Cap-and-Trade Flaws
by Matt Varvaro
Issue 115 - September 10, 2008

The popular "cap and trade" system of regulating greenhouse gas (GHG) emissions has attracted the support of many conservatives because it relies on the capitalist principle of economic incentives and avoids direct government mandates. Senator John McCain, a proponent of cap and trade, describes the idea as "market-based" on his campaign website. However, when one considers the costs of its implementation and its overall economic consequences, it becomes clear that the proposal is nothing of the sort. Instead, it promotes inept centralized planning and massive bureaucratic inefficiency.

Essentially, under this system, the federal government would distribute permits indicating the amount of GHG that a company is permitted to emit into the atmosphere, for which they have a certain number of "credits." If a company wishes to emit more GHG than its permit specifies, it must purchase more credits from other companies. This creates an incentive to emit less GHG, because if a company requires less GHG emissions than they have credits for, they can sell their unused credits and make money; those who emit a lot of GHG, on the other hand, are financially punished. This may sound like a logical process, but two important factors clearly illustrate the flaws of this scheme and undermine the misplaced optimism that surrounds cap and trade.

The first is the tremendous economic strain that it would inflict upon the United States' economy over the next few decades. One revealing study was conducted by Arthur Laffer, who popularized the "Laffer Curve" and was a member of Ronald Reagan's Economic Policy Advisory Board. Along with co-writer Wayne Winegarden, Dr. Laffer warns that "the U.S. economy could be 5.2 percent smaller in 2020 compared to what would otherwise be expected if cap-and-trade regulations are imposed. This equates to a potential income loss of about $10,800 for a family of four for the initial Kyoto GHG reduction target." The causes of this economic damage are further outlined in the report: "Fossil fuels, (oil, coal and natural gas) provide 86 percent of our current energy needs. It is not currently feasible for the alternative energy sources to significantly expand their energy contribution sufficiently in the near-term to substitute for the demand growth...Consequently, a GHG cap could effectively become an energy production cap - or an energy supply shock." The authors cite similar energy supply shocks of 1974-75, 1979-81, and 1991-91, during which "the economy declined, unemployment rose, and the stock market declined in value." Some proponents of cap and trade simply fail to take these costs into account, while many others acknowledge them but regard them as necessary sacrifices toward our goal of "energy independence." It is unlikely, however, that most Americans would be willing to make such a sacrifice, especially if it will cost them an excess of $10,000 over the next dozen years.

The second and most obvious case against cap and trade is the complete failure that has characterized its tenure in Europe. In early August, Businessweek commented on the effects of the European Union Emission Trading Scheme (EU ETS), which has been in place since 2005: "Now, three years on, the environmental benefits from the EU ETS remain unclear: The continent's CO2 output actually rose 1.1% last year." Considering that the ultimate and primary purpose of such a program is to decrease CO2 output, the numbers indicate that the cap and trade scheme has been a flop.

Moreover, the Center for American Progress, a liberal think-tank that supports cap and trade, reported the following EU ETS fiasco: "The market price of emission allowances took a serious hit when it became apparent in mid-2006 that the number of allowances had actually exceeded total emissions, thus undermining the cap altogether. Allowances exceeded emissions by around 80 million MTCO2e [metric tons of CO2], or about 4 percent of a total market of 2 billion MTCO2e. This mistake was caused by a combination of incomplete and inaccurate EU emissions registries and individual governments showing way too much latitude in their allocations to politically-connected polluters." In other words, the governments handed out more credits for emissions than the actual amount of CO2 that was being emitted, which caused the prices to plummet to the point that each credit was practically worthless. The report then provides that laughable description of the bureaucratic miscues that caused this dilemma but then, astonishingly, adds, "These problems are not inherent flaws in a cap-and-trade system."

This is where the report gets it exactly wrong. Indeed, these problems are inherent flaws in cap and trade, as they are inherent in any such centralized, national planning scheme. What proponents of cap and trade fail to understand is that, in order for this system to succeed, the federal government will have to know how many credits to hand out, what the cap should be, and how and when to adjust these figures - at all times. As we saw in Europe, any slight miscalculation can cause significant harm to the system and to the overall economy.

What must be understood, and what should be fairly obvious at this point in history, is that no government is capable of handling such a responsibility and that matters such as these are best left to the market. Conservatives, of all people, should be aware of this reality and should realize that a program like this is doomed to failure.

Matt Varvaro is a high school student in Port Washington, New York.