It seems that cap-and-trade is running out of steam, particularly when one looks at the heavy cost to industrial states. Last week, I spent several days in the Great Plains states speaking to business groups and the media on the acute economic effects that a cap and trade system on GHGs could have on their local economies. Residents from the Siouxland area in particular are very concerned about this impact.

Jobs are clearly the dominant issue weighing on the mind of the electorate as demonstrated by this week’s stunning upset by Senator-elect Brown in Massachusetts and to enact a sweeping cap and trade system that would slow economic recovery seems unlikely.

The cap and dividend system proposed by Senators Cantwell and Collins is a better alternative to Waxman-Markey or Kerry-Boxer due to the fact that it puts a ceiling on CO2 allowance price rises. However, if Congress truly feels compelled to enact climate change policy this year, then a carbon tax is a much more transparent, efficient and fair way to approach to curbing greenhouse gas emissions.

Once again the developing countries said what they always say, but this time, a little louder. Fortunately, someone at Copenhagen had not drunk the capper’s Kool-Aid. Obama signed an Accord with no hint of caps for the top five poor countries. And then he finally dispelled the myth that Kyoto was built on. “Kyoto was legally binding and everybody still fell short anyway.” Kyoto-style caps are a poison that has destroyed global climate policy. But like the deadly cyanide, the taste of poison has been masked by the Kool-Aid of tough targets and emission certainty.

Todd Stern’s trend-line caps would cap India at half the emissions level of the US in 1880, not 1980! And had China accepted such a cap from Stern in 2000, China would have been buying about $90 billion worth of carbon permits on the international market right now. From Who? Europe? How would they explain that to their citizens? As Stern says, “You've just got to do the math. It's not a matter of politics or morality or anything else. It's just math.” Likely, China did more math than Stern. But fixation on the math of caps is what went wrong.

What’s all this got to do with the Senate? (1) The Senate is not accepting any worthwhile cap if the biggest, fastest-growing emitter isn’t having one. (2) Passing a cap so “China will follow” has gone from sublime to ridiculous. Now some may think that China did cap its “intensity” down 45 percent in 2020. But DOE said, back in May 2009, that 45 (actually, 45.08) percent is exactly what China would accomplish under business as usual. Here’s the math.

So, if we can’t cap poor countries, what’s our global policy? Well there’s one thing we all agree on. Pricing carbon (cap or tax) is a good idea. So that’s the answer. Scrap caps, and commit to a global price for carbon. I’ve been saying that for a year, Cooper has said it for a little longer, and Stiglitz has just said it. The World Bank is interested, and I see others moving that direction.

The main hurdle is to get the US climate team to stop pretending that the only possible commitment is a cap. Then, after quite a few mea culpas and a heart-to-heart talk with China on the benefits of climate policy for their oil addiction (and ours), we’ll get China on board. (Again the environmentalists will have to do some math. They still don’t get how conserving oil lowers the world oil price and helps the climate).

Next the Senate will need to meet our commitment to a global carbon price. That could be done with a cap or taxes, but understanding our global commitment will reshape the whole debate. Yes, we need to get the cart on the road, but the global-policy horse must come first, or we won’t get far.

A carbon-price commitment will add one more reason not to let unstable cap-and-trade prices bubble up temporarily. And it’s never popular when carbon speculators send gas and electricity tax rates sky high. So a price limit is key, but one method should be avoided at all cost. Foreign offsets.

Europe’s use of foreign offsets, and the Waxman-Markey promise of more billions, have taken their toll on global cooperation. Why do you think the developing countries were demanding that we cap ourselves down 45 percent? They knew we couldn’t meet that target—but what excited them was visualizing more tens of billions for offsets. About two thirds of that cost is pure profit to them. As Stern said, “It’s just math.”

It’s often tough to predict what will happen in the Senate, and that’s certainly the case right now. While some are looking at alternatives to an economy-wide climate bill, Majority Leader Reid recently reiterated his commitment to pursing comprehensive energy and climate legislation this year.

The Edison Electric Institute continues to favor enactment of comprehensive legislation that reduces greenhouse gas emissions 80 percent by 2050, while providing strong consumer cost-containment provisions to help mitigate electricity price increases as we transition to a low-carbon future. This remains the best way to achieve environmental goals, while softening the impact of higher energy prices on U.S. jobs and the economy. We also believe it’s the surest path to achieving the 60 votes necessary to move legislation in the Senate.

The Senate has many options on the table as the new year begins to unfold. We hope that comprehensive cap-and-trade legislation with strong consumer protections remains a centerpiece of discussions as the debate continues.

As our legislators weigh the pluses and minuses of a US cap and trade system -- a US carbon market -- a few critical features must be taken into consideration:

1. There is no need for any single nation to adopt a carbon market internally even if the nation is an active participant in the international carbon market. The international carbon market I designed and wrote into the Kyoto Protocol in 1997 is generally identified with the European Union Trading System (or EUTS) that is now trading since 2005 and involves about $125 billion/year trading. Its trading doubles each year and it is expected to become the largest commodity market in the world soon. Trading in the EUTS emphatically does not require an internal carbon market. It requires only a binding commitment by a nation to carbon emissions bounds.

To be more precise: the carbon market of the Kyoto Protocol is consistent with any form of carbon control on the part of a participating nation - including cap and trade, or taxes, or direct carbon emissions limits, to name a few. As the US increasingly participates in the international climate change negotiations and regulations, therefore, it could do so with an internal tax system to regulate its emissions, or using any other internal measure - including an internal cap and trade system.

2. Carbon taxes seem easier to understand than a cap and trade system, because we are used to using taxes for public goods. But taxes have several drawbacks: the most obvious is that they do not control the quantity emitted - which is the key point one is trying to achieve - except indirectly, and if they do so they are not necessarily reliable. With taxes one pays more for emitting - but there are no firm emission limits in the aggregate that one achieves from a carbon tax, no matter how successful this may be. Cap and trade, by contrast, starts with an aggregate limit that cannot be exceeded.

Another drawback of the carbon tax is that its revenues - which can be allocated for the public good - need not do so. There is a "political" and a "time" separation between the act of taxing emissions - and the act of investing or spending the amount taxed. In the carbon market, by contrast, each dollar paid by an over emitter goes directly and instantaneously to an under emitter. One is penalized, the other is rewarded, exactly as one would want it to be. No political or time separations exist with the carbon market.

Finally the carbon tax is a chosen number - while the carbon market price is determined by market forces, and therefore represents more efficiently the consumer's preferences, it is allocated more efficiently, and the carbon price of course the limits on emissions that the nation decides it wishes to achieve as a whole.

3. There is a close connection between international and domestic policies, and the former tend to dominate. Domestic cap and trade system and domestic carbon taxes in any given nation are likely to become "subordinated" to the international carbon market - namely, the carbon price (or carbon tax) in both will converge -- this is what is generally called a "no arbitrage" dynamics of markets. It can be seen as follows: if can buy a carbon offset (for emitting a ton of carbon) cheaper in the US market than I can in the Kyoto Protocol market (the EUTS) -- then I will always do so until through excess demand at home prices equalize in both markets.

Since the US emits a fraction of the global emissions - the larger market (in this case, the EUTS) will always dominate the domestic market. The same is true with US carbon taxes, that will eventually will tend to equalize with the international price for emitting carbon in the EUTS. This is natural and to be expected. At the end of the day, therefore, it does not matter much what one does domestically - except for the efficiency and ability t impose hard limits mentioned above.

4. In addition, carbon markets have other features that carbon taxes cannot emulate. With carbon markets, being clean translates in direct and marketable profits. Being clean is more profitable, being dirty is less so. In the case of carbon taxes, instead, it is a mater of paying less taxes -- while in the case of the carbon market one actually makes money from being clean, from using clean energy sources, etc.

The profit motive that arises from markets is strong -- and should not be underestimated. Hundreds of towns and cities in the US have expressed their desire to join the Kyoto Protocol carbon market - including California - because the profit motive is so powerful, and because they believe in the goal of reducing emissions in a binding way (which taxes do not guarantee).

5. It is true that carbon markets can be awkward for smaller transactions involving single individuals, which is the case when taxes are more efficient. A nation can adopt both a carbon market and carbon taxes.

A nation can also participate in the carbon market (EUTS) only as a seller (after it has adopted internationally binding emission limits) or only as a buyer - or as both, which is the standard today.

6. The "convergence" feature described above between domestic carbon prices or taxes and international prices - is a powerful market force and it will eventually prevail. It will lead to a convergence between domestic and international objectives, which is a welcome outcome. This is a very positive feature of the international carbon market that operates no matter what each nations does internally.

The future of the global economy will also change as the international carbon market makes clean energy more profitable than fossil energy.

This will affect the production of each good and service in the global economy - all goods that are intensive in fossil fuels become less profitable, and those using clean energy become more profitable, since energy is the mother of all markets and everything uses energy to be produced.

41% of our global carbon emissions come from power plants - and the power plant infrastructure according to the International Energy Agency involves about US$50 trillion in infrastructure that has to be restructured. Taxes may not be as efficient as markets to help the transition to clean energy in the world economy - and in the US.

US industry - for example our automobile industry - needs reliable "carbon price" signals - and although taxes are more stable than carbon prices - the latter may represent more accurately the cost of emissions to the global economy.

Neo-classical economics would have us pick a price for carbon where marginal cost equals marginal benefit - and choose a price limit (i.e. a carbon tax) over a quantity limit where the marginal benefit curve is flat. A freshman economics class would not be the least bit challenged by this construct. They may be challenged, however, by the graph shown in the link below – not so much in what it means, but in choosing a policy to address it. Maybe, just maybe, this is why a hard emissions cap, and the capital investment it would drive (coincident, if done right, with greater energy productivity) is worth whatever complexities it presents. Saying a carbon tax is more efficient raises the question: “more efficient at what?" https://docs.google.com/present/edit?id=0AZV4QCgP4lvNZDlqNWtrNV8yOGR6NXhya3N4&hl=en

In our 2008 paper, “Time for Plan B: Cutting Carbon Emissions 80 Percent by 2020,” [PDF] Lester Brown, Jonathan Dorn, Frances Moore, and I lay out an ambitious plan to cut worldwide net carbon emissions 80 percent below 2006 levels by 2020. As part of that plan we call for tax restructuring: instating a carbon tax of $20 per ton that would increase predictably by $20 each year, and offset that with a reduction in income taxes (or credit, for those earning too little to pay income tax). A dividend system could work similarly. As others have turned it, the goal is to tax what you burn, not what you earn.

As we note in “Time for Plan B”: “Restructuring taxes is more efficient, easily understood, and transparent, and it can be implemented quickly and economy-wide. A carbon tax that is offset with a reduction in income taxes would permeate the entire fossil fuel energy economy. The tax on coal would be almost double that on natural gas simply because coal has a much higher carbon content per unit of energy.

“Once a schedule for phasing in the carbon tax and reducing the tax on income is in place, the new prices can be used by all economic decisionmakers to make purchasing and investment decisions. A carbon tax of $240 per ton by 2020 may seem steep, but it is not. If gasoline taxes in Europe, which were designed to generate revenue and to discourage excessive dependence on imported oil, were thought of as a carbon tax, the tax of $4.40 per gallon of gasoline would translate into a carbon tax of $1,815 per ton. This is a staggering number, one that goes far beyond any carbon emission tax or cap-and-trade carbon-price proposals to date. It suggests that the official discussions of carbon prices in the range of $15 to $50 a ton are clearly on the modest end of the possible range of prices. The high gasoline taxes in Europe have contributed to an oil-efficient economy and to far greater investment in high-quality public transportation over the decades, making the region less vulnerable to supply disruptions.

“Environmental tax restructuring is not new in Europe. A four-year plan adopted in Germany in 1999 systematically shifted taxes from labor to energy. By 2003, this plan had reduced annual CO2 emissions by 20 million tons and helped to create approximately 250,000 additional jobs. It also accelerated growth in the renewable energy sector, creating some 64,000 jobs by 2006 in the wind industry alone, a number that is projected to reach 103,000 by 2010. Between 2001 and 2006, Sweden shifted an estimated $2 billion of taxes from income to environmentally destructive activities. This shift of $500 or so per household came from hikes in taxes on electricity, fuel, and CO2 emissions. The government estimates that without carbon taxes, emissions would be 20 percent higher than they are now. Other countries using tax shifting include Denmark, the Netherlands, Italy, Norway, and the United Kingdom.”

Perhaps now the United States will consider joining that list.

The outcome of this week's Massachusetts special election leaves leaders on Capitol Hill facing a host of new questions. The biggest one is do they get the message that voters have been sending since the Tea Parties were first held and which was unambiguously sent on Tuesday? If they get it, the question about energy policy is how to successfully manage the Senate's new make up in order to pass an effective, sustainable climate policy? A complex question. Yet, the answer is simpler than it appears.

Now that Democrats no longer have the 60-vote majority necessary to sustain even the hope of passing the contentious cap and trade bill in 2010, lawmakers serious about addressing greenhouse gas emissions need to look elsewhere. That means giving serious consideration of alternative policies—there costs, benefits, and rationale.

One of the nation's pre-eminent economists, William Nordhaus of Yale, has made the case, "a harmonized international carbon tax is likely to be a more effective mechanism [than cap and trade] for responding to the threat of climate change." Other U.S. thought leaders such as Harvard professor Richard Cooper and former Clinton economic adviser Robert Shapiro have published research demonstrating the superiority of a carbon tax over cap and trade. Well-respected think tank Resources for the Future published research demonstrating a simple carbon tax would be five times more cost-effective than an emissions trading approach.

A carbon tax is simpler, more transparent, less susceptible to gaming, and doesn’t have to be punishingly high. Economists like Shapiro favor using a carbon tax to reduce an economically more distorting tax like the payroll tax. Now, this revenue-neutral approach now may get its deserved hearing on Capitol Hill.

To bring this argument full circle -- taking it back to Tuesday's Bay State shocker – the Brown lesson is have faith in the good judgment of the people, do the right thing and let the chips fall where they may. He ran the table with that strategy. If Congress learns the lesson it will develop a climate policy that is good for the environment, good for the economy, and bad for rent-seekers.

Yesterday’s Massachusetts Senate election changed the political dynamics in the Senate. No longer do the Democrats control the super majority needed to pass broad climate change legislation. Some pundits say the election was proof that the public opposes big government programs and higher energy prices linked to the comprehensive cap-and-trade bills passed by the House and the Senate Environment and Public Works Committee. Does the election change what the federal government is likely to do on climate change? Or was the global warming legislative debate moving beyond cap-and-trade even before the election?

Capping a free good and letting a competitive market find replacements is a pro-business solution to a social need. Taxing a free good means the Government sets the price BUT will likely need to change that price over time (particularly with carbon). Free enterprise advocates who want a carbon tax - followed by their own future fights to keep the tax low - are advocating a free enterprise of convenience rather than competition.

There are basically three policy routes for controlling emissions—cap and trade, carbon tax, and policies and measures (CAFE, efficiency standards, incentives for new technology, etc). Although the last possibility, policies and measures, produced significant reductions in carbon intensity over the last 10 years, many in the environmental movement claim it’s no longer an acceptable choice, unless everything else fails. That effectively narrows our options to two.

Cap and trade is enormously complex, leaving it vulnerable to rampant manipulation and outright fraud. Analysts worldwide have extensively documented its failings and its deficiencies relative to alternatives. For instance, the Marshall Institute has published two studies on this very issue—“A Cap and Trade System v. Alternative Policies to Curb U.S. Greenhouse Gas Emissions” and “Why Cap and Trade is the Wrong Policy to Curb Greenhouse Gases for the United States.” Rob Shapiro, a contributor to this blog and former Under Secretary of Commerce in the Clinton Administration, has also published research demonstrating that a straightforward carbon tax shift is far superior to an elaborate emissions trading scheme. Earlier this decade, a Resources for the Future study found that a carbon tax was five times more efficient or cost-effective than cap and trade.

If a carbon tax is so superior, why is cap and trade being pushed so hard?

Lawmakers and some environmental advocates favor cap and trade because it endows Washington with the power to give or withhold high-dollar favors. Many politicians also foolishly think the added layers of bureaucracy necessary for an emissions market will somehow shield them from the public outcry over the steep price hikes it would trigger. Rent seekers, like some utilities and equipment manufacturers, lobby for this approach since it would enable them to profits through influencing regulations instead of actually earning them in the market place. And then there are the Wall Street traders. They’re in it for the “green” -- not the promised environmental improvements but the financial windfall for facilitating trades.

Comparisons of this proposed system for mitigating carbon to the program used to control sulfur dioxide emissions are flawed. Technology for SO2 control was readily available; there is none, at this time, for greenhouse gas emissions. Additionally, railroad deregulation made shipping low sulfur western coal economical.

Instead, the EU’s Emission Trading System offers the best comparison. And it has been a dismal failure: causing large energy price increases, scaring off investment, and attracting widespread fraud and abuse while failing to deliver promised emission reductions.

Though a carbon tax would also be vulnerable to lobbying for special treatment, its transparency and simplicity makes it much harder. Some opponents claim that the public’s distaste for a “tax” -- especially during a period of economic stress -- makes this policy a political non-starter. But recent polls show otherwise, particularly since carbon tax would be offset by reducing the payroll tax.

Although a carbon tax is clearly superior to cap and trade, the current state of political polarization in Washington leaves prospects for any climate legislation dim. There are too few statesmen willing to set aside major points of contention and lead a bi-partisan effort to address the climate issue honesty and objectively. Almost 50 years ago, President Kennedy said, “Let’s not seek the Republican answer, or the Democratic answer, but the right answer. Let us not seek to fix the blame for the past. Let us accept our responsibility for the future.” If there was a greater willingness to be guided by that philosophy, America would make greater progress on all of the critical issues confronting our county.

It is still far from clear whether a cap-and-trade approach to carbon control will emerge from congress for signature by President Obama. The smart money seems to suggest that it will not. IF cap-and-trade fails, it’s fair to open up the debate again to see if there is an alternative that is preferable. Despite being in the minority on this issue, I believe that we would do much better in the U.S. to approach climate control using a carbon tax. To be sure, there are respects in which cap-and-trade may be preferable to a carbon tax, not the least of which is that -- until now, at least -- the belief among experts is that the former is more politically palatable than the latter. But if a cap-and-trade bill cannot be passed, it’ll be time to reconsider that argument.

Briefly, the advantages of a carbon tax are its transparency, the reassurance it provides to business that costs will not go sky-high and, finally, its revenue raising potential. This last point is by far its most compelling advantage.

Regarding transparency, except for those recent arrivals to planet Earth from other galaxies, just about everyone realizes that a cap-and-trade approach will raise the price of fossil fuels (oil, coal and natural gas). In other words, cap-and-trade is a tax on the latter, though not in name. That’s exactly how it will end up reducing fossil fuel consumption and, hence, carbon dioxide emissions. And naturally, that’s why politicians prefer it to a straightforward tax. But the public understands this by now and may -- just may -- prefer to be taxed in an open and transparent way.

If one believes as I do that at least some business support will be required for any serious carbon control effort, the chances of eliciting it will be greater under a carbon tax than under cap-and-trade. This is because under the latter (in which the quantity of emissions is subject to a hard cap), there is no certainty about what the price of carbon control will be. This will make it more difficult for businesses to commit to the needed investments in carbon mitigation (though one could make a similar argument about carbon taxes, I concede).

Finally and most importantly, a warmer world is not the only serious burden we may be leaving for our descendants. The federal budget deficit for 2009 was $1.6 trillion, or 11.2 percent of GDP. According to CBO it will be $1.4 trillion for 2010 and will be no lower than $540 billion for any year during the entire decade. By the end of the “teens,” and unless these two programs are significantly reformed, baby-boomers will be retiring by the millions and beginning to collect Social Security and Medicare. AARP will do everything it can to see to it that any reforms will be minor. This means that we are headed back toward trillion-dollar annual deficits in the future, even if the economy recovered from its current swoon.

Expenditure cuts can and must be part of the way we deal with this future fiscal disaster. But it’s obvious that the federal government will need new revenues, too. Rather than raise taxes on our labor (income taxes) or savings (capital gains taxes), why not tax things we want to discourage rather than encourage? A carbon tax that started off gradually and rose according to schedule over a twenty or thirty year period could provide much-needed revenues to help reduce the deficit. This, incidentally, could be accomplished through a cap-and-trade approach, of course, if all the permits were auctioned off. But we saw over the past year how congress could not resist the temptation to hand out permits free of charge to a variety of favored constituencies (some of whom were quite reasonable candidates for assistance). If a significant fraction of the revenues from a carbon tax were firmly pledged for deficit reduction, rather than handed out to congressional supplicants, a carbon control bill could fairly be billed as “Double Dividend for the Future.” This just might win broader and more passionate popular support than cap-and-trade was able to attract in 2009.

This is a rare opportunity to kill (or at least wound) two birds with one stone, both of which pose serious threats to our children’s and their children’s well-being in the decades ahead.

It’s way too soon to write an obituary for cap and trade this year. Yes, the Senate, like a boa constrictor, is trying hard to digest a major health care bill – and it has other major legislation to consider on financial services reform and jobs. But intelligently drawn climate legislation can help unleash major new clean energy and climate mitigation projects across the country, creating new jobs in a sector that’s been in the doldrums due, in part, to uncertainty about federal climate rules. It can also avoid a potential detour into EPA regulation under the Clean Air Act, which is bound to be less flexible and more costly than a new federal law.

Of the alternatives to cap and trade floated in this week’s question, I see no hope of a meaningful carbon tax passing any sooner than cap and trade legislation. The Clinton-era BTU tax taught a painful lesson for Democrats – that carbon taxes have a major political cost at the ballot box. The cap-and-dividend proposals are similarly flawed, as they penalize industry and create inefficiencies as massive funds are cycled through the federal government and eventually are rebated to industry and consumers. More importantly, the restrictions on trading and offsets ensure that the legislation would cost far more – while doing less for the environment – than the House-passed ACES bill. One of the strengths of ACES is that it freely allocates a significant portion of allowances to power companies and natural gas distributors and heavy industry – which ensures that the funds for retooling their facilities stay in the private sector rather than circulating through federal coffers.

The more hopeful prospect for the Senate would be to reconsider the phasing-in of targets to create enough time for industry to adjust. For example, it might begin with a slight delay for large power plants and manufacturing facilities – and consider whether another approach for transportation allocations might be warranted.

Its heartening to know that bipartisan leadership has emerged. If Senators Kerry, Lieberman and Graham can work with President Obama to forge a compromise early this Spring, there would be ample time to conference a bill this Summer. That would be good news for both parties in elections this fall – and it would give the U.S. a strong boost in its efforts to encourage better cooperation in international climate negotiations in November.

The collapse of any prospects for global emissions trading scheme at Copenhagen drove another nail in the coffin of the proposed US program. In order to understand the reason behind its fall, just dispatch the overly complex anti-growth and anti-free enterprise ogre in the cap and trade concept: the cap.

Much has been made of the scams, profiteering and financial skullduggery which inevitably comes with a multi-billion commodities market. Take, for example, the incidence of fraud in Europe’s existing trading scheme. In less than two years, criminals were able to game the EU’s Emissions Trading System for over $7 billion in purloined tax revenues. And abuse isn’t limited to white collar crimes. Last year, Interpol identified the emissions market as a potential playground for organized crime syndicates. (“Leave the gun, take the carbon credits.”)

The great focus given these rampant scandals in the “trade” portion left little attention for an adequate debate over the what and how of the “cap.” This feature of the policy would have endowed a single super regulator with more power than President and Congress combined to control America’s economy. The output of energy, farming, steel, IT processing -- any activity which consumes power and, therefore, creates emissions -- would under the thumb of this Cap Czar. That’s a command and control tool of which the old Soviet Union would have been proud.

Now is the time to consider other strategies which will not crimp the enterprise engine which drives the economy. One is a carbon tax. Another is promotion of new clean energy technologies <em>sans</em> any massive subsidies that would further burden the deficit. And given the recently broken controversy over integrity of some of climate change’s key scientific research, some independent analysis of the speed of global warming would be sensible.

Amid high unemployment, low growth and massive public debt, neither the US economy seeking recovery (nor the US politicians seeking re-election) can afford the massive price tag that would come with an inefficient emissions policy.

One of the more surreal aspects of the current climate change debate in Congress is how almost everyone wants to talk about everything except solving the actual problem. And the problem is that humanity is already above the target CO2-e part per million (ppm) standard in the atmosphere that the best available science tells us to achieve. Present atmospheric CO2 is at roughly 390ppm and science tells us to get to 350ppm or lower. But it is clear that the “business as usual” crowd finds loophole-laden and hyper-flexible economic mechanisms more comforting than concrete science-based greenhouse pollution reductions. By way of example, many “cap and trade” supporters have become catatonic in their group-think belief that any cap and trade system will get us to the Holy Grail. Whatever legal mechanism Congress eventually passes to address global warming must meet two fundamental tests: 1) It must build upon the science-based foundations of the Clean Air Act; and 2) It must be straight-forward.

Einstein supposedly remarked that "everything should be made as simple as possible, but not simpler". The CLEAR proposal, with an upstream point of regulation and pro-rata rebate of auction revenue, might meet this test very well. A few key revisions, however, would keep it from slipping into “simpler”:

1. A price cap may turn CLEAR in CTEAR, thus ruining both the acronym and the environmental efficacy of the policy. Markets with price caps aren’t really markets - and unintended consequences from controlling prices are more a rule than an exception. And since CLEAR lets the Executive Branch and Congress adjust policy stringency...a price cap is redundant in any case.

2. Abatement opportunities are cheapest in the early years. With little shrinkage in Carbon Shares at the outset, and a 2-year banking limit, CLEAR discourages the low-hanging fruit. Banking should be extended to at least 5 years - and abatement requirements leveled (CLEAR’s 0.25% rising to 9% over 35 years - and 2% per year flat - leaves plenty of middle ground).

3. Limiting the market to First Sellers does reduce market efficiency and will make the policy more expensive. Recognizing this, at a minimum, First Sellers should be permitted to create and trade physically delivered warrants amongst one another. Such warrants create a valuable hedging tool that can help narrow the efficiency gap relative to an unfettered market. The Government could also auction long-dated warrants to get a liquid market started.

4. Most carbon models forecast 80 to 90% of abatement in hybrid economy-wide cap and trade to come from the electric power sector. Yet if CLEAR’s higher fuel costs are passed directly to utility ratepayers, then, at the margin, abatement will be forced onto higher cost sectors. Market-based policies for regulated industries are always a challenge - but CLEAR needs to task regulators with formulating a remedy for direct fuel cost pass-through.

5. With about ⅓ of global greenhouse gas emissions coming from sources other than combusting fossil fuels, we can’t achieve a 2-degree policy target without (in particular) deforestation and methane projects offshore. CLEAR should add a strategic reserve that fast-tracks large scale projects, buys the credits, and re-sells them in domestic Carbon Share auctions. This will also help offset the price cap removal and accelerated emission reductions I mentioned earlier.

CLEAR is a good proposal, with the potential to be a great one. I hope 2010 is the year business gets a CLEAR set of rules - so their low-carbon innovations create American jobs, wealth, and energy independence.