Obama’s budget assumes a cap-and-trade system

President Obama recently announced a plan to cut the federal deficit in half by the end of his first term, in part by raising revenue through the auctioning of carbon permits under a cap-and-trade system. In one sense, there’s no new information here. Obama campaigned heavily on cap-and-trade and he’s always favored auctioned permits, so the plan is just a restatement of some prior campaign pledges. Right?

Sort of, but this is still a very big deal. The new budget has at least four big implications.

The first is purely political. By including carbon revenue in his budget projections, Obama is not only presenting cap-and-trade as a fait accompli, he’s also casting it as a matter of fiscal responsibility. Deficit reduction is the ultimate bipartisan fetish object, and with this announcement Obama has performed an effective flanking maneuver on opponents who are going to try to worry a climate bill to death over economic concerns. Don’t get me wrong: the political battle over cap-and-trade will be bruising. But the rhetorical ground on which it will be fought just tilted more heavily in the favor of environmentalists.

The second implication concerns policy design. Permit auctions are an important element of a well-designed cap-and-trade system, but also one easily traded away to buy off special interests. It now seems likely that some significant percentage of permits will be auctioned right from the start of the trading system. Obama is sticking firm in his support of a 100% auction, and while I’d be (very pleasantly) surprised if he actually gets this, it’s the right starting point for a negotiation.

The third implication concerns spending. Auctioned permits will raise a huge bundle of cash. The budget projects about $80 billion dollars per year in carbon revenue. Assuming that about 80% of U.S. carbon emissions fall under the cap, that works out to a price of $14 per ton, which is very much in line with what analysts have been predicting for 2012. Oddly, the budgeted revenue stays constant over time, but this likely just reflects the enormous uncertainty around both prices and the shape of future legislation.

There are no shortage of ideas for what to do with the money, and here also the budget places a stake in the ground. 20% of the funds are slated for “clean energy technologies” (think smart grid, clean energy generation, and energy efficiency) and 80% will be returned to taxpayers in the form of a Making Work Pay tax cut. At a high level, this strikes me as an excellent allocation of the funds, balancing investment in new infrastructure with protections for citizens who will be negatively affected by higher energy prices.

The fourth implication is international. It remains unlikely that the U.S. will have a climate bill passed in time for the negotiation of a Kyoto successor treaty in Copenhagen at the end of the year. Given that reality, though, anything the administration can do to demonstrate seriousness helps enormously to unstick the diplomatic process.

So that’s that. There’s still a tough hill to climb before a bill is signed into law, but the contours of the administration’s plans are becoming clear.

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  1. Chris - March 4, 2009

    2 points on the cost:
    1. Won’t increased costs to companies drive up their costs and therefore prices on energy-intensive products (which is going to disproportionately effect the lower income individual)?
    2. Obama’s reduction of the deficit incorporates surge-level spending in Iraq over the next 10 years correct? Is that a valid assumption?
    I’m all for cap-and-trade, and clean energy projects, but let’s be clear on the budgetary items.

  2. Adam Stein - March 4, 2009

    1. Yes, which is presumably why the Obama budget rebates most of the money raised from carbon permits to individuals. Low-income individuals should come out ahead under this plan.
    2. Er…not sure. His budget assumes a more-or-less complete withdrawal from Iraq over the next few years, but I’m not the best source for info on that.

  3. richard schumacher - March 4, 2009

    Yes, it will drive up prices. Clean energy costs more than dirty energy. Yes, this will fall disproportionately upon the poor, just as everything else does. Obama’s tax and health care reforms will offset that.
    A direct tax on fossil carbon content would be simpler and easier to implement, and the net tax ought to be at least $30 per ton of fossil carbon, but any progress on this is desperately overdue and very welcome.

  4. jackie - March 4, 2009

    Can you explain $30 / ton

  5. richard schumacher - March 4, 2009

    $30 per ton of carbon is about enough to make several existing non-fossil energy sources (wind, nuclear, geothermal, thermal Solar) less expensive than coal for electric power generation without further subsidies.

  6. Mike - March 4, 2009

    Can you explain low income?

  7. Adam Stein - March 4, 2009

    Are you asking exactly who will come out ahead under the plan? If so, then I can’t really say, because I don’t really know the details of the Making Work Pay program, which is the vehicle through which the money would be rebated.
    But I probably shouldn’t use the term “low-income”. I think the benefits to individual citizens will be pretty broad-based. Maybe “middle class” would be a more accurate term. But I’m sure more details are coming.

  8. Misanthropic Scott - March 4, 2009

    It’s annoying to me that the assumption has been all along that any system must be cap and trade rather than a nice simple revenue neutral carbon tax.
    We know that a tax will work since we saw what happened with even a brief time of higher fuel prices. People drove less. People stopped buying SUVs. In short, people actually started behaving in a more environmentally conscious way.
    A cap and trade system will probably have a much smaller effect on price, especially since all evidence is that no one wants a serious effect at the moment, despite how desperately we need real effects.
    And, a cap and trade system puts Wall Street in charge of something that may well cause global civilizational collapse and possibly even human extinction.
    How much do we trust Wall Street?
    For me, even though I’m working in the financial industry right now and am about a 5 minute walk from the NYSE, the answer is not at all.

  9. Brian - March 4, 2009

    thanks for covering this tidbit; the initial article poses good subject for contemplation.
    unfortunately, the very “fait accompli” of a cap-and-trade system, even if it were only in this country and we didn’t depend on north korea, is ridiculous on its face.
    excuse me, but who sets a price for the clean air i lose? or my children?
    only the wealthy can get away with this stuff, the absconding of resources that belong to all.
    pollution indulgences is what this amounts to. i hope there is a hell for buyers.

  10. Brian - March 5, 2009

    yes, we do have to start somewhere. so great, we’re all (almost) agreed.
    but how about we start down the path that will focus on fixing the problem (carbon spewing) rather than the path that will appease the utilities and pols (same-old).
    in choosing one path, as we are now faced with, we need to see a bit farther along each path before we choose.
    the choice is between (1) a path where the message is: it’s okay to pollute if you can afford it or pass on the costs to do so; and (2) a path where the purpose is to develop a less invasive, more sustainable method of living on earth.
    in my mind, the choice is clear. cap and trade is faulty by design. unless, of course, the design is to continue polluting.