1. These are all truly just personal views. This morning, I decided to put together all the many weird things I have learned about the politics in the Senate and in the world, and revisit economic theory, to analytically address the question: “What would the Senate do, to really get it truly right?"

2. I will assume for now that the "social cost of carbon" is at least $12 per ton of CO2 emitted. That implies that "getting it right" does not mean doing nothing. Doing it wrong may well be worse than doing nothing, but here I am asking how to do it right.

Progress in thinking about this question has been very limited in most places here, because of polarization and lack of truly global thinking. One group says that "A US bill will be near useless without a global agreement for everyone to take strong action." That's clearly true. Senator Inhofe was full of glee when the new EPA Administrator agreed with EPA studies making this point. But one group responds by saying "let's do nothing." Another group says "let's pass a cap and trade bill, any cap and trade bill and that will help us get that global treaty." The first group says "But you have no hope of getting that global treaty in the end anyway. Listen to what China and India have said."

My take on this: there is hardly any value in working towards an "apples and oranges" treaty, which would not be ratified anyway. If we care about global CO2 emissions, we either give up on treaties, or we work towards a feasible strong carbon control regime. The only reasonable plausible option for a strong global carbon regime is a regime based on a global (floor) carbon price, to be strongly binding on nations accounting for at least 80% of world emissions. The initial level of the price should be $12, because that's what it takes to maximize chances of ratification, which is where we need to start.


US DOMESTIC BILL-WRITING SHOULD BE AIMED AT MAKING THAT HAPPEN.
It's not good enough to just say "let's pass a bill, any bill, in order to prepare for Copenhagen.' We need to think about what kind of bill would actually give us the best chance of success there -- and thereafter.

That means:

1. NO FREE INTERNATIONAL GIVEAWAYS. All international offsets should be eliminated. All international free allowances should be eliminated. Instead, the bill should allocate 5% of the net revenue immediately to a special trust fund, to be allocated to purposes to be decided by a strong carbon control treaty, if and when such a treaty is ratified by the US and goes into effect internationally.

2. THE LAW SHOULD SPECIFICALLY STATE that certain things go away if and when the Senate ratifies a strong carbon control treaty -- and that does require a definition of what that means. Basic elements: (a) initial price at least $12, binding on all emitters above a certain size in any of the ratifying nations, never to go below $12; (b) treaty goes into effect only when ratified by nations representing 80% of year 2009 emissions; (c) WTO enforcement of rule that there be no backdoor subsidization of energy prices; (d) at least 95% of all revenues collected in any nation are to be disposed of as decided by that nation, subject of course to (c); (e) strong mechanisms to ensure long-term compliance.

3. The US law must (as a matter of political reality) contain a variety of "border adjustments," which include output-based free allowances, border provisions, and free allowances to industries other than electric power to reflect their inability to raise prices in the face of international competition. All of these should meet two key tests: (1) NO major sector should get a net windfall. (For example -- CBO has estimated that 20% of free allowances would be enough to make sure than the stock of no company falls at all. The free allowances should be a little lower than this.); (2) THEY ALL GO AWAY AS SOON AS A STRONG CARBON CONTROL TREATY IS RATIFIED AND EFFECTIVE. The first clause is very important, because we shouldn't want any major sector to feel that ratifying a treaty which eliminates "leakage" actually hurts it.

4. Domestic offsets should still be allowed, BUT ONLY FOR RESULTS, NOT FOR PROJECTS. They should only go as "payments" after the fact to farmers or foresters who actually increase the carbon in the soil, as verified by measurements they pay for done via USDA, embedded in the USDA soil and environment programs. No EPA role. No additionality, etc. -- except per usual USDA rules to prevent forms of cheating they already know how to deal with.

5. Aside from border adjustments -- the only net losers are households (who would have to pay not only higher energy bills but higher prices for other products passed on by
producers) and old coal plants struggling to stay alive in the face of other generators. As happens when a government takes away someone's house, it is reasonable that they should both get some payment, less than what they lose, as a "one-time" payment that IS DONE IN A WAY THAT DOES NOT WEAKEN the incentive effect of higher carbon prices. NOTHING ELSE should be allowed by way of free allowances or revenue distribution, at this time of great deficits, when new spending ideas need to be considered on a level playing field -- with just one exception, I would argue. The 1% now allocated to new domestic "adaptation" activities to preserve endangered species addresses an important neglected need; species are dying out a lot faster than the ice caps are shrinking. IN SUM -- beyond border adjustments, the only "free allowances" or revenue allocation should be for these three things: (1) money to households; (2) compensation to old unregulated generators (5% in the House Act); and (3) 1% for the endangered domestic species. The money to households and the money for the species should simply be based on net revenue, since they want money, not allowances. All three should be PRESERVED even after a strong carbon control treaty, but free allowances to those old generators should be converted to an equivalent stream of money. Likewise, the domestic offsets should be converted to an equivalent stream of cash.

6. Perhaps most controversial -- if a strong carbon control regime occurs, the US domestic carbon trading mechanisms (from auctions to banking to allowances) should all be immediately nullified. Except for electric utilities, the controlled emitters in the US should all just pay the global price to the relevant US government agency. In the electric utility sector, it should perhaps be the global carbon price, or the lower of (the European carbon price or $35), whichever is higher of these two. The point is that carbon leakage issues, and a need for border adjustments, disappears only if US producers pay the same price as their competitors -- but electricity is not a trade-impacted industry. The $35 limit is based on the fact that new technology exists to take care of all CO2 in flue gas
at a cost of $20-$40, depending on site; there is simply no need for anything higher, and there is great value in signalling that we are not about ready to subsidize higher-cost Jurassic Park technologies.

7. To compensate households, DOE and IRS should be tasked to develop a statistical model (probably using regression and analysis of variance) to predict how much the direct energy cost to households would increase, as a function of variables available to IRS and to the EIA household energy consumption data. This may take a little insight to do right, but is eminently possible. (For example, Census data on ZIP code attributes may help.) Since the cost would be proportional to the price of carbon, the households should receive direct "dividend" payments from IRS based on these formulas. (Households not covered by IRS would receive some kind of parallel treatment, via electronic payment/welfare systems.) Probably the payment should equal something like 80% of the predicted loss by formula, or less if revenue is not enough to cover that much (which is unlikely). (The 20% reduction is to allow for energy conservation possibilities.)

8. No compensation to households for indirect costs, due to rising prices of other goods, is warranted, in my view.  Partly, it's too hard to track. Partly, it affects a wide range of products, across all sectors of society, widely distributed. In the end, a simple payment to the taxpayer as a whole is warranted -- by simply putting the funds into the US general accounts, to be used initially for badly-needed deficit reduction, and later for anything Congress later agrees on. Agreement on new spending or disbursement should be for later, and not "linked" to global warming in particular.

9. I suspect that a strong carbon control treaty might actually ratified by the Senate, even though it requires a 2/3 vote, if a bill of this sort goes into law. In fact, the hope of getting rid of border adjustments LATER might even attract some key votes from Senators who otherwise would worry a lot about the trade wars that such border adjustments might cause. Presumably the senators most concerned about "leakage" of carbon and of jobs would consider it acceptable to get rid of those adjustments IN THE CONTINGENCY where a better way is found.

Anyway -- this is the best hope I can now see of finding a way through what now looks like a near-impossible morass.

Let me emphasize that I am not aware of any discussion of this kind of “mixed strategy” right now in any part of Congress. Also, I apologize for not including citations to the many important sources which led me to this point.

Addendum I: More on the Political Realities

The idea is that some folks who would NOT vote for the initial domestic bill MAY be able to vote for ratifying a strong global carbon control treaty, after the domestic bill has become law, and they can clearly state that they are voting for what they view as an improvement. Some Senators say that a cap-and-trade system is not a "tax" in a any sense, while others say it is. The hope would be to pick up a few votes from the second group, after the initial cap-and-trade bill squeaks through.

Actually, logic says that amendments of a domestic bill related to a strong carbon trade regime might receive "yes" votes even from senators who would not vote for the domestic bill itself! If anyone is awake at this confusing point.

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Addendum II: Why reimburse households via regression and the government?

Why not have electric utilities do the reimbursing, as part of the utility bill? Instead of predicting additional costs of electricity, natural gas and oil, why not have the utilities in each area use their data on the ACTUAL BILLS of specific customers to decide on the compensation payments for the specific customer? In fact, that's what the House Act tried to do!

It's a gross error for several reasons:

1. Using ACTUAL PAST bills instead of a prediction based on household characteristics basically benefits those consumers who have used more energy than they need to use, based on the normal patterns for their area, income level, etc. In effect, it's a dilution of incentives.

2. It's an unpredictable administrative nightmare, because of all the micromanagement needed of utilities in 50 states by way of 50 PUCs (micromaangement which might involve government scrutiny of consumer energy bills).

3. The incentive effect is further screwed up by the fact that consumers may have problems figuring out which part of what they get is "dividend" and which is based on current electricity prices. Incentives can be screwed up simply by confusing people's perception or felling about how much energy is costing them.  This problem should not be underestimated.

The statistical model approach, applied cleanly at the national level, would be far superior.

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Addendum III: Basic realities about carbon tax or user pollution fee versus cap and trade:

At a recent hearing, a famous Senator began his questions with an attack on the idea of carbon tax. It seems there has been some honest misunderstanding on his point, and I hope that
he was open enough to really hear the explanations from the three serious economists on the witness panel. These misunderstandings really are an important part of the choices we face.

For example: "Under cap-and-trade, each company knows what targets it has to meet, and it knows it has to meet them. But under a carbon tax, you can't predict what the company will do, because it could just pay the tax and forget it. That's a fundamental difference, no?"

No. Under cap-and-trade, they can also just buy emission allowances and forget it. What matters is the price of carbon they must pay. Both systems are basically equivalent, for the individual firm which does not get special kickbacks.

Another example: "Under cap-and-trade, we can allocate the auction revenue or emission allowances to do other worthy things. But under a carbon tax, we couldn't do that."

No. In fact, CBO has ruled that giving away emission allowances is the same as giving away money. Many people FEEL less embarrassed about giving away allowances -- but they shouldn't be! Since auction revenues and carbon tax revenues are both money coming into the Treasury, they pose the same set of opportunities and questions.

Finally, what most environmental lobbyists believe: "Under cap-and-trade, we can get a guarantee that certain targets will be met precisely. Under a carbon tax, we can't."

Guess what. THIS IS NOT TRUE EITHER. This is EXTREMELY important to understand, because of the international implications and because of the need for better focus in understanding what we are arguing about.

In practice, there is fair amount of imprecision in the House bill anyway, despite vigorous attempts to "nail down that we will meet the targets precisely." The target is 83% reduction by 2050. But EPA predicts only a 44% reduction by 2050. Close enough for lobby/government work???

If we choose to, we could construct an adaptive formula to DECIDE the natonal carbon price, the level of the carbon tax. When emissions are above the desired trajectory, the price could go up. When they are on track, it could be held steady. EXACT tracking may not happen, but, in fact, it can be made a whole lot closer than the House Bill is in holding to a target. With lags and quarterly data (as the plans for quarterly auctions require), it is VERY workable. It would not move prices as fast as a cap-and-trade market might, but this is an advantage when the ultimate product (CO2 in the atmosphere) is an accumulation over time anyway, and when volatility would make the market less efficient.

This is important to the international situation, because a global carbon price and a global adaptation mechanism is the only half-way plausible mechanism available to meet GLOBAL targets on GLOBAL emissions, which are the only things that really matter here! There is absolutely no need and no sense in negotiating separate national targets, if such were even possible anyway.

HERE IS ANOTHER WAY TO LOOK AT THIS: If anyone out there really believes those EPA forecasts about the House bill (the source of the "cheap as a postage stamp" claim), WHY BOTHER WITH THE TRADING? Why bother with auctions? Why not simply sell emission allowances directly at the price given in the EPA forecasts? Or better... to keep it even simper... why not allow firms to just pay that price per ton of CO2 at the end of each year, as part of their taxes?

Of course, there are still some differences of opinion out there about what the carbon prices or targets should actually be, at the present time. For an international system, I don't think that an "automated system, where the computer decides" is all that realistic; that's why some new international councils and voting rules would be needed, IN ADDITION to whatever automated rules constrain the system.