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Volume 1 | Issue 1 | Page 33 | Jan 2010
This In Focus article can be found in A Simple Market Mechanism to Clean Up Our Economy
What Should Be Done With the Revenues From a Carbon-Cap-and-Auction System?

Here are three reasons why an atmospheric trust should use a significant fraction of the revenues (net of administrative costs) for purposes related directly to “enhancing the asset” rather than pay out as current dividends:

1. What are “dividends” in this case?

Dividends imply the net proceeds produced by the capital after subtracting all transaction and other costs. Dividends should be paid from net profits without touching the capital asset. In order to maintain the atmospheric asset, humans need to cut emissions drastically and that will require both the development and deployment of low carbon technologies at a very rapid rate. Can we expect private markets to do this alone, even with the price signals adjusted by the carbon auction price? If research and development is left up to the private sector, new technologies will be patented. Patents are simply legal monopolies, and monopoly prices will ration use of new technologies to those who can afford them. Since information is not depleted through use, price rationing due to patents creates artificial scarcity. If the resulting prices are too high, China and India are likely to continue burning coal, in which case, we could not achieve atmospheric carbon stocks of 350 parts per million, even if the U.S. reduced emissions to zero. Patents expire in 20 years, but that may be too late. Therefore, some amount of direct investment by the trust would be necessary to restore and maintain the asset at the required rate. For example, if research and development receives a share of revenues to create carbon neutral energy technologies made freely available to all, it could dramatically trim the costs of reducing carbon emissions. Not only would this make it easier to tighten caps in the U.S., but other nations would also be more likely to adopt these technologies and reduce their own emissions. The question really boils down to this: who is best placed to develop and disseminate the necessary technologies– the private sector or the trust? There are advantages and disadvantages to both. Hedging our bets by allowing a significant role for both would be best at this point. These investments should be monitored closely. The trust can then adjust the fraction of the revenues that is devoted to direct investment, based on the relative effectiveness of its investments compared to those of the private sector.

2. Who are the shareholders?

The shareholders in the atmospheric commons are both the current generation and future generations. If the government returned all the revenues as dividends to only the current generation, does that leave enough for future generations? One could argue that it is the asset itself that the present inhabitants need to bequest to future generations; the carbon-cap-and-auction system (through the higher prices on carbon emissions it will produce) will allow the restoration and maintenance of the asset. This comes back to the question whether or not the price signals alone will get the job done fast enough. There is a strong possibility that they will need some help. In any case, by making the fraction of the revenues returned as dividends a variable rather than fixed at 100%, one could monitor the effectiveness of the private market in getting the job done and adjust the percentage returned as dividends accordingly over time.

3. What are the dividends spent on?

In essence, the trust is charging for the depletion of a common asset. If revenues are returned to private individuals, they will likely spend them on private goods and services, yet the production of these is the root cause of the carbon emissions that damage the asset in the first place. Making the cap global, or extending it to carbon emissions generated by all imports, would partially address this issue but presents its own political feasibility problems. It makes sense that at least some of the revenues from depletion of this common asset be spent on public, rather than private, goods and services aimed directly at restoring and maintaining the asset. Again, there would be room to adjust this percentage based on performance.

In summary, all these reasons boil down to one question: how effective would the private market alone be at reducing carbon emissions over time? If the cap is set and enforced adequately, then it will not be possible to exceed it. There is certainly truth to this, but there will be significant effects on the price of fossil fuel. With no technical change, the price will shoot up. If technical change is rapid enough, the price would rise less and might even be stable, even as caps are tightened. Direct investment by the trust would help speed technical change, because it would produce public domain technologies that would be more quickly adopted, and this would moderate the price rise. Predicting the magnitude of these effects is very difficult. It makes sense to allow the fraction returned to be variable, to make the system more adaptive and effective without affecting the political feasibility of the system.

Comments (1)

This proposal ignores human nature and political reality

The authors have their heart in the right place but can't see the problems with their proposed solution.  The idea of having a board to allocate revenue from permit auctions puts the money into the political process, with a host of problems from the very beginning: The revenue becomes a magnet for unproductive rent-seekers, like the New York banks. The established interests have a much better chance of capturing the allocation process than new technologies or companies out of political favor (even if they could do the job better; see what happened to the joint venture between Conoco-Philips and Tyson Foods to make "green diesel"). The mere mention of a new tax going to fund lawmaker's priorities is enough to kill the idea in today's economy. Auctioned permits are a problem by themselves, because a variable auction price does not give any level of certainty about avoided costs.  Think about a permit price which yo-yos like the price of oil.  This would prevent business from allocating long-term capital to carbon reduction, because the cost of interest could bankrupt a company in a downturn while competitors skated by on temporarily cheap permits.  This would force companies to rely mostly on the level playing field of permits, because everyone would pay the same.  This is the same phenomenon which keeps companies building gas turbines instead of wind farms; the cost of gas is highly variable, but the costs fall in a downturn while the cost of capital can bankrupt the wind farm despite its fuel being free. The EPA lawyers have it right:  we need a carbon tax, refunded to the citizens.  This leaves no room for shenanigans and the market can sort out the best ways to avoid costs (as it always does).