The Congressional Budget Office recently issued its report on the Waxman-Markey bill. The Washington Times soon trumpeted: "CBO puts hefty price tag on emissions plan: Obama's cap-and-trade system seen costing $846 billion."

This is quite misleading. Actually, the CBO report tells us virtually nothing about the economic costs of the bill or how much consumers will lose out of pocket. In fact, the way most people understand the idea of a budget deficit, it doesn't really say much about that either. CBO's analysis is based on some very technical accounting that can easily be misinterpreted. In particular, CBO treats the issuance of free carbon allowances quite differently than most people would expect.

CBO's job is to project the bill's effect on the federal budget. Here's the bottom line from the report, which is what the Washington Times story was reflecting:

CBO estimates that implementing this legislation would result in additional revenues, net of income and payroll tax offsets, of $253.2 billion over the 2010-2014 period and $845.6 billion over the 2010-2019 period. We estimate that direct spending would increase by $241.3 billion and $821.2 billion over the same periods, respectively.

Those sound like really big numbers (though less so on an annual basis), but the numbers don't mean what they seem to.

There's an important point that many readers may miss: "Those changes in revenues and direct spending would mainly stem from the process of auctioning and freely distributing allowances under the cap-and-trade programs established under this legislation." When the government creates an allowance, CBO counts that as creating a government asset; giving it away free counts the same as spending an equivalent amount of cash.

Thus, most of these revenue and expenditure numbers from CBO don't involve cash or issuing T-bills as debt. CBO says the government will actually have only about $49.9 billion over the 2010- 2019 period in additional discretionary spending. Mostly, the "expenditures" consist of giving away free allowances. CBO estimates that $973 billion worth of allowances would be sold or given away over a decade, of which about twenty percent would be sold, which in turn would mean something like $200 billion in income. So from a cash point of view, the effect on the budget appears to be even better than CBO portrays it.

CBO's approach seems logical from an accounting point of view. But if you're worried about how the deficit could affect interest rates or exchange rates, the cash figures would seem to be more relevant. If the Chinese are worried about our deficit, they're not likely to care much one way or another about the theoretical accounting treatment of allowance giveaways. The government's creditors should like Waxman-Markey better than CBO does.

In some ways, the CBO report is most useful in ways that don't directly relate to the federal budget. I'd like to spend a bit of time on these incidental aspects of the report.

Besides having an excellent summary of the bill, the CBO report contains other useful information. First, the "base" of the allowance program is broad. CBO estimates that about 7,400 facilities would be affected by the cap-and-trade programs established by the bill. According to CBO's estimates, the programs would cover about 72 percent of U.S. emissions of GHGs in 2012, about 78 percent in 2015, and about 86 percent in 2020.

The second thing to notice is the price of carbon. CBO estimates that the price of GHG allowances would rise from about $15 per mtCO2e of emissions in 2011 to about $26 per mtCO2e in 2019. One ton of carbon produces roughly three tons of CO2, so this is equivalent to a carbon tax of between $45 and $78 per ton. But CBO also makes it clear that these are soft figures because the models aren't very robust.

Third, offsets have a big impact on costs. CBO estimates that covered entities would use international offsets in lieu of about 190 million allowances in 2012 and in lieu of about 425 million allowances in 2020. Together, the provisions allowing the use of domestic and international offsets would decrease the price of GHG allowances by $35 (69 percent) in 2012.

One final thing: CBO nowhere gives an estimate of the total cost of compliance to industry. We know the marginal cost of compliance from the allowance prices, but the average cost from the cap-and-trade program itself should be lower. (On the other hand, some allowances will be freed up from compliance with other regulatory mandates, which may be expensive.) From the consumer point of view, the biggest question is probably how much of a decrease in the availability of energy takes place, since that's what will drive up prices in competitive markets. CBO doesn't tell us that either.

And of course, CBO doesn't say a word about the environmental benefits of mitigating greenhouse gases, because those benefits are off-budget.

The moral of this story: Don't confuse accounting budgets with real economic impacts.

Related Links:

What to make of the new climate poll

Carol Browner strongly backs bipartisan cap-and-trade bill

Make the kids pay: The economic effects of climate change on future generations

As the Waxman-Markey climate/energy bill nears a make-or-break vote in the House, those who work to improve it need more than ever to understand it first. Smart strategy is based on sound information. On that note: one of the central critiques of the bill is a red herring at best and at worst simply false.

Here's the critique, which should sound familiar from endless media repetition: Waxman-Markey gives away 85% of emission allowances to polluters, instead of auctioning them like Obama wanted.

This, it is said, will enrich dirty-energy shareholders at the expense of consumers. It is evidence of the bill's corruption by special interests; evidence that cap-and-trade is just the fiasco critics warned; evidence that Democrats are just as beholden to big corporations as Republicans. And so on.

Two problems with the critique: it asks the wrong question and offers the wrong answer.

The wrong question

By capping greenhouse-gas emissions, the bill transforms them into a finite commodity, thereby giving them monetary value. In effect, it creates a huge new pool of value, in the form of emission allowances.

How should that value be distributed?

On this subject, discussion has been dominated by the "allocation vs. auction" debate: should the government distribute the allowances or auction the allowances and distribute the resulting revenue? Allowance auctioning has taken on a kind of iconic quality -- it's become a rallying cry for progressives. I've indulged in that cry myself, more than once.

But ultimately it's the wrong question. It just doesn't make a ton of difference.

Imagine the government had a big pile of vouchers, each of which could traded in for $5. It could trade in the vouchers itself and distribute the cash, or it could just distribute the vouchers. Now ask yourself: is the mechanism -- the system governing who trades in the vouchers -- the most important policy question here? Obviously not. A voucher and a $5 bill are of equal value. 

What matters in a cap-and-trade program is who receives the value of the allowances. Follow the money, not the mechanism.

(One note: Alan Durning makes the argument here that auctioning the allowances and distributing the cash is more transparent -- that distributing allowances somehow hides what's going on. But it's not a secret who's receiving the allowances; here's a PDF laying it out. I don't see why a procedural disagreement should be the central battle. Procedural issues don't have a record of success rousing the public.)

The wrong answer

Now that we're talking about the right thing -- the value itself, rather than the procedural mechanism that produces it -- let's ask: who does get it in the bill? Is it really "polluters"? Is this bill nothing but a porkfest full of special interest giveaways?

The answer to that is a qualified no. The Lieberman-Warner climate bill from 2008 -- that was a porkfest. It handed out allowances like candy, with no particular policy rationale aside from which constituencies had the most political muscle. Perhaps that bill colored media and public perceptions of cap-and-trade to the point that everyone's just predisposed to see that dynamic at work no matter what. Once a storyline is established, it's hard to uproot it.

But Waxman's staff is a storehouse of incredible policy acumen, and the allowance distribution scheme in the bill, while certainly not perfect, is surprisingly policy-driven.

There are a variety of ways of breaking down the allowance allocations. Here's how staff of the House Energy and Commerce Committee group the distribution in 2014:

You can question those latter two categories. To some people (i.e., me), money for carbon capture and sequestration (CCS) looks more like an industry handout than a clean energy investment. There are other allocations you could frame differently.

Point is, roughly half the allowance value goes to consumers. Roughly a quarter goes to Clean Stuff like clean energy, prevention of international deforestation, adaptation, state efficiency programs, and the like. And roughly a quarter goes to Dirty Stuff like merchant coal generators, oil refineries, and trade-exposed, carbon-intensive industries like steel. Not how I'd do it, but not "giving away 85% of allowances to polluters." The bulk of the value is going toward protecting consumers and transitioning to a clean energy economy.

Another way of breaking it down is to ask how much value will go to various purposes over the lifetime of the bill. Nat Keohane, an economist at the Environmental Defense Fund, has worked up some numbers based on EPA projections for the value of allowances. Here's what he's found (note that he categorizes things somewhat differently than above):

Again, not how I'd do it, but not "85% of allowances to polluters." Somewhere around 22% of allowance value is going to big, polluting industries over the lifetime of the bill. Given the amounts we're talking about here, that's a huge amount of money, but it's nowhere close to 85%.

Other debates

I suspect it's futile to say so, but this is not meant to cheerlead for the bill. There are plenty of legitimate debates to be had over how it's structured. Some beefs:

I'm ambivalent about the strategy of using LDCs to get value to consumers, though I think Joe Romm's contributors mount a pretty convincing defense. You need some way of accounting for regional disparities, and the dividend crowd hasn't, to my knowledge, offered anything plausible.

Anyway, point is, these debates and many more are worth having. Yay for debate and dissent!

But lots of progressive time and energy are being devoted to what is effectively a fake controversy and a false charge against the bill. The bill is not entirely a pork party for polluters. It's only a quarter pork party!

Related Links:

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UPDATE:  At the end, I'm going to respond to what has now become a widespread myth that because Waxman-Markey supposedly mutes the electric price signal to consumers, it hurts the cause of energy efficiency.

The Subcommittee on Energy and Environment will hold a hearing titled, "Allowance Allocation Policies in Climate Legislation:  Assisting Consumers, Investing in a Clean Energy Future, and Adapting to Climate Change" on Tuesday June 9, [at 9:30 am, info here, webcast here].  The hearing will examine allocation policies under the American Clean Energy and Security Act (ACES).

The allocation of the greenhouse gas emission allowances is certainly one of the most controversial and complicated parts of the Waxman-Markey bill.  Here are some key overview posts:

But if you really want to become an expert on the pros and cons of the issue, I would suggest that you tune into the hearing, where both sides will get a full airing of their views, with the following expert witness:

E&E Daily (subs req'd) explains the origin of this somewhat unusual House Energy and Commerce hearing - unusual since it comes after Committee approval of the bill:

House Energy and Environment Subcommittee Chairman Ed Markey (D-Mass.) will follow through tomorrow on a promise to hold a hearing on the emission allocation provisions included in the comprehensive global warming bill the Energy and Commerce Committee approved last month.

Markey agreed during the markup for the hearing on perhaps the most contentious piece of H.R. 2454, the allocation language that distributes hundreds of billions of dollars worth of allowances to industrial firms that emit greenhouse gases.

Democrats held several general hearings on the emission allowance issue, but they did not give the committee a chance to publicly vet the actual legislation released less than a week before the 33-25 vote that sent the bill to the floor. Republicans objected to the procedural gap but were unable to force a delay in the markup, which Democratic leaders pledged to conclude before the Memorial Day recess.

TOUGH QUESTION POSED BY A READER

In the earlier post - "Preventing windfalls for polluters but preserving prices" - two of the country's leading experts on the electric utility industry and energy economics, Peter S. Fox-Penner and Marc Chupka, wrote:

Here's where W-M got it right.  It forbids distributors from giving customers the value of the free allowances as a "per unit price rebate."   So retail customers will still have to pay a price for power and natural gas that includes a carbon price signal.  The free allowance value must be given to them as a lump sum rebate.

A reader writes:

Your discussion overlooks a HUGE loophole in the Bill that eliminates any assurance that the carbon price signal will make it thru to LDC customers. Here is the key text from the bill including the key loophole (the word "solely"):

"An electricity LDC shall not use the value of the emission allowances distributed under this subsection to provide to any ratepayer a rebate that is based SOLELY (emphasis added) on the quantity of electricity delivered to such ratepayer."

Fox-Penner and Chupka reply:

The commenter is correct - the language in W-M is not "airtight," and does leave open the possibility of state regulators giving partially quantity-based rebates, if they choose to use rebates at all.  The unfortunate history here is that the states in general, and state utility regulators in particular, are sensitive about being told exactly how to regulate their charges.  They believe their duties are set forth in their enabling statutes, and that the federal government should not "micromanage" them with a "one size fits all" solution.  Undoubtedly the savvy drafters of W-M understood that being overly prescriptive would jeopardize too many votes on this basis.

Nevertheless, we think the law, common sense, and elementary economics all make it pretty clear that quantity-based rebates are a bad idea and I will wager that most regulators will avoid them. We sure hope so.  Even if they do have some partial quantity rebates, however, the cause is far from lost.  First, the carbon price signals are still intact at the wholesale level, and it is at this level that decisions to build new supplies and dispatch them are made.   Carbon price signals impact customer energy efficiency decisions, but these are (unfortunately) not terribly price sensitive due to so-called market imperfections in the energy marketplace (see Energy Efficiency Economics and Policy).

[JR:  I consider this to be an essential point that many people get wrong.  Energy efficiency is cost effective today in every state.  The primary reason most states are not doing much energy efficiency is market imperfections -- in particular, utilities are strongly discouraged from promoting energy efficiency (indeed, most are rewarded for promoting energy and efficiency).  Price is important, but secondary -- especially since, as I've noted many times, the carbon price under W-M is going to stay low for at least a decade because there are so many underutilized clean energy strategies available to this country.  If you want more energy efficiency, you need multiple government programs to promote it, including incentives and standards, such as are found throughout Waxman-Markey.  Also, you should empower public utility commissions to use money from allowances to fund energy efficiency programs, which W-M does.]

Finally, the most important price signal to send retail customers is the time-based or dynamic price, which easily varies across the course of a day by a factor of three - much more than carbon prices will change retail power prices for many years. (See The Power of Five Percent: How Dynamic Pricing Can Save $35 Billion in Electricity Costs, and The Impact of Informational Feedback on Energy Consumption - A Survey of The Experimental Evidence)

Finally, this thoughtful writer reminds us of something we often repeat:  The state energy regulatory community is the single most important policy actor in the United States - moreso as we electrify transportation and our transport fuels flow through state-regulated grids as well as nearly all the rest of our energy.   State regulators do as well as they can with agencies whose missions and capabilities are often greatly under-resourced and face a huge array of issues and cases.   The federal government does astonishingly little to help these agencies cope with policy issues or provide technical assistance (though what little is provided is often extremely valuable).   Our transition to a low-carbon economy hinges to a very large extent on how well regulators carry out not just this particular provision of W-M, but also on dozens if not hundreds of other decisions they will make, often with only a handful of utilities and activists engaged in obscure regulatory proceedings that lead to these actions.

The Obama stimulus package had a $60 million line item we are told is reserved for assistance to state regulatory commissions.  If so, we applaud this overdue initiative.  We hope the money is used wisely, and that this is only the beginning of the Obama Administration's deep energy policy engagement with governors and state regulators towards a shared purpose of economically transforming our energy infrastructure.

For completeness sake, here is one more brief overview of the allowances, from E&E News:

... lawmakers decided to give away 85 percent of the emissions permits in the early years of the cap-and-trade program, with the remaining 15 percent of permits auctioned.

The largest share of the free permits, 35 percent, goes to the electric utility industry in 2012 and 2013. More specifically, 30 percent is given to local companies that distribute power to residences and businesses. The sector's free permit portion shrinks every few years after, and the allowances phase out completely between 2026 and 2030.

Energy-intensive industries receive the next biggest share of free permits at 15 percent. The allowances are aimed at helping companies most vulnerable to international competition from developing countries that won't have such stringent environmental requirements, including steel, paper and cement makers. The free allowances start in 2014 and drop by about 2 percent per year, ending in 2025.

Another 10 percent of the free allowances would go to states for investments in renewable power sources and energy efficiency. That share decreases starting in 2016, dropping to 5 percent by 2022.

Natural gas distribution companies also get 9 percent of the allowances in the early years, ending between 2026 and 2030. The smallest and shortest-lived number of allowances goes to oil refiners, who get 2 percent starting in 2014. Their allowances end in 2016.

Other free allowances are divided among the auto industry, efforts to capture and sequester carbon emissions, clean energy efforts, work to prevent deforestation and adaptation programs.

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