Reading over Brad Johnson’s summary table of the differences between the Kerry-Lieberman climate and energy bill, the White House’s original proposal, and the ACES legislation that passed the House last year one key thing that leapt out at me was the “hard collar” on the price of permits. All three proposals involve the allocation of tradable permits. This is preferred to a carbon tax for two reasons. One is that it doesn’t include the word “tax.” The other is that it lets you set a policy-determined total level of emissions and then have the market work out the price, rather than setting a price and then having the market set the level of emissions.
The Senate bill modifies this idea by mandating that permit prices trade within a certain band. That starts as a floor of $12 and a ceiling of $25 per ton. The floor increases at 3%+CPI, the ceiling at 5%+CPI. As a matter of policy design, the first time I heard it it sounded like a huge cop-out. But looking at the issue anew as this legislation is unveiled, I actually think the price floor aspect of this is really important. The reason is that it’s the solution to the potentially giant problem of “offsets,” the notion that a firm should be allowed to earn extra emissions by undertaking (or paying for someone else to undertake) negative-emission activities like tree-planting.
The problem with this is that it’s an enforcement nightmare. But the trouble with not doing offsets is that you’d be abandoning what is, in principle, a powerful tool for stabilizing the concentration of greenhouse gases. What the floor does is let you assume the worst about the offsets—the regulation is super-lax, tons of stuff is offset, and much of it has little value—and still be left with essentially an escalating carbon tax in the event that the market price of permits crashes. I think accepting a price ceiling is a small price to pay for the advantages you get with a floor, since realistically a giant spike in permit prices would be politically unsustainable anyway.
That said, I’m not in love with the difference in the growth rates between the floor and the ceiling. Why not five percent over CPI for both? The short-term difference between CPI+3 and CPI+5 is small, but the medium-term difference—and thus the impact on investment decisions—would be giant.