toiled over these issues for years? Well, no.

This is a political decision. Political decisions often lead to what we economists call sub-optimal results. The less optimal the solution the less likely there will be much benefit to the environment, our energy use and our economy.

Now let us look at the term trade in cap and trade. Who trades? Who defines the market? Who defines the price? Who are the investors in this business? How will derivatives and speculation be handled? Above all, who defines the price of carbon? If the wrong price signals are sent than there could be heavy costs to pay. We need to be very careful to develop these costs and the trade market. Also, why not trade other things on these cap and trade markets? How about trading waste certificates?

How about focusing in on the real problems here instead of heading toward the yoga mats and getting into the trance of cap-and-trade?

Cap-and-trade could be a good thing if it is done right. It could be downright economically damaging if it is done in the wrong way. We are facing down unemployment rates that are likely to head to 10 percent in the next quarter or so. 15 million Americans are out of jobs. Is this the time to give even further reasons to American industry to fire a few more breadwinners from our suffering working classes?

Global climate change is a huge issue that we need to handle in careful, thoughtful and strategic ways considering many aspects the results of our policies. Are we? Not really.

Another rather silly mantra being accepted as the calming way to solve our environmental and economic problems simultaneously is “green investment”. This is, and let me be very clear about this: a tea cup in a tempest. We have heard of tempests in teapots. Those are big arguments on small issues. A tea cup in a tempest is a very small argument that will have a very small result in the time period in which we will need results for the big issues, the tempests, of the day. Can we get real on this?

The new green energy investments can be very good solution starts for the medium and long runs to solve the medium and long run issues we face. However, they will take time to implement. They will likely be tiny proportions of our total economic activity (which is in the quadrillions of dollars per year) in the next few years. They are much less effective than the obvious answer: getting people jobs in industries that are able to ramp up quickly.

What kind of green investments do we need to really make a dent on the economic-energy-environment problems we face? That would be in the many trillions over the next decade. Where will this come from?

If we are going to be serious about greening our energy systems then let us be serious about it. A few billion here and there is chump change. I am not arguing against green investments. I am arguing against the claim that fairly small green investments will make big impacts. We need monumental, epic and aggressive changes in our economic-energy-environmental system. But this is a long term solution. It should not be seen as a short term quick fix.

Also, the “absurd” notion of tax breaks for the working people, for investors and for others is not so absurd if they are targeted properly. The “Great Recession” is far from over. Let us get real with this as well.

Cap-and-trade can be a good idea if done right, but I have my doubts on how this is being done and when it is being done. If anything, there should be a phasing in of any of the sticks to industry over time period that does not cause more job losses. There should be a quicker phasing in for the carrots for industry and others that may lead to greater energy efficiency and great environmental efficiency. Instead of further bailing out of financial giants we should start to bail in companies, entrepreneurs, investors and others who can help develop this better economic-energy-environment system.

Do we really want a policy that may or may not help the environment depending on the concessions that can be developed on many issues, and at the same time may increase unemployment? I don’t think so. We need policies that give industry and others hope in these difficult times. We need policies that will help generate inventions and innovations in the medium and long runs. There are many trade offs here. These are not easy issues and there are no easy answers..

We need to construct policies that work in the short run to get the economy back on its feet and not wobbling. We need to also construct policies that will help develop better energy and environmental efficiencies, and a better economic-energy-environment system in the medium to long run to help resolve or at least mitigate those massive looming tempests, such as peak oil, global climate change and more. But tea cups and mantras won’t do this.

Updated at 10:32 a.m. on Oct. 5.

Fair question. Does society want a cap on emissions or a cap on policy cost? If you view climate risk as a fat-tail risk of catastrophic consequences then capping emissions is better. Capping emissions ensures that low-carbon investments get made and that (with global participation) atmospheric concentrations of co2 decline. In theory, a variable carbon tax could do the same thing - but the reality of that is unlikely. Nonetheless, why not use both? Cap and trade for power plants and large industrial sources makes imminent sense (as Europe has done). I think this could be done simply and effectively without permits (see www.justcapit.org). Then a carbon tax for the transportation sector might be set at a level where we get more emissions cuts from that sector than we would under cap and trade (remember, even the effects of $4 gasoline were tolerable). In any case, Lieberman-Warner in 2003 was 58 pages. ACES is 1426 pages. We need simple, clear policy that lets the private sector compete to create both clean domestic energy supply and more efficient means of managing demand.

Cap-and-Trade versus the Alternatives

Let’s credit Senator Lisa Murkowski (R-Alaska) for raising questions about the viability of cap-and-trade versus other approaches for the United States to employ in addressing CO2 and other greenhouse gas emissions linked with global climate change.

Senator Murkowski claims that only one approach – cap-and-trade – has received significant attention in the Congress. Let’s put aside for the moment the reality that most of the 1,428 pages of H.R. 2454 – the American Clean Energy and Security Act of 2009 (otherwise known as the Waxman-Markey bill) – is not about cap-and-trade at all, but about a host of other regulatory approaches to reducing emissions that lead to climate change. We can also put aside the fact that both conventional regulatory approaches and carbon taxes have been discussed repeatedly in numerous House and Senate committees over the past decade, and received detailed attention from a succession of U.S. administrations.

So, let’s not quibble about the Senator’s claim that cap-and-trade is the only approach that has received serious attention. Instead, let’s address the key substantive questions which Senator Murkowski raises, because they are important questions: Is cap-and-trade the most effective way of addressing climate change? Are there other approaches capable of achieving the same results at lower cost? From my perspective, as a card-carrying environmental economist, these are indeed the key questions.

While political leaders in the European Union, Canada, Australia, New Zealand, Japan, and the United States (Congress) move toward cap-and-trade systems as their preferred approach for achieving meaningful reductions in emissions of CO2 and other greenhouse gases, many people – including some of my fellow economists -- have been critical of the cap-and-trade approach in the climate context and have endorsed the use of carbon taxes. So the Senator is correct that we should reflect on the merits of that alternative approach.

But, first, what about conventional regulatory approaches, that is, performance standards and technology standards? Experience has shown that such standards cannot ensure achievement of emissions targets, create problematic unintended consequences, and are terribly costly for what they achieve.

Why can conventional standard not ensure achievement of reasonable emissions targets? First, standards typically focus on new emissions sources, and do not address emissions from existing sources. Think about greenhouse gas standards for new cars and new power plants, for example. Second, standards cannot possibly address all types of new sources, given the ubiquity of energy generation and use (and hence CO2 emissions) in a modern economy. Third, emissions depend upon many factors that cannot be addressed by standards, such as: emissions from existing sources and unregulated new sources; how quickly the existing capital stock is replaced; the growth in the number of new emissions sources; and how intensively emissions-generating plants and equipment are utilized.

Next, what about those unintended consequences? First, by reducing operating costs, energy-efficiency standards – for example -- can cause more intensive use of regulated equipment (for example, air conditioners are run more often), leading to offsetting increases in emissions — the “rebound effect.” Second, firms and households may delay replacing existing equipment if standards make new equipment more costly. This is the well-known problem with vintage-differentiated regulations or “New Source Review.” Third, standards may encourage counterproductive, unintended shifts among regulated activities (for example, from purchasing cars to purchasing SUVs under the CAFE program). All of these unintended consequences result from the problematic incentives that standards can create, compared with the efficient incentives created by a cap-and-trade system (or a carbon-tax, for that matter).

If you favor a regulatory approach, then you may welcome what’s coming from EPA as a result of the Supreme Court ruling of a few years ago combined with the Administration’s endangerment finding. For my part, I don’t welcome it; I worry about it, because the set of regulatory approaches that could be forthcoming will accomplish relatively little, and do so at an unnecessarily high cost. (More about that in some other, future post.)

To virtually all participants in the policy world, it has become increasingly clear that the only approach that can do the job and do it cost-effectively is one which involves at its core putting a price on carbon. That leaves cap-and-trade and carbon taxes. Let me take these in turn.

To think about cap-and-trade in this regard, let’s stand back from the debate regarding the details of the Waxman-Markey House bill or the new Senate proposal by Senators Boxer and Kerry, and think about the essence of the cap-and-trade approach. (For some of those details, however, please see my previous posts, where I have commented on various aspects of Waxman-Markey and described a proposal I developed for The Hamilton Project of an up-stream, economy-wide CO2 cap-and-trade system to cost-effectively achieve meaningful greenhouse gas emissions reductions.)

Here are the basics. First, aggregate emissions from regulated sources are capped, and the cap is enforced through a requirement for affected firms to hold emissions allowances. Importantly, allowance trading minimizes costs of meeting the cap. It does this because allowances migrate to the highest-valued uses, covering emissions that are the most costly to reduce. So, the emission reductions undertaken are those that are least costly to achieve. In essence, the uniform market price of allowances creates incentives for all covered sources to reduce all emissions, and do so cost-effectively.

A cap-and-trade system can be more environmentally-effective and more cost-effective than standards. First, in terms of environmental-effectiveness, a cap-and-trade system can ensure achievement of emissions targets. Cap-and-trade allows policymakers to set specific overall emissions targets. And a well-enforced system guarantees achievement of those targets, because emissions will not exceed available allowances. An economy-wide, upstream cap-and-trade system on the carbon content of fossil fuels can cover all fossil-fuel-related CO2 emissions without needing to regulate each emissions source individually.

In terms of cost-effectiveness, a well-designed cap-and-trade system minimizes emission reduction costs. Unlike NOx, SO2, and other pollutants, GHG emission reductions have the same effect no matter how, where, or when they are achieved. This makes the climate change problem unique in the degree to which compliance flexibility can be used to lower costs without compromising environmental integrity. Hence, a cap-and-trade system can minimize costs while still meeting environmental objectives by offering three forms of flexibility: what flexibility; where flexibility; and when flexibility.

In regard to “what flexibility,” many types of actions offer low-cost emission reductions, and a cap-and-trade system allows emission reductions through whatever measures are least costly. By contrast, standards can target only certain identified emission reduction measures, leaving other cost-effective opportunities untapped. Furthermore, predictions of what measures are cost-effective may be wrong.

In regard to “where flexibility,” the costs of emission reductions vary widely across industries, across facilities, and even across users of the same equipment. A cap-and-trade system exploits this variation in costs by achieving reductions wherever they are least costly. By contrast, standards would only be cost-effective if they accounted for all of the variation in costs across sectors, technologies, and regulated entities — but it is completely infeasible for standards to do this. Emission reduction costs across sectors and technologies change over time, making the flexibility offered by a cap-and-trade system even more valuable. Also, lower-cost opportunities to reduce emissions may exist in other countries. Importantly, a cap-and-trade system creates a common currency (emissions allowances) that makes it possible to link with other systems.

A cap-and-trade system also minimizes costs through “when flexibility.” Costs can be reduced through flexibility in the timing of emission reductions by avoiding: premature retirement of capital stock or lock-in of existing technologies; and unnecessarily costly reductions in one year due to unusual circumstances when less-costly offsetting reductions can be achieved in other years. A cap-and-trade can incorporate “when flexibility” without compromising cumulative emissions targets through: allowance banking and borrowing; and multi-year compliance periods.

Beyond such “static cost-effectiveness,” cap-and-trade creates incentives for innovation, and thereby lowers long-run costs. By rewarding any means of reducing emissions, a cap-and-trade system provides broad incentives for any innovations that lower the cost of achieving emissions targets. Although standards may encourage development of lower cost means of meeting the standards’ specific requirements, they do not encourage efforts to exceed those standards.

Several cap-and-trade systems have been successful at achieving environmental goals and cost savings: the phase-out of leaded gasoline in the 1980s; the phase-out of ozone depleting substances; and the Clean Air Act amendments of 1990 SO2 allowance trading program to cut acid rain by 50%. Perceived shortcomings in other cap-and-trade systems reflect design choices, not problems with the policy instrument itself. This applies both to California’s RECLAIM program, and the pilot phase of the EU Emissions Trading Scheme (which is operating successfully in its real, Kyoto phase).

In summary, compared with conventional standards, a cap-and-trade system can be more environmentally-effective and more cost-effective. As with any policy instrument, however, careful design is important.

As I mentioned, it is clear that the only approach that can do the job and do it cost-effectively is one that involves putting a price on carbon. So, what about the other carbon-pricing approach -- a carbon tax?

I am by no means opposed to the notion of a carbon tax, having written about such approaches for more than twenty years. Indeed, both cap-and-trade and carbon taxes are good approaches to the problem; they have many similarities, some tradeoffs, and a few key differences. I am opposed, however, to the confused and misleading straw-man arguments that have sometimes been used against cap-and-trade by carbon-tax proponents.

While there are tradeoffs between these two principal market-based instruments targeting CO2 emissions -- a cap-and-trade system and a carbon tax – the best (and most likely) approach for the short to medium term in the United States is a cap-and-trade system. I say this based on three criteria: environmental effectiveness, cost effectiveness, and distributional equity. So, my position is not capitulation to politics. On the other hand, sound assessments of environmental effectiveness, cost effectiveness, and distributional equity should surely be made in the real-world political context.

The key merits of the cap-and-trade approach I have described above are, first, the program can provide cost-effectiveness, while achieving meaningful reductions in greenhouse gas emissions levels. Second, it offers an easy means of compensating for the inevitably unequal burdens imposed by a climate policy. Third, it provides a straightforward means to harmonize with other countries’ climate policies. Fourth, it avoids the current political aversion in the United States to taxes. Fifth, it is unlikely to be degraded – in terms of its environmental performance and cost effectiveness – by political forces. And sixth, this approach has a history of successful adoption and implementation in this country over the past two decades.

Having said this, there are some real differences between taxes and cap-and-trade that need to be recognized. First, environmental effectiveness: a tax does not guarantee achievement of an emissions target, but it does provides greater certainty regarding costs. This is a fundamental tradeoff. Taxes provide automatic temporal flexibility, which needs to be built into a cap-and-trade system through provision for banking, borrowing, and possibly a cost-containment mechanism. On the other hand, political economy forces strongly point to less severe targets if carbon taxes are used, rather than cap-and-trade – this is not a tradeoff, and this is why environmental NGOs are opposed to the carbon-tax approach.

In principle, both carbon taxes and cap-and-trade can achieve cost-effective reductions, and – depending upon design -- the distributional consequences of the two approaches can be the same. But the key difference is that political pressures on a carbon tax system will most likely lead to exemptions of sectors and firms, which reduces environmental effectiveness and drives up costs, as some low-cost emission reduction opportunities are left off the table. But political pressures on a cap-and-trade system lead to different allocations of allowances, which affect distribution, but not environmental effectives, and not cost-effectiveness.

Proponents of carbon taxes worry about the propensity of political processes under a cap-and-trade system to compensate sectors through free allowance allocations, but a carbon tax is sensitive to the same political pressures, and may be expected to succumb in ways that are ultimately more harmful: reducing environmental achievement and driving up costs.

The Hamilton Project staff concluded in an overview paper (which I highly recommend) that a well-designed carbon tax and a well-designed cap-and-trade system would have similar economic effects. Hence, they said, the two primary questions to use in deciding between them should be: which is more politically feasible; and which is more likely to be well-designed?

The answer to the first question is obvious; and I have argued here that given real-world political forces, the answer to the second question also favors cap-and-trade. In other words, it is important to identify and design policy that will be “optimal in Washington,” not just from the perspective of Cambridge, New Haven, or Berkeley. In “policy heaven,” the optimal instrument to address climate-change emissions may well be a carbon tax (largely because of its simplicity), but in the real world in which policy is developed and implemented, cap-and-trade is the best approach if one is serious about addressing the threat of climate change with meaningful, effective, and cost-effective policies.

The single most important step that Congress must take to reduce greenhouse gas emissions is to put a price on carbon, either through a cap-and-trade system or a carbon tax.

Without a price on carbon, other strategies for reducing emissions would fall short. There would be limited incentive to develop and deploy cleaner energy technologies on the scale necessary to reduce emissions significantly. Likewise, there would be little inducement to invest in geo-engineering, which in any event is highly speculative at this point, with a bramble of unresolved technological, cost, environmental, legal, diplomatic, and national security issues.

Lost in today’s debate about cap-and-trade is the idea’s Republican pedigree. Cap-and-trade emerged in the Reagan administration’s second term as a market-friendly alternative to command-and-control regulation for reducing sulfur dioxide emissions linked to acid rain. George H.W. Bush’s administration’ embraced the idea and insisted on including it in the Clean Air Act Amendments of 1990, in spite of skepticism from environmentalists and some in the business community. The record shows that cap-and-trade has worked, reducing sulfur dioxide emissions more quickly and at lower costs than initially predicted.

If cap-and-trade cannot gain approval, then a carbon tax, with all or most of the proceeds returned to taxpayers, would be a good alternative for putting a price on carbon. Unfortunately, the “cap-and-tax” rhetoric has serves to polarize both approaches.

Whether Congress sticks with cap-and-trade or goes the carbon tax route, putting a price on carbon cannot wait. The most recent science shows that the impacts of carbon pollution on the climate are happening at a rate faster than scientists projected a few years ago. We are taking dangerous chances with the only atmosphere that we have.

Polling shows that voters across the political spectrum want climate change addressed. Congress needs to act expeditiously to pass balanced and effective legislation that puts a price on carbon emissions while avoiding economic harm. That end product will be better if stewardship-minded Republicans are constructive players in shaping it. Simply opposing the Democrats’ legislation will not help solve climate change. Republicans must be equally committed to reducing emissions and putting forward sound ideas to achieve the reductions needed. The end product will have the greatest chance of success if it passes with broad, bipartisan support.

President Clinton failed to send the Kyoto Treaty to the Senate for ratification because the Senate had already indicated by a 95-0 vote that it would not approve a treaty that exempted developing countries and which would damage our economy. The Kyoto construct was fatally flawed in 1997. Time has not been kind to the targets and timetable advocates. Legislative proposals that are based on fixed targets and timetables over decades will result in the same problems that the European cap and trade scheme has experienced. The presumption that any group possesses the knowledge to set such targets is reflecting what Frederic Hayek termed the fatal conceit.

If the parties in Copenhagen stay with the Kyoto model, nothing will happen that can get passed by the Senate. Developing Countries are exempt from Kyoto and it is hard to imagine a set of circumstances that would lead them, especially the major ones—China and India—to agree to binding emission reductions commitments. A different construct for global action is clearly called for.

Arbitrary emissions reductions are a fiction in a world with a growing population and growing economic aspirations and a world where fossil fuels will remain dominant for decades to come. At best, we can slow the growth of emissions by investing in technology, creating incentives to use energy more efficiently, and creating incentives for existing and emerging technologies to be deployed here and in developing countries as quickly as possible.

Politics is supposed to be the art of the possible. So, global action would be promoted by the US delegation and those from the EU focusing on what is possible and what is consistent with our state of knowledge and economic, energy, and technology realities. Climate orthodoxy may give advocates a feeling of moral superiority but it won’t produce an effective agreement.

The United States Senate should also focus on what is practical and realistic. An open and honest debate of climate policy options—cap and trade, carbon tax, or policies and measures—would show that cap and trade is the worst choice. Such a debate should also consider what the US has accomplished this decade. Although conventional wisdom is that we have sat on our hands, good progress has been made in reducing carbon intensity in the economy. Our improvement, in fact, is better than most of the EU countries who ratified the Kyoto Treaty. We can do better but only if we focus on realistic objective and practical, cost-effective ways of achieving them.