Cap and Trade: Who Wins, Who Loses


President Obama recently announced his plan for environmental protection and Congress took up the debate. Called “Cap and Trade” Obama explained it simply in several public appearances. The government puts a limit on the total amount of carbon emissions that are acceptable in the United States. Carbon emissions come, basically, from burning carbon-based fuels – natural gas, petroleum and coal – in the production and use of energy. Users and producers of energy emit carbon dioxide (and other pollutants) into the atmosphere.

As Richard Ebeling writes at the Mises Institute, under cap and trade “the government will formally nationalize the atmosphere above the United States.” The program bypasses fundamental questions like what is pollution, how much does it take to cause harm, who is harmed by it and linking the causation between pollution and harm. Fear of lawsuits, torts and injunctions (which could provide the answers) keeps the Administration from addressing these questions head-on. Reliance on the same, tired old source for solutions – Wall Street – ensures that those being harmed aren’t necessarily the ones who will benefit.

Under Cap and Trade, each carbon-emitting entity – cars, power plants, factories, etc. – is allotted some share of that total limit, or Cap, permitted for carbon spewed into the air in the United States. For example, a power plant producing electricity for 50,000 homes and businesses might be allowed to emit 2 tons of carbon per year. That’s their “cap,” the maximum amount of carbon they are allowed to put in the air.

Now for the “trade”: if that plant finds a cleaner way to produce the electricity needed for 50,000 homes and businesses, say only 1 tons of carbon per year, they can sell the right to emit 1 ton of carbon to a power plant that puts 3 tons of carbon into the air while generating electricity for 50,000 homes and businesses. The plant that buys the right to emit an extra 1 ton of carbon per year is not required to limit their emissions to 2 tons – they bought the right for the extra ton.

It all sounds very lovely as long as the caps will control the total amount of carbon added to the air from the United States. The money gained by selling the rights for “unused” emissions will provide financial incentives to the makers and users of cars, power plants and factories to pay for the technology to be cleaner. Since the money spent to pay for the more efficient technology can be recovered in the Cap and Trade marketplace, the cost of the cleaner energy shouldn’t require higher costs to consumers of the now cleaner air.

This is great if you live near a power plant that manages to reduce the carbon emissions into the air you breathe below the maximum cap level. Here’s the problem: what if you live next to the power plant that paid for the right to put an extra ton of carbon into the air? Two things happen. First, you will be paying for the extra carbon because the power company will have to charge more to pay the cleaner power company for the right to produce the extra ton of carbon. That leads to the second problem: the extra ton of carbon is being emitted into the air around your home. That means that you could end up paying more for your electricity, while also breathing more polluted air.

Cap and Trade is not a solution, it is another money-making scheme cooked up by the “dangerous dreamers” of Wall Street. In the EU they at least have the good grace to call it a “Trading Scheme.” A global carbon trading market already exists. “Pollution rights” have been traded since the 1990s when the Environmental Protection Agency held the first auction of air emission allowances, or pollution rights, at the Chicago Board of Trade. Starting with sulfur dioxide allowances, other pollutants were added in the next ten years to eventually create a complete trading market on the Chicago Climate Exchange. “The right to use water or air is more valuable than food, and we can use the price system to allocate that right,” said Richard Sandor at the 2005 Milken Institute Global Conference (yes, that Milken). The Chicago Mercantile Exchange and the New York Stock Exchange are now prepared to expand the environmental markets for industrial pollution, also known as the carbon markets, into “futures and options on more than 40 U.S. and international indexes [for pollution rights].”

But, really, do we want the same bunch of guys that gave us junk bonds, mortgage-backed securities and credit default swaps allocating air and water? Globally? Into the future?

Like sending subprime mortgages throughout the global economy, this scheme will allow pollution rights to be bought and sold by anyone. So, it isn’t just the factory next door to the power generator in Detroit that will be emitting the extra tons of carbon – factories in other countries will be able to sell their carbon emitting rights to power companies in Detroit. It’s a great money-making scheme for a solar powered producer in Costa Rica – but a very bad deal for those breathing the air and paying for power in Detroit.

The Cap and Trade scheme is being supported by President Obama’s main economic advisor, Larry Summers – who once said we should export pollution to Africa because their per capita figures are too low. “I think the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that.”

Cap and Trade gets the polluters mixed up with the victims of pollution. Shouldn’t the money generated from the sale of pollution rights accumulate to the persons harmed by the pollution? The idea that you can structure economic incentives to produce socially beneficial results really ends up being about creating paper profits for the money-traders at the expense of the people living with the pollution. This does not seem like a fair trade to me.

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.