Wynne government ignores lessons from recent past on the pitfalls of cap-and-trade

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Appeared in the Windsor Star, March 2, 2016

Last week, the Ontario government released draft regulations under which 102 large industrial emitters will get free allowances to produce greenhouse gases (GHGs) at current levels in 2017 and would then have to reduce their emissions by more than four per cent a year until 2020. Distributors of gasoline, home heating fuel and natural gas will have to purchase permits for every litre or cubic metre they sell. The levy would add 4.3 cents to a litre of gasoline and about $5 to $6 a month for heating the average home, while raising more than $1.3 billion from consumers.

When done right, emission trading can emulate a carbon tax, considered to be the most efficient (and least economically distorting) approach to pricing in the cost of environmental externalities into people’s choices. When done badly, however, as is more common, cap-and-trade can cause significant economic harms. While one could write a book on the potential pitfalls of cap-and-trade, three stand out vividly: politicized permit allocation; economic strangulation; and energy price volatility. Let’s focus on the first pitfall.

In 2009, the United States was considering a cap-and-trade bill named Waxman-Markey, which, like the Ontario plan, counted on giving away most carbon permits, mainly to energy producers. At the time, both President Barack Obama and U.S. Budget Director Peter Orzag both observed that giving away emission permits would enable politicians to game the system, playing favourites with freely-allocated permits, and, in the words of Peter Orzag giving away permits “…would represent the largest corporate welfare program that has ever been enacted in the history of the United States.”

Harvard economist Gregory Mankiw spelled it out concisely: “Economists recognize that a cap-and-trade system [with free permit allocation] is equivalent to a tax on carbon emissions with the tax revenue rebated to existing carbon emitters… That is, Cap-and-trade = Carbon tax + Corporate welfare.”

And another economist with a long career studying cap-and-trade systems, Ian Parry at the respected U.S. think-tank Resources For the Future (RFF) observed “Freely allocated tradable emission permits may actually hurt the poor the most, as they transfer income to shareholders via scarcity rents created at the expense of higher prices.”

All that brings us to today. Unsurprisingly, the Wynne government made the choice to politically-allocate the permits, rather than using an auction approach generally favoured by economists.

One has to wonder, did the Wynne government make any effort to learn from past experiences with emission trading of greenhouse gases?

The government claims that households, particularly poorer households, will not feel the pain of the new cap-and-trade regime because the government is going to give them some of the money paid in by better-off households, and help them improve their energy efficiency. But again, one has to ask, was there any due diligence in trying to avoid mistakes of the past?

A study just last year, from the University of Chicago studied the experience of 30,000 homes in Michigan, some of which were given assistance to improve household energy efficiency, and others that were not. The researchers found that the cost of improving household efficiency was more than twice the value of the energy savings.

Having committed itself to international targets for GHG emission reductions (and omitting for now the wisdom of accepting those targets), governments at all levels across Canada are looking for ways to reduce their GHG emissions. Some approaches are clearly better than others and some are not only worse, but egregiously worse. Cap-and-trade is clearly of the latter sort. The Wynne government should have known this, but instead, politics has undermined policy, and Ontarian households are going to feel the pain, while politically connected industries will reap a windfall.

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