Energy Committee Tries to Figure Out to Whom to Pay the Rent

No, Chairman Bingaman isn’t lurking around the Capitol avoiding calls from his landlord.  We’re talking about economic rent.

This week, the Senate Energy and Natural Resources Committee continued its excellent series of hearings on climate change policy options.  At issue this time was a hearing “on the costs and benefits for energy consumers and energy prices associated with the allocation of greenhouse gas emission allowances.”  Whether or not cap-and-trade programs were more or less transparent and costly than carbon taxes and fees was a topic debate during the hearing, as it has been throughout the series. 

Dr. Denny Ellerman, recently retired senior lecturer at the Sloan School of Management at MIT, kicked off the hearing with some powerful testimony, including thoughts on how different carbon control programs create economic rent.  He offered:

When a cap is chosen as the means to limit emissions, the scarcity rent is embodied in the allowances that must be surrendered by regulated entities in an amount equal to their emissions. Allowance value is a more convenient term than scarcity rent, but we should always remember that the value embodied in allowances reflects the scarcity created by the cap.

When a tax is chosen as the means to limit emissions, the scarcity rent takes the familiar form of tax revenues. For a tax that would be expected to have the same effect on emissions as a cap, the tax revenues will be the same as allowance value on an ex ante basis. The ex post result may differ according to the way each of these alternatives operates in response to departures from expectation. As you are well aware, collecting tax revenue is not the end of the process. Those revenues will be used (or we might say in this context, “allocated”) in some manner. In this sense, the tax alternative to cap-and-trade shares the explicitness and transparency of allocation in cap-and-trade. In fact, if it is decided that all allowances will be distributed entirely through auctioning, the allocation issue is identical, namely, deciding what to do with the tax or auction revenue. In this limiting case, the difference in the nature of allocation between the cap-and-trade and tax alternatives is very slight. In both cases, the government is the immediate recipient of the scarcity rent and it must decide what to do with it.

Interestingly, Ellerman also posits that cap-and-trade programs with allocation values determined by Congress can be more transparent than taxes because the rent seekers are made explicit in the lawmaking process.   A related point is often made by Dr. Robert Stavins of Harvard’s Kennedy School of Government -- that the rent seeking process under cap-and-trade does not dilute the environmental effectiveness of the policy, which could occur when rent-seekers pursue exemptions under a carbon tax.

These are important points to consider as some people continue to state that a carbon tax is the preferable policy option.  But anyone that thinks taxes are simple should just do a quick read of this.  Or better yet, for an easy-to-read explanation of the economics at issue, check out this briefing document.