Sunday, July 5, 2009

More on Waxman-Markey

Over at the National Review, Stephen Spruiell and Kevin Williamson list their top 50 reasons for voting against the Waxman-Markey climate change bill (tip: Volokh Conspiracy). (I'm on a roll with global warming posts - earlier posts here and here.) I agree with much of what they write, but there's a number of points with which I disagree. Also, their first reason displays a stunning ignorance of economics:

1. The big doozy: Eighty-five percent of the carbon permits will not be sold at auction — they will be given away to utility companies, petroleum interests, refineries, and a coterie of politically connected businesses. If you’re wondering why Big Business supports cap-and-trade, that’s why. Free money for business, but higher energy prices for you.

There are two reasons this is bad economics. First, as the Coase Theorem points out, if there is an externality problem (say, excess pollution) and transaction costs are low, private parties will bargain to an efficient level of the externality. Furthermore, the end result is independent of the initial property right delineation - ignoring income effects. If polluters receive the right to pollute, pollution recipients will pay polluters to reduce their emissions, and if polluters do not have the right to pollute, they will pollution recipients to allow pollution. Either way, according to the Coase Theorem, the same level of pollution will result.

The Coase Theorem cannot solve the climate change problem, however, since transaction costs are too high (transaction costs are the costs of reaching an acceptable agreement). Thus cap-and-trade schemes are a way of lowering transaction costs. The government presumably sets the cap at pollution levels that recipients would bargain to, and, in theory, the scheme enables polluters to reduce emissions at the lowest possible cost.

Anyway, whether the government auctions off the permits or gives them away, the same amount of pollution will be eliminated. The only difference is that auctioning the permits grants the government a windfall revenue increase, and giving them away grants businesses a windfall. Given that we are in a recession, I don't think that granting businesses a windfall is such a bad thing.

The second display of poor economic reasoning is the claim that although Waxman-Markey will be "free money for business," it will lead to "higher energy prices for you." This sentence is not even internally consistent. If businesses actually made money by receiving permits, why would they charger higher energy prices? Businesses typically lower their prices when they are profitable.

Many commentators have said that Waxman-Markey will lead to higher energy prices. This will happen only as the government lowers the cap and forces businesses to buy permits or to implement pollution-reducing technology. And this probably won't happen for a few years. If the government made polluters buy permits, price increases would be more immediate.

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