U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

56–384—PDF 2008

S. HRG. 110–1041

TAX ASPECTS OF A CAP-AND-TRADE PROGRAM

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

SECOND SESSION

APRIL 24, 2008

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

MAX BAUCUS, Montana, Chairman

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

DEBBIE STABENOW, Michigan

MARIA CANTWELL, Washington

KEN SALAZAR, Colorado

CHUCK GRASSLEY, Iowa

ORRIN G. HATCH, Utah

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

PAT ROBERTS, Kansas

JOHN ENSIGN, Nevada

JOHN E. SUNUNU, New Hampshire

RUSSELL SULLIVAN, Staff Director

KOLAN DAVIS, Republican Staff Director and Chief Counsel

(II)

C O N T E N T S

OPENING STATEMENTS

Page

Baucus, Hon. Max, a U.S. Senator from Montana, chairman, Committee

on Finance ............................................................................................................ 1

Bunning, Hon. Jim, a U.S. Senator from Kentucky ............................................. 12

WITNESSES

Orszag, Dr. Peter R., Director, Congressional Budget Office, Washington,

DC .......................................................................................................................... 3

Greenstein, Robert, executive director, Center on Budget and Policy Priorities,

Washington, DC ................................................................................................... 4

Derwent, Henry, president and CEO, International Emissions Trading Association, Geneva, Switzerland ............................................................................... 6

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Baucus, Hon. Max:

Opening statement ........................................................................................... 1

Bunning, Hon. Jim:

Opening statement ........................................................................................... 12

Derwent, Henry:

Testimony .......................................................................................................... 6

Prepared statement .......................................................................................... 35

Responses to questions from committee members ......................................... 42

Grassley, Hon. Chuck:

Prepared statement .......................................................................................... 50

Greenstein, Robert:

Testimony .......................................................................................................... 4

Prepared statement .......................................................................................... 51

Orszag, Dr. Peter R.:

Testimony .......................................................................................................... 3

Prepared statement .......................................................................................... 65

Responses to questions from committee members ......................................... 81

Salazar, Hon. Ken:

Prepared statement .......................................................................................... 88

(III)

(1)

TAX ASPECTS OF A

CAP-AND-TRADE PROGRAM

THURSDAY, APRIL 24, 2008

U.S. SENATE, COMMITTEE ON FINANCE, Washington, DC.

The hearing was convened, pursuant to notice, at 10:09 a.m., in

room SD–215, Dirksen Senate Office Building, Hon. Max Baucus

(chairman of the committee) presiding.

Present: Senators Rockefeller, Bingaman, Kerry, Salazar, Snowe,

and Bunning.

Also present: Democratic staff: Bill Dauster, Deputy Staff Director and General Counsel; and Jo-Ellen Darcy, Senior Environmental Advisor. Republican staff: Nick Wyatt, Tax Staff Assistant.

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. The hearing will come to order.

First, I apologize to the witnesses for the delay. Many of us are

deeply involved in the negotiations on the Farm Bill. I hope we get

that wrapped up this week, and again, I apologize.

In May 1791, Thomas Jefferson wrote his daughter, Martha,

‘‘When we consider how much climate contributes to the happiness

of our condition, we have reason to value highly the accident of

birth in Virginia.’’

Well, I would say I would quibble a little bit about the choice of

Virginia. I often think my State is a little better, especially in the

summer. But no one would quibble with the sentiment that we

have reason to value highly the accident of birth in America.

In the years since Jefferson’s time, we have learned how very

much climate contributes to our condition. It is much more than

even Jefferson could have guessed. In the years since Jefferson’s

time, we have also learned how human activity is changing our climate.

Jefferson also wrote to his granddaughter, Cornelia, ‘‘Never put

off to tomorrow what you can do today. Never trouble another with

what you can do yourself.’’ It is in that spirit that more and more

Americans are coming to the view today that it is time to address

the problem of climate change. More and more Americans are coming to the view of addressing climate change as something we can

do ourselves rather than leaving it to our children and grandchildren.

As attractive as the climate may be in my State of Montana, we

are already seeing the effects of climate change. Over the last 40

2

years, annual snowfall has decreased by 60 inches, and over the

last 40 years, wildfires of more than 1,000 acres have increased 6-

fold. Less snowpack, although not so much this year, but ordinarily

over most of the last years, means less water for irrigation, and

that can lower crop yields and, in some cases, our farmers are having a tough time hanging on.

We need to address the problem of climate change, but it matters

how we address climate change. We must protect our way of life,

we must protect our economy, and we must protect both our global

competitiveness and our environment.

Majority Leader Reid has put addressing climate change on the

Senate schedule. In June, the Senate will consider a cap-and-trade

program for emitters of greenhouse gases. It is likely that much of

the Senate debate this June will focus on the effect that a cap-andtrade program would have on our economy.

The Environmental Protection Agency recently analyzed the capand-trade proposal that the Senate will consider. The EPA found

that under that program, from 2010 to 2030, America’s economy

will grow by 80 percent. Now, that is 1 percent less growth than

without the proposal. That is, by and large, good news. As with any

analysis, though, there are uncertainties, and we have to move

ahead with the best information we have.

It is possible that action may have costs. It is highly likely that

inaction will also have costs, probably greater. We have asked our

witnesses today to share with us their analysis of the effects of cap

and trade, and we also have asked them for their thoughts on the

best ways to design such a system.

We will also want to ask, how should the tax code treat allowances allocated to emitters under cap and trade, and your general

thoughts on that would be very helpful. For example, what about

the revenues generated from an auction of allowances? How can we

cushion the effect of increased energy costs that can result from the

cap-and-trade program, and how can we minimize those effects on

our economy and consumers?

So let us consider how addressing climate change may contribute

to changes in our Nation’s condition. Let us not put off to tomorrow

the analysis that we can do today. Let us do all that we can to ensure that our children and grandchildren will continue to have

every reason to value highly the accident of birth in America.

Let us turn now to witnesses. Senator Grassley, whom I had spoken to earlier, is also in the Farm Bill negotiations and will try to

get over.

Our first witness is Peter Orszag, Director of the Congressional

Budget Office; next, Robert Greenstein, who is the executive director of the Center on Budget and Policy Priorities; and next, Mr.

Henry Derwent, president and CEO of International Emissions

Trading Association and former Director of International Climate

Change, Air, and Analysis at the Department of Environment,

Food, and Rural Affairs in the U.K.

I would just remind all witnesses, we would ask you to hold your

testimony to about 5 minutes, and your statements will automatically be included in the record.

Dr. Orszag, you are first.

3

STATEMENT OF DR. PETER R. ORSZAG, DIRECTOR,

CONGRESSIONAL BUDGET OFFICE, WASHINGTON, DC

Dr. ORSZAG. Thank you very much, Mr. Chairman and members

of the committee.

I want to make five points. First, global climate change represents one of the Nation’s most significant long-term challenges.

There is a growing recognition that the risks involved may be extensive, and possibly even catastrophic. Reducing greenhouse gases

through something like a cap-and-trade system can limit the damages from global climate change, and especially the risk of substantial problems or damages.

Second, under cap and trade the mechanism for reducing emissions to meet the cap is an increase in the price of carbon-intensive

goods and services. That is essential to the success of a cap-andtrade system. The price increases encourage demand shifts away

from energy-intensive and carbon-intensive goods and services and

encourage shifts in production toward less carbon-intensive methods. The size of the price increase depends on the stringency of the

cap. The more stringent the cap, the larger the price increase. That

is simply, again, to achieve the necessary reductions.

Under S. 2191, more commonly referred to as the LiebermanWarner legislation, the Congressional Budget Office has estimated

a permit price of roughly $30 a ton in 2015. Just to put that in

terms that may be more understandable to people, that would be

about a quarter per gallon of gasoline. There are other effects on

other energy prices as well.

The CHAIRMAN. That is a quarter increase in the cost of gas?

Dr. ORSZAG. Per gallon.

Third point. The permits themselves will be very valuable. We

estimate that in 2012, under Lieberman-Warner, the permits would

be worth approximately $145 billion, and that value would rise

over time as the cap became more and more stringent. What you

do—what you as policymakers do—with those permits makes a lot

of difference, both in terms of the distributional consequences and

the macroeconomic effects.

In particular, you face a choice between auctioning the permits

or giving them away. There is a false argument that is made that

giving the permits away would avoid the price increases for consumers. As I have already said, those price increases are essential

to the success of the cap-and-trade system, and they would occur

even if the permits were given away.

So what are the real comparisons between auctioning and giving

them away? And here I am going to refer to this chart, and I think

you also have copies of it in front of you. If not, we can make sure

you get them.

The CHAIRMAN. Do Senators have copies? Do you have a copy,

Senator?

Senator BUNNING. Yes.

The CHAIRMAN. Good.

Dr. ORSZAG. So, just to walk across what we have presented

here, there are, again, two dimensions to evaluate the effect: one

is on distributional consequences and the second is on efficiency or

macroeconomic consequences. If you sell the allowances (auction

the permits) and you use the money to rebate, on an equal basis,

4

a lump sum (the same amount per household), then what you

would do is change the distributional consequences (see panel 1).

Those price increases by themselves that occur under a cap-andtrade system are regressive because low-income households consume more of their income in energy-intensive things than highincome households, and also consume a larger share of their income.

You can offset that regressivity through something like a lump

sum rebate, and that is the pattern that you see here, where the

percentage change in after-tax income is actually higher for lowincome households than for high-income households, so that the

overall program is progressive because what you are doing with the

auction revenue is so progressive.

However, using the money for that purpose entails some macroeconomic consequences. There is a cost to changing the way we

conduct business in the United States, and if you use the revenues

fully to cushion the blow distributionally, you wind up with the

macroeconomic and efficiency consequences that I show on the bottom part, a loss of about a half a percent of GDP.

Alternatively, you could sell the permits and use the revenue to

reduce either payroll taxes or corporate taxes. If you did that, the

distributional consequences are regressive, both because of the

price increases and because of the tax changes themselves, but the

macroeconomic consequences are attenuated because you are using

the money to sort of cushion the blow on the macroeconomy. So you

can see on the bottom panel that the macroeconomic loss is much

smaller, about half as much, if you use the money for that purpose.

Now let us go to the final column and evaluate giving allowances

away. There you see that you have all the regressivity of the second panel and all the macroeconomic costs of the first panel. When

you give the permits away, you are effectively doing the same thing

from an economics perspective as auctioning the permits and then

giving the revenue that you raised as a result to companies, so you

are getting neither the macroeconomic benefit nor the distributional benefits from doing that.

I will just leave you with the thought that you could combine different approaches, trying to hit distributional and macroeconomic

objectives. But, regardless of how you rank those, it is going to be

more difficult the larger the share of the permits that are given

away, because on both dimensions you are not doing particularly

well through that approach.

Thank you very much.

The CHAIRMAN. Thank you, Dr. Orszag.

[The prepared statement of Dr. Orszag appears in the appendix.]

The CHAIRMAN. Mr. Greenstein?

STATEMENT OF ROBERT GREENSTEIN, EXECUTIVE DIRECTOR, CENTER ON BUDGET AND POLICY PRIORITIES, WASHINGTON, DC

Mr. GREENSTEIN. Thank you, Mr. Chairman and members of the

committee.

I would like to cover four points. First, the impact of a cap-andtrade program on low- and moderate-income consumers; second,

how Congress could use the tax code and other tools to address

5

that so we do not get an increase in poverty; third, how you could

use the tax code to address effects on middle-income consumers;

and fourth, some other tax policy considerations.

Significant increases in the price of energy and energy-related

products will occur as a result of effective policies to reduce emissions, and households with limited incomes will be affected the

most by those higher prices, both because they spend a larger percentage of their budgets on energy, on necessities, and because

they are the least able to afford, say, a new fuel-efficient car or

heating system.

If nothing is done to protect them under a cap-and-trade program, many more Americans will slip into poverty, and those who

are poor will become poorer. Specifically, just from a 15-percent reduction in emissions—what one would get to in about a decade or

maybe a little less under many of the major bills—the bottom 20

percent of the population, that is the 60 million Americans with the

lowest incomes, would, on average, pay increased costs of $750 to

$950 per year as a result of the increased energy costs. But this

is a group whose average income is only a little over $13,000 a

year.

Now, the good news is, it would take only a modest share of the

value of the permits to address that. We estimate that it would

take only about 14 percent of the value of the permits to fund a

climate rebate program that would preserve the purchasing power

of the bottom 60 million Americans and provide significant relief to

many of the next 60 million, the next 20 percent, as well.

My second point is, well, how would we do that? We would recommend doing it through two main mechanisms. The first is the

Earned Income Tax Credit, which this committee knows well. Congress and this committee relied on the EITC expansions in both

1990 and 1993 to offset the impacts on low-income working families

of increases in gasoline and other excise taxes enacted in those

years, and a climate rebate could readily be built into the EITC,

adjusted to be calibrated to increases in consumer energy costs as

a result of cap and trade so that we would offset the average effects

on low-income working families.

However, the relief for low-income families cannot be provided

entirely through the tax system because half of the people in the

bottom fifth would be missed. They are not in the income tax system. We are talking about low-income elderly and people with disabilities, and some of the poorest children in the country.

So a tax-based strategy involving the EITC would need to be coupled with a second form of assistance to reach those households.

That, too, is readily doable. Every State in the country has an electronic benefit transfer system that uses debit cards to provide food

stamps and various other benefits; they are just programmed onto

the debit card.

One could program onto the debit card a climate rebate and simply automatically enroll all the households that either receive food

stamps or are enrolled in the low-income subsidy for the Medicare

prescription drug benefit. What you would then have, between that

and the Earned Income Tax Credit, is a mechanism to very efficiently reach most low-income households in the country without

setting up a new program or new bureaucracy, and with extremely

6

low administrative costs. Again, we estimate it would cost 14 percent of the value of the permits to do that.

Point number three: middle-income consumers. If most or all of

the permits are auctioned, you would then have sufficient resources

to also mitigate impacts on middle-income consumers. To add them

in, we are talking about going from 14 percent of the permits to

maybe in the vicinity of 50 percent of the permits, depending on

how you do it.

The best mechanism for the middle-income relief would be a new

climate change tax credit. This would be far more effective in mitigating effects on middle-income consumers than a reduction in personal income tax rates. If you reduce personal income tax rates, obviously you would get very small effects for people in the 10- and

15-percent brackets, the bulk of the middle class, and the biggest

benefits for people at the top who are the people who least need

help in shielding them from the impacts of higher energy costs.

My final point involves energy tax incentives. That is simply to

make the point that the higher prices for energy products that

would result from a cap on emissions would create strong market

incentives for energy conservation and private-sector investments

in clean energy technologies.

My point is, some investments, meritorious investments that require tax incentives today, because otherwise there is not enough

market incentive for them, will no longer require tax incentives, or

as robust tax incentives, under cap and trade because the market

incentives will fundamentally change as a result of the much higher price for fossil fuel energy, thereby advantaging alternative energy sources.

I would recommend that the committee ask CBO or another appropriate body, if you pursue cap and trade, to evaluate existing

energy tax incentives to try to sort through which ones would still

make sense and which ones would no longer be needed or ought to

be modified under a cap-and-trade system that modifies market incentives.

The bottom line is that well-designed—and I underscore welldesigned—cap-and-trade legislation can generate sufficient resources to avoid increasing poverty to mitigate impacts on middleincome consumers, and obviously this committee would need to be

in the middle of ensuring that that occurred.

Thank you.

The CHAIRMAN. Thank you very much, Mr. Greenstein. That was

very interesting, very helpful. Thank you.

[The prepared statement of Mr. Greenstein appears in the appendix.]

The CHAIRMAN. Mr. Derwent?

STATEMENT OF HENRY DERWENT, PRESIDENT AND CEO,

INTERNATIONAL EMISSIONS TRADING ASSOCIATION, GENEVA, SWITZERLAND

Mr. DERWENT. Mr. Chairman, distinguished members of the committee, thank you for giving me the opportunity to provide some

testimony which is drawn from my own experience, not only as

chief executive of the International Emissions Trading Association,

which probably puts my preferences pretty firmly on the table alVerDate 11-MAY-2000 14:40 Jun 11, 2010 Jkt 000000 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 56384.000 TIMD PsN: TIMD
7

ready, but also from my previous role over 10 years in charge of

domestic and international climate change policy in the lead department in the United Kingdom.

My written testimony offers you a story from the United Kingdom, with some notes of caution and some encouragement to design

of taxation systems covering carbon. There is a cap-and-trade story

from the U.K. and from the E.U. I think it is reasonably well

known, and we may get into it later. But there are some important

taxation proposals which accompanied it and had the same root in

a public/private sector report in 1998, taken up by then-Chancellor

of the Exchequer, Gordon Brown.

We have a climate change levy in the United Kingdom, which is

a tax on the business use of energy. It is recycled, to a large extent,

back to business by means of a rebate in the employer’s contribution to National Insurance, so, if you like, a tax on employment.

One of the rationales was to try to reduce such taxation in order

to tax bads, rather than goods, and in this case, environmental

bads.

A proportion of those levied proceeds, however, does go into a

group of programs which were intended to cover venture capital investment in early-stage low-carbon technology, into loans for smaller companies looking to improve their energy efficiency, and in energy efficiency advice across business.

At the same time, the United Kingdom introduced climate

change agreements for energy-intensive industries, by means of

which 80 percent of the tax could be rebated if those companies

met a negotiated target for improved energy efficiency.

It is not easy to see exactly how successful any policies in this

field have been over a period marked by extraordinary fluctuations

in the basic commodities of oil, gas, and so forth. However, there

is quite a significant body of evidence to suggest that the levy on

its own had only a limited impact on investment decisions and on

behavior, certainly among less energy-intensive companies. It was

generally regarded as a blanket tax about which companies could

do very little.

The impact of the agreements, however, has been significantly

greater, as management’s minds were focused by the prospect of

meeting a target and having a very large payment to the tax man

dependent on achieving or not achieving that.

The whole package was regarded by the U.K. with parliamentary

and our business associations as not damaging U.K. business overall because, in particular, it stimulates energy efficiency, much of

which action results in savings to industry, and therefore savings

to the national economy.

We have managed to make cap and trade and energy taxation

work together in a variety of different ways over those years. They

can be put together reasonably successfully, but there are a number of technical design issues which need to be covered.

How does this fare on the argument of whether to go for a capand-trade system or a taxation system? I think one of the strong

arguments usually put forward in favor of taxation is the predictability of a cost impact and the low transaction costs. I do not think

that the U.K. experience altogether bears that out, because the tax

principles that were very, very simple to begin with were, after a

8

great deal of lobbying, turned into an extremely complex and

changeable set of obligations.

The other conclusion one draws is that, whether through tax or

trading, its artificial ‘‘cliff-edges’’ are affecting large quantities of

money to be paid, which really does make the difference.

Our industry has, for a long time, supported the importance of

a carbon price. I will end by quoting from a recent Confederation

of British Industry report: ‘‘We believe that cap-and-trade schemes,

such as the E.U. emissions trading scheme, have several distinct

advantages over taxation as a measure focused on large emitters

in the power and industrial sectors. By setting a cap on emissions

for those sectors within the scheme, they offer certainty about the

level of reduction. And despite calls for a global carbon tax, international agreement for a global cap-and-trade system looks very

much more likely.’’

Plus, as I said before, the impact on U.K. competitiveness, once

certain safeguards have been undertaken, is generally regarded to

be neutral at worst. Thank you.

The CHAIRMAN. Thank you all very much.

[The prepared statement of Mr. Derwent appears in the appendix.]

The CHAIRMAN. Dr. Orszag, in your testimony you state that the

less fluctuation in price allowances, the closer the cap-and-trade

system will come to achieving the economic efficiency of a carbon

tax. One mechanism for minimizing fluctuation in the price

bounces is the so-called ‘‘safety valve,’’ which has been bandied

about here as something that we should seriously consider, when

the government sells additional allowances or once the price of carbon reaches a certain level.

I am just curious how you would work with all of that. To contain the cost of this new system is the key to make this thing work.

The National Commission on Energy Policy and the Nicholas Institute have developed a new cost-containment proposal you may be

aware of. Essentially, their proposal would take allowances for outyears and place them in the reserve pool. Allowances from the reserve pool would then be released if the price of allowances reached

a certain level. The purpose, again, of this proposal is to achieve

cost containment without compromising the environmental goals of

the cap, and I would just appreciate your thoughts on all that.

Dr. ORSZAG. Well, that would be equivalent, just to be clear, basically to a safety valve in which any permits that are sold today

under the safety valve then come out of some future allocation. So

I think it may be clear to think about it that way.

The CHAIRMAN. Right.

Dr. ORSZAG. And you face the same trade-off there that you face

in general, which is, all right, you will provide more certainty then

about your ultimate emissions and concentration levels, but at a

cost in those out-years of having potentially more uncertainty

about prices and costs. So you cannot have perfect certainty both

over the cost each year and emissions each year.

The CHAIRMAN. Right. Correct. Your thoughts on how to address

that problem.

Dr. ORSZAG. The basic insight that comes from comparing the environmental dynamics and the economics is that a ton of reductions

9

this year is basically no different than a ton of reductions next

year, and having some flexibility across time in terms of when you

do the emissions reduction can matter a lot in terms of the cost of

achieving any long-term objective.

That is the big reason why a tax, actually, in most studies, is

more efficient than a simple cap and trade, because both of them

allow you, in each year, to achieve the reductions where they are

the cheapest, but a tax allows you to achieve them when they are

the cheapest, and that makes a big difference.

The CHAIRMAN. How comfortable are you with your estimates as

to revenue raised and the rebate program to address distributional

problems and costs of cap and trade, and just the parameters? If

you could just give a sense of the degree to which your estimates,

you think, are pretty accurate, or the range.

Dr. ORSZAG. Yes. Well, let me do that. The permit prices, for example, are one way of calibrating that. We provide, at the end of

our cost estimate of Lieberman-Warner, comparisons to other numbers that are out there. So, for example, I had given you—I am

going to just look it up very quickly—roughly $30 a ton in the middle of the next decade under Lieberman-Warner.

There are studies. I will not cite them, but basically there are

studies from EPA and from other entities. We are right in the middle of it. There is a significant range. I would say a reasonable

range might be plus or minus $5 or $10 per ton, maybe even more

than that. But we are in the middle of the range that is out there.

I think I am comfortable, but there is significant uncertainty. I

guess I would put it that way.

The CHAIRMAN. Now, comparing this with the Clean Air Act allowances and the cap and trade, clearly this is much more complicated. Lessons learned from SO2 cap and trade that could be applied to this, and just, what are the big problems? If you can put

your finger on the greatest additional complexities, what would

they be?

Dr. ORSZAG. I was going to say, the big difference is, this is far

larger. This effect basically is much more of the Nation’s economy

in a deeper sense than just the electricity sector, and it also has

larger cost implications than the sulfur dioxide trading program. So

I think there are lessons that we can learn about the volatility of

permits in a cap-and-trade system with the fluctuations that occur

each year, and other things from the sulfur dioxide program, but

it is much, much smaller. Extrapolating from that can prove

treacherous.

The CHAIRMAN. My time has expired.

I would turn to Senator Grassley, but he is not here. I have to

leave to go to the Farm Bill negotiations, so Senator Bingaman will

now take over the hearing. Thank you.

Senator Bingaman?

Senator BINGAMAN. Let me thank you all for your testimony. Let

me start with you, Dr. Orszag, and ask, you made the point in your

testimony, as I understood it, that the decision about whether to

auction these allowances or permits or to give them away will not

affect the price increase for energy products. Can you elaborate on

that?

10

Dr. ORSZAG. Sure. And I think this is important because the contrary is often asserted. If you give the permits away to whatever

firm, at some point that firm is going to realize that, yes, they have

the permit in hand, but, if they are going to produce the widget or

produce the kilowatt-hour of electricity, they are going to use up

that permit.

Instead of doing that, they could sell it for whatever amount of

money. If they do not then pass that cost on, if they do not then

charge consumers for that lost opportunity, they are not serving

their shareholders, and ultimately market forces will come to bear.

That is one way of looking at it. Another way of looking at it is,

you are not going to get down to the cap from wherever you were

going to be unless there are price increases that encourage both

consumers to switch their behavior and producers to switch the

way that they do business, and that requires a pricing mechanism.

It just does not happen any other way.

Senator BINGAMAN. But you are saying that prices will increase.

Dr. ORSZAG. For consumers, yes.

Senator BINGAMAN. For consumers. Either way, whether you auction them or whether you give them away.

Dr. ORSZAG. And I will give only a very small caveat, which is,

in some regulated electricity sectors where the regulations are done

at a State level, the effects may vary slightly if you give the permits away rather than auctioning them. But to a first approximation, consumers are going to pay the same regardless of how you

allocate the permits.

Senator BINGAMAN. Let me ask about, if we were to adopt some

type of safety valve, either through this mechanism that Senator

Baucus described or otherwise—and as you know, we have such a

safety valve in the bill that Senator Specter, I, and others introduced—how could you rationally settle on what the safety valve

price ought to be? I mean, we put $12 in the bill that we introduced last year. That was, to some extent, taken out of thin air.

I know Mr. Derwent was telling us right before the hearing that

the price for a permit under the European trading scheme is now

about 25 euros, which is about, what, 40 some-odd dollars. So how

would we go about setting the price of a safety valve if we included

such a thing in the legislation?

Dr. ORSZAG. I think the way you would do that is, you would

take the models that are out there that try to calculate what the

optimal path of carbon emissions and carbon prices would be, and

you could set the safety valve either at that, or maybe slightly

higher than that if you wanted to add a little margin in. But basically there are both academic and official agency estimates of what,

in some sense, the optimal price is, based on the cost of changing

our behavior and the environmental benefits that follow from that,

and that is what you would want to use.

Obviously there still is some guesswork involved because it is

model-based, but that is probably the best-informed way of going

about choosing that number.

Senator BINGAMAN. Mr. Greenstein, you gave us a suggestion for

how 14 percent of the value of permits could be used to buffer the

effect on those with low income, the bottom two quintiles, as I understand it, of the population. As I understand the LiebermanVerDate 11-MAY-2000 14:40 Jun 11, 2010 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 56384.000 TIMD PsN: TIMD
11

Warner bill, it does provide that 18 percent of the revenue generated from auction of permits or allowances would be used for lowincome assistance. I think it has half of that going to the LIHEAP

program as it already exists. It has another 25 percent of that 18

percent going to weatherization, and another 25 percent going to

a rural assistance program that is not yet established.

But you are saying that a better way to do it is through this

EITC and this food stamp provision, the debit provision. Why do

you believe that putting the money in those existing LIHEAP and

weatherization programs does not make more sense?

Mr. GREENSTEIN. Well, let me start by noting that our analysis

is that less than 5 percent of the value of the allowances under

Lieberman-Warner is specifically set aside for low-income assistance.

Senator BINGAMAN. I think maybe that is 5 percent of the value

of the allowances, but 18 percent of the expected revenue from the

sale of the allowances, because they contemplate giving them away.

Mr. GREENSTEIN. Right. But you cannot compare that 18 percent

to my 14 percent.

Senator BINGAMAN. Right.

Mr. GREENSTEIN. Let us suppose that you were giving away 90

percent of the allowances and only auctioning 10 percent.

Senator BINGAMAN. Right.

Mr. GREENSTEIN. If you used half of the auction proceeds for lowincome relief, you would only have 5 percent.

Senator BINGAMAN. Right. I understand.

Mr. GREENSTEIN. Given the point that you and Dr. Orszag’s answers just established, that the consumer price increases will be

the same, essentially, whether you give away the permits or auction the permits, to determine how much you need for low-income

relief there has to be a percentage of the total value of the permits,

not a percentage of that value of the permits that is auctioned. You

need about 14 percent of the total value of the permits to fully offset the impact on the bottom fifth, and part of the impact on the

next-to-the-bottom fifth.

So, Lieberman-Warner, when you look at it, the only part that

is specifically low-income is the LIHEAP weatherization part. Nine

percent of the allowances would be allocated to load-serving entities, but (A) that would be for low- and middle-income relief combined; and (B) many load-serving entities do not have good data on

the income of their consumers. It would be difficult, in many cases,

to separate low- and middle-income, and you would, in effect, be

replicating within private utility companies almost a kind of bureaucracy or mechanisms that we already have. The most efficient

way, in our view, to provide low-income assistance is to use the

Earned Income Tax Credit, as you did in 1990 and 1993, together

with the various other efficient systems I discussed.

We already have the electronic benefit system, we already have

the debit cards. We know how they work. We already have existing

programs: the low-income drug benefit and food stamps. We could

very simply use the existing mechanisms to offset the increase in

costs, whereas I think Lieberman-Warner falls short on two fronts:

(A) the total amount of low-income relief falls well short of what

12

is needed; and (B) the mechanism to deliver it would actually be

pretty inefficient and would probably miss substantial numbers.

LIHEAP. That is the other point I should make. LIHEAP only

reaches about one-sixth or one-seventh of the low-income households eligible for it. It is a block grant. Each State has its own eligibility criteria. What we get through something like the EITC and

the EBT mechanism that I am mentioning is, you simply have a

set national eligibility structure, you know who the people are who

were enrolled, and you can simply reach them. LIHEAP is great for

what it does, but, if you are talking about offsetting impacts on 60

million low-income people, the bottom fifth of the population, I do

not think LIHEAP is equipped to be the main mechanism as distinguished from one that fills gaps that remain after you use things

like the EITC and the Electronic Benefits System.

Senator BINGAMAN. Senator Bunning?

OPENING STATEMENT OF HON. JIM BUNNING,

A U.S. SENATOR FROM KENTUCKY

Senator BUNNING. Thank you, Mr. Chairman.

Rather than ask some questions, I think I am going to read

something into the record that needs to be said.

Let me make something clear: I do not think a mandatory capand-trade program is the right policy for America. I believe it will

send our manufacturing jobs overseas, prevent economic growth,

and cost the average American thousands of dollars a year in increased energy and food costs, not to mention the fact that America

could bring its greenhouse gas emissions to zero and it would not

reverse the growth in worldwide emissions, thanks to the rapid expansion in China, India, and other developing nations. But I can

see the handwriting on the wall. I see what many of my colleagues

in the Senate would like to do, and every one of our three presidential candidates has made their support for cap and trade very

clear.

I know climate change legislation is coming. I will fight to make

sure it includes a broad international agreement with China and

India, safety valve prices, as you have mentioned, that protect

Americans’ hard-earned money, and emissions targets that are realistic. But that will not be enough. These mandatory cap-andtrade bills all require new technologies that we only hope will be

commercially ready. I am not willing to bet America’s economic future on a guess.

There are some things we can do today. Regardless of how the

cap-and-trade debate plays out, we can provide the tax incentives

American industries need to deal with carbon. I believe we need a

Manhattan Project for carbon emissions. The greatest minds in

America should be working on ways to capture and use carbon

emissions and develop new, clean technologies.

For too long I have watched uneconomical technologies get all

the financial support. I have seen members of this committee act

with prejudice against some technologies, especially coal, in favor

of less effective or unproven proposals.

Our proposals should be based on goals. If you can produce an

environmentally sound transportation fuel, you should not care

whether it comes from coal or switchgrass. If you can produce a

13

megawatt of clean energy, we should not care if it comes from

waste heat on a paper mill or from underground geothermal. I will

agree to aggressive carbon capture requirements and life-cycle

greenhouse gas reductions, but we must be technologically and

feedstock neutral.

Congress should help America do everything it can to replace foreign oil. Let me make that so clear, because that is one vein of our

problems foreign policy-wise, economically, and everything right

now, to reduce and reuse carbon emissions. If my colleagues are serious about addressing global warming, this is the place to start.

Helping our economy deal with carbon now before we consider a

cap-and-trade bill should be the goal we all agree on.

I want to thank you all for your information.

Senator BINGAMAN. Senator Salazar?

Senator SALAZAR. Thank you very much, Senator Bingaman.

Let me, Dr. Orszag, ask just a ‘‘yes’’ or ‘‘no’’ question.

Dr. ORSZAG. I do not like those, but all right.

Senator SALAZAR. Did you say that, if the allowances were sold

or auctioned off, they would produce $145 billion under the

Lieberman-Warner legislation? Was that the number you used,

$145 billion?

Dr. ORSZAG. That is the number I used. Now, not all the permits

are auctioned off under that legislation, but we treat even the permits that are given away as a form of revenue.

Senator SALAZAR. So you are looking at a $145-billion pot of

money.

Dr. ORSZAG. In total, it is $145 billion. That is correct.

Senator SALAZAR. All right.

And I think you said that right now Lieberman-Warner would

cost a consumer a quarter per gallon of gas. Is that 25 percent or

25 cents?

Dr. ORSZAG. Twenty-five cents.

Senator SALAZAR. So 25 cents on a gallon of gas. So, if

Lieberman-Warner were to be passed, your projection would be

that it would cause an increase of 25 cents on a gallon of gas?

Dr. ORSZAG. That is correct.

Senator SALAZAR. All right.

Let me ask you. I just wanted to clarify that in my mind, because

there are other questions I am going to ask.

And I have a statement for the record, Mr. Chairman, that I will

just submit for the record so I can ask questions.

[The prepared statement of Senator Salazar appears in the appendix.]

Senator SALAZAR. You, Dr. Orszag, have three models that you

have up there on the bulletin board. One of them is, the allowances

would be sold and you would have the rebates. The other one is,

the allowances would be sold and you would have corporate tax

cuts. The other one is, you have the carbon allowances simply given

away. Then you have gone through the scenarios on what impacts

it would have on the economy, as well as on consumers.

My question is whether or not there is another model here that

could be followed that might marry up with what Senator Bunning

was talking about here in terms of embracing a Manhattan Project

14

for how we deal with climate change that brings in the whole energy efficiency and technology world.

As Chairman Bingaman knows in the Energy Committee, and as

we know on this committee, and as we know on the Agriculture

Committee, this is an issue that we have been working on in 2005,

2006, and 2007. I look at a $145-billion pot of money, and I do not

know whether this is the right allocation for that pot of money.

Now, what if you were to take a scenario where you would put

33 percent of $145 billion into energy efficiency programs and incentives? You would take 33 percent of that money for low-carbon

intensive energy generation such as solar and wind and other

kinds of geothermal. You take another 33 percent that you would

invest in new technologies, such as clean coal technologies and carbon sequestration. So essentially you would say we would do an allowance. We can sell these allowances. We are not going to give

them away. We can generate $145 billion into this pot, and what

we are going to do is, we are going to incentivize the creation of

a Manhattan-like project on energy.

Now, have you done an analysis on what that would do to our

economy, and ultimately what that would mean to consumers?

Dr. ORSZAG. Well, a few things. First, and without judging the

merits or demerits of that approach, what it would mean is that

you would wind up with, at least initially, the regressive pattern

of results because you are not spending the money to cushion the

blow for lower- and middle-income households in any direct way.

Second, I also do want to just emphasize that, while additional

government spending on research and development may be warranted and beneficial, it is also the case that the price increases

that will occur will spur significant activity in finding low-carbon

activities and new technologies. Markets work when you provide

incentives for them to work.

Right now, there is very little to no incentive to find low-carbon

technologies. With a price on that, markets will have a strong incentive to find those pathways to lower carbon emissions technologies. It may not be sufficient and you may want additional government assistance for that, but that would be a big spur to technological advances.

Senator SALAZAR. My only point here is, the three scenarios that

you have in the chart that is being presented here, there are lots

of other scenarios——

Dr. ORSZAG. Absolutely.

Senator SALAZAR [continuing]. That we could actually have you

analyze in terms of what we would do with these $145 billion of

money if we were to sell the allowances.

Dr. ORSZAG. And that is exactly right. Just very quickly, I think

you have correctly hit the point: it is a lot of money, and you need

to think carefully about what you do with it. You are exactly right,

that there are lots of things you could do with it.

Senator SALAZAR. It is a lot of money, Dr. Orszag, and this is not

your issue, this is our issue here. But when you think about the

fact that we put about $200 billion a year into Iraq and we are

talking here about the whole issue of climate change—they are two

different issues, I recognize that—but the importance of what we

15

do with our planet and what we do with our energy future is something that also has a huge, huge priority.

You had a quick comment there, Mr. Greenstein? I know my

time is already up.

Mr. GREENSTEIN. Yes. You really can do a combination here. In

other words, you could use some of the proceeds for relief for lowand moderate-income consumers. You could use some of the proceeds for basic alternative energy research, which clearly would be

a sound use of some of the proceeds. You also could get more

money for the basic research by looking at all of the existing energy

tax incentives and other subsidies and seeing which ones are no

longer needed under a cap-and-trade regime, freeing up some

money there and reinvesting it in more promising research on new

technologies.

So you can do a combination effort where you try to get the best

part of the investments in terms of new energy technologies, particularly from basic research, and things like low- and moderateincome relief, some protection for hard-hit communities, coal mining and others. It does not have to be—and I think Peter is saying

this—all one or all the other.

Senator SALAZAR. Thank you very much.

Thank you, Mr. Chairman.

Senator BINGAMAN. Senator Rockefeller, you go right ahead.

Senator ROCKEFELLER. I am just going to pause here for a moment and gather my thoughts.

Senator BINGAMAN. Should I ask my questions and then call on

you? Is that acceptable?

Senator ROCKEFELLER. I think that will be good, yes.

Senator BINGAMAN. All right. We will do that.

Mr. Derwent, let me ask you for any comments you might have

on one of the points Senator Bunning made, which is often made,

that putting in place a cap-and-trade system like is being discussed

here will drive manufacturing overseas. I would be interested in

your experience in Great Britain, or your experience with the European trading scheme, generally. Do you believe that it has had that

effect? Do you believe that it has accelerated the rush by companies

to move their manufacturing out of the European community?

Mr. DERWENT. It is still in its early days. The schemes have not

been in place for very long, and people do not make quick decisions

about up and moving entire production facilities from one continent

to another without a certain amount of thought about what is going

to happen for the future.

The studies that have been done in the U.K., and more broadly

in the E.U., have indicated pretty clearly that the amounts involved, the amount of additional costs, are trivial for 90 percent of

the industries affected by the provision.

But that 10 percent includes one or two industries that are particularly energy-intensive and particularly exposed to foreign competition, about which something must be done. That is, I think, politically understood throughout the European Union. The way of

doing it in the much more stringent third phase of the E.U. emissions trading scheme is, at this moment, being debated in the European Union, as it is here. I have just come, in fact, from testifying before the European parliament on precisely this point.

16

But it is the way that you choose to affect that decision by that

comparatively small number of industries—aluminum being a good

example, steel being another—otherwise, an increment on energy

costs really does not make a huge amount of difference to profitability.

You need to make sure that you can constrain that effect, the effects of relocation, at minimal damage to the impacts of the scheme

that you want to adopt, particularly a cap-and-trade scheme. While

a price cap is a way of doing that, and in the thought of any other

methodology it could be a good one, there are some warnings, I

think, which need to be taken. You can create diverse behavior in

the market, which can end up totally overwhelming the message

that you wanted that price cap to give.

You can actually stop the supply of new low-carbon technologies

when it is comparatively high cost and people say, hey, I do not

quite know whether this is going to be justified or not. You fail to

achieve what the entire objective of this exercise is, which is to reduce the concentrations in the global atmosphere of a global pollutant. That may be largely to do, certainly in the future, with what

happens in China and India. But they follow the lead set by the

United States, in particular, and the negotiating positions of the

whole of the developed world is much, much stronger on the back

of strong action taken, as it were, at home.

Senator BINGAMAN. Thank you.

Dr. Orszag, let me ask you. You make reference to the 25-centsper-gallon increase that would result. My impression is that the

biggest increase in cost of energy that consumers will see is not

going to be in the price of gas at the pump, it is going to be in the

price of home heating oil, it is going to be in the price of natural

gas to heat homes, it is going to be in the price of electricity that

they are purchasing from their utility company.

One of the big concerns that we hear from a lot of utilities is,

if you put in place too heavy a burden too soon, the result will be

that there will be a very major additional shifting for use of natural gas that will drive up the price of natural gas overall, and that

will obviously be a great disadvantage to folks who depend upon

natural gas for heating and air conditioning purposes.

What is your response to that?

Dr. ORSZAG. Well, first, with regard to the cost increases, the

numbers that we gave you in Table 1 of my testimony for effects

on middle-income families, for example, of roughly $1,200 from a

15-percent reduction in carbon emissions, I think that is not far off

from the price effects that are embodied in the Lieberman-Warner

bill. I think 25 cents a gallon is not going to cost most middleincome families $1,200 a year, which is consistent with your point

that most of the effects are through some other mechanism.

The other part of your question had to do with switching technologies, and that is part of the adjustment that would occur, and

there are then price effects that follow from that. As you shift away

from coal and towards other technologies, you can drive up the

prices of inputs of those other technologies. That is part of the adjustment process.

I know that time is running out. I just do want to emphasize the

point that our distinguished international visitor made, which is,

17

with regard to the manufacturing question, it really is important

to focus on, in particular, several sectors: iron, steel, aluminum,

paper, chemicals, things like that, where energy costs are a much

larger share of their value added or their activity than for manufacturing as a whole.

Senator BINGAMAN. Senator Rockefeller, are you ready with your

questions?

Senator ROCKEFELLER. I am.

I am going to throw out a notion, and I would love it if you would

react to it. You take the Lieberman-Warner amendment, which industry says is too radical, and you look at what that does, it reduces carbon dioxide emissions by 70 percent by the year 2050.

Now, the question that some of us would honestly pose is, will we

still have a planet in 2050? In other words, this thing seems to be

moving so much faster than we think, so we are dealing with a carbon tax, cap and trade, tax incentives, all kinds of things. We created tax incentives here that we could not pass.

It also implies that there is a sector-by-sector solution: if we just

add up all the sectors together and they all do the right thing,

somehow it will come out right. My view is all different, and I

would like to know what your view is.

George Bush has used a borrowing technique for budgeting,

which is why we never saw the Iraq war, any of those things in

the budget. He borrowed from China, South Korea, Japan. They all

have plenty of money, and they can continue to do so. My thought

is that we would take maybe three, maybe four but no more, and

carve out four subjects in our National agenda, obviously the lead

of which would be climate change. There would be health care,

there could be infrastructure, there could be scientific research and

development, all that kind of stuff. So, you pick out four.

But let us just concentrate on climate change. Then you say, no,

we are not going to do this sector by sector. We are not going to

have companies coming out with different solutions and getting

their patents, therefore precluding others from doing things which

they think are either a little better, a little worse, or whatever. But

we would have a national solution.

The only way you have a national solution is if you have a national budget. So you set aside and you say, now, we are not going

to do pay-go. Democrats are so proud of our pay-go, who feel so virtuous, as we are able, therefore, to do absolutely nothing regardless

of who gets elected. That is not very sensible on any account, but

it certainly is not sensible if you believe that climate change is

coming faster than I think it is, than most people think it is.

You just say, all right, the government is going to pay for this.

It is going to do the whole thing, maybe $10, $15, $20 billion. I

mean, a year ago George Bush gave $20 billion to the Saudis to

buy more arms; am I not correct? I was just thinking, gee, they

really need arms. What is this really for? What it really is for, obviously, is oil relations. We have to get rid of that. We can get rid

of that. You have to use nuclear. You have to use everything that

everybody can think of.

And you have to use coal. People do not like coal. There is coal

as it is, and there is coal as it could be. So my idea would be for

the government to pay for—not to control. No government person

18

would be in charge of this project. It would be a Robin Oppenheimer, Jr., who is a scientist, so to speak, and knows this field—

and they spend whatever money it takes. I would posit that, over

a period of 5 years, they would be able to come up with a way to

completely sequester carbon dioxide, CTL (coal-to-liquids), plus

emissions for power. But you do that, because any other system

fails.

Now, on our side, so proud of pay-go, we are trying to get tax

credits for the Children’s Health Insurance Program, which got vetoed twice. Why? Because we raised the cigarette tax. The President does not want the tax—I cannot imagine anything that goes

together better than the cigarette tax and Children’s Health Insurance, but no matter, it was vetoed, so we do not have it. So along

comes the rest of this. We are sort of tinkering with our different

little things. A tax on carbon has never been passed here. We know

that. Cap and trade can. Jeff has an amendment—Senator Bingaman has an amendment—Senators Warner and Lieberman have an

amendment. All of these seem to be small pieces of solving a huge,

huge world problem.

I have some ideas, which I will not share here, how the Chinese

could solve their problem. I do not have any ideas on how the Indians—I am going to leave that up to you, Peter—can solve their

problem. We have to solve our problems, first. So just respond—my

time is already over—to the idea of simply carving out four subjects

of prime national survival interest, because I think we have about

25 to 40 years to fix this country or else we are going to be tipped

down forever on many fronts, climate change obviously above all.

So we exempt them. Everything else is pay-go. But these four

areas, of which climate change is the lead, we borrow. The theory

on that is, if we have a $9-trillion debt, you say, well, we cannot

do that, we will add onto our great-grandchildren’s debt. I just

want to make sure I have great-grandchildren. So, I would like

your reaction.

Dr. ORSZAG. Well, Senator, as you know, I have testified before

this committee many times. I think this is the first time I have

heard a very similar idea from you and Mr. Bunning, who also

proposed——

Senator BUNNING. I thank you for seconding my original proposal. Thank you.

Dr. ORSZAG. Let me just say, to come back to your broader point,

climate change is among the most serious long-term problems we

face. We are running an experiment, and we do not know how it

will come out, and there are lots of things that could be done,

whether it is additional research and development or whatever.

Cap and trade can actually provide, to the extent you auction the

permits, for example, funding if the pay-go rules still apply. It can

provide funding for that activity. I know that raises other questions.

There are lots of things that can be done. It is also the case, as

Senator Bunning pointed out earlier, that just the U.S. paths by

themselves are not sufficient, both because they end in 2050, and

it matters what happens thereafter, and because global emissions

are what really matter.

19

But this is clearly among the largest risks that we are running,

and I think most analyses suggest that well-designed policies to

start bending the curve on emissions have larger benefits than

costs.

Senator ROCKEFELLER. That would mean that my idea is not impressive to you.

Dr. ORSZAG. I did not say that. What I said earlier is that—first

of all, I am not going to get into the debate over pay-go, because

part of my official responsibility is helping you enforce the rules

that you may not like. But second, let us just talk about a Manhattan Project for climate change, basically, which is what Senator

Bunning suggested. There are clearly technological changes that

need to occur as part of the process of moving to a different emissions path that is more consistent with longer-term sustainability

and minimizes the risks that we are running. That is one sensible

approach to starting down the path that we need to for the changes

that we need.

I would just note that you would also get an additional kick to

research and development activity through pricing carbon. In other

words, a carbon tax or a cap-and-trade system would then elicit

private sector activities in a way that could be supplemented by

government research and development, and, if all you did was massive government research and development, without any price signal, I would be concerned that you would not get the results that

you would want.

Mr. GREENSTEIN. May I respond also?

Senator ROCKEFELLER. Please. And I apologize.

Mr. GREENSTEIN. I view your idea as having a couple of components, but the core of it being a significant increase in investment

in R&D. The pay-go part is really your mechanism to come up with

the money for your goal, which as I understand it, is significant increased investment in R&D. I do not think there is any question

that it would be desirable to have that significant increase, particularly in basic alternative energy and other energy research.

A couple of points on the financing. First, much of that would

normally be, and ought to be, funded through the discretionary side

of the budget. The discretionary side of the budget, as you know,

is not subject to pay-go. I would argue that if we do not enforce and

adhere to pay-go on the tax and entitlement side, that the result

over time will be to dramatically decrease the money available for

investment on the discretionary side of the budget.

Second, as Peter just indicated, I would argue that a cap-andtrade system is a natural complement that would help further

what you are talking about, in other words, significant increases in

this kind of research, in three ways: first, as Peter just indicated,

the price signal, the higher cost for fossil fuel energy, will incentivize the private sector to invest more in the kinds of research we

need than it would do in the absence of the price signal; second,

by auctioning allowances, one would gain money, a significant

share of which could be used to fund the R&D; third, as I noted

earlier, some of the existing government investment in energy R&D

would become superfluous or redundant in a cap-and-trade regime

because the price signal would mean that certain things you now

need incentives for you no longer do, and you could free up that

20

money for the higher bang-for-the-buck kind of research you are

talking about.

So it seems to me, from all of these perspectives—having more

investment on the discretionary side of the budget, incentivizing

private sector investment through an emissions cap, auctioning the

permits under an emissions cap and reinvesting some of that

money in this research, and cleaning out some of the existing research that will no longer need it and shifting that money to where

it is more productive—that between this combination of mechanisms we could get a significant investment in what they are talking about.

Senator BINGAMAN. Senator Kerry? He has not asked any questions. Is that acceptable to you, Senator Bunning?

Senator BUNNING. I would love for Senator Kerry to ask questions.

Senator BINGAMAN. Why don’t you go right ahead?

Senator KERRY. Thank you, my colleague. I appreciate that. I

will not be long.

Dr. Orszag, my preference in this is to have the highest level of

auction possible. I think it is the cleanest, it is the most effective

way to set the market price, it is the most effective way to get the

benefits to the folks who need them without all the politics and all

the pressures that are going to come in.

Can you talk about that for a little bit, please? There are allowances in the cap-and-trade bill that we have. We have sort of

begun, fundamentally, upstream with certain sectors. Do you see

any problems with that? Is that going to be effective, in your judgment? Are the levels that we have set with respect to allowances

versus auction appropriate?

Dr. ORSZAG. Well, first, just to unpack that a little bit, we estimate that in 2012 the value of the permits, under the LiebermanWarner legislation, will be $145 billion. Most of that in that year

will be permits that are given away to firms. So, as my testimony

emphasized, when you give permits away to firms, you are foregoing an opportunity to use that money either for a macroeconomic

benefit or for research and development in new technologies, or for

cushioning the blow for low- and middle-income households.

So I am not going to say whether it is appropriate or not, but

it is difficult, for other than political economy considerations, to

come up with a policy justification for that approach relative to

other uses of that same money.

Senator KERRY. So you are concerned about that level of allowance in the bill?

Dr. ORSZAG. I would say, regardless of whether your motivation

is to promote technological advances or to a distributional concern

or a macroeconomic efficiency concern, it is hard to justify giving

the permits away rather than using the revenue for some other

purpose that furthers those objectives. So, you may have some

other objective in mind.

Senator KERRY. Like passing the bill.

Dr. ORSZAG. That may be among them, yes.

Senator KERRY. Well, I think we have to think about that very

closely.

21

It is your judgment that the auction itself would be far more effective, is it not?

Dr. ORSZAG. Well, it would raise revenue that you could use for

other purposes.

Senator KERRY. What about the effectiveness of setting the market price? I mean, I remember when we did the 1990 Clean Air

Act, the industry came in and said, oh, please do not do this to us,

it is going to cost us $8 billion, you are going to put us out of business, it is going to take 10 years, we are going to be non-competitive. The environmental community said, no, that is just business

argument. They are trying to give you a worst-case. It is going to

cost $4 billion and take 5 years, and we can do this.

To the credit of George Herbert Walker Bush and John Sununu

and Bill Reilly, they agreed to do it, and we did it. Guess what?

It cost half of what even the environmentalists said it would cost

and it was done in half the time. The price went from over $1,000

down to below $100, and then it bounced up to about $100. So does

that not give you a pretty fair indication that the market, in fact,

has a dramatic ability to attract capital, solve the problem, and set

the price without enormous disruption?

Dr. ORSZAG. One of the significant benefits of both a cap-andtrade system and a tax as opposed to a strict regulatory approach

is that you are using the power of markets to achieve the emissions

reductions where they are cheapest to achieve, and that is a huge

benefit. Yes, sir.

Senator KERRY. And that experience speaks to that, does it not,

in volumes?

Dr. ORSZAG. Yes, it does, although there have been some caveats

raised about the development of sources of lower sulfur coal that

had not been anticipated. But the basic point is, the marketplace——

Senator KERRY. Well, you are saying that it was possible that

there were additional benefits that came through unforeseen

changes in behavior.

Dr. ORSZAG. Yes.

Senator KERRY. But the same is almost certainly going to be true

with respect to the marketplace on carbon as a whole, whether it

is a new fuel or a new technology. I mean, the reason nobody could

accurately set the price is that nobody has a way of measuring

what happens in the innovative scientific community once the capital begins to flow towards a nationally established goal. Then

there are the unforeseen events which we have seen throughout

the computer industry, and every technology, as a matter of fact.

Is it not a fact that we are going to see unforeseen benefits that

will flow through the market that we cannot predict today?

Dr. ORSZAG. There is a lot of uncertainty. I guess I would say

there are unforeseen benefits. There may be unforeseen costs. We

are not going to know what the permit price actually is until we

do this. One of the benefits of some of the things that we were discussing earlier, like a safety valve or other ways of trying to limit

price fluctuations, is that it helps you mitigate the effect if things

turn out to be either too high or too low relative to what you had

anticipated.

22

Senator KERRY. Last question, because my time is rolling by and

I will have to wait until the next round. But just very quickly, Mr.

Greenstein, or anybody else who wants to add to this, it has been

suggested that incentives may need to be reviewed as a consequence of putting in place the cap-and-trade system.

What type of tax incentives do you believe, or are capable of

being ascertained now as no longer being needed, conceivably? Second, there is sort of—what kind of new tax incentives might complement the cap and trade? So, both sides of that.

Mr. GREENSTEIN. This is to identify the specific tax incentives

that would be useful and the ones that currently exist that could

be modified. I would hesitate to comment on it; it is kind of beyond

my expertise, and I have not looked at it. What I think is clear,

and Dr. Orszag has said this a couple of times this morning, is that

you would have a different set of market incentives under a capand-trade system under which prices for fossil fuels were rising

than you have today. And certain kinds of activities that are not

profitable today, unless you provide a tax or other incentive, would

become profitable without the incentive under a cap and trade regime.

What I recommend is not that someone like me sort of off the

top of my head make some comments, but that you ask CBO or

other institutions, as you are doing cap-and-trade legislation, to do

a review of the existing incentives. The idea would be to figure out

which ones make sense or might be augmented, which ones are no

longer needed and you might phase out, and which ones would

need to be modified.

Out of that, if you were able to do that politically, you would

save some money that you could reinvest in other forms of incentives for which there would be higher value, and it would seem to

me that you would want to shift more towards those kinds of basic

research that would be important to making breakthroughs, but for

which the private sector would not be able to capture enough of the

gains, or the gains would be so uncertain that there would not be

enough incentive for the private sector itself to finance that kind

of basic research.

Senator KERRY. That makes sense to me. I think that is a pretty

good principle.

Do you want to add anything?

Mr. DERWENT. I would, if I may, agree very much with Mr.

Greenstein on that point. If you introduce market instruments,

then they should be enough. But to deal with the deployment

issues, what is much more difficult to deal with—particularly if the

time scale is as condensed as Senator Rockefeller was, I think,

right in saying it is—is making sure that the next generation of

low-carbon technologies, those which we can see all around us at

the moment, at least in embryonic form, must be supported by government. If government has money, that is the place to be putting

it. When you are talking about making sure that the existing technologies are actually used, where they are not used at the moment,

look for the reason—the reason is, there is no economic price of carbon—and create that price.

Senator KERRY. Right.

23

Mr. DERWENT. But if I may, I will just, perhaps not totally, return the compliment that Dr. Orszag made to me at an earlier

stage, by saying that I think that the price effect on its own often

is frustratingly ineffective. This has more to do with psychology, I

suspect, even in very well-run businesses, than it has to do with

strict economics. But our experience in the U.K. has been that you

have to actually create a tipping point, or a focus, or a target before

you find that the economic rationality of finding a way of producing

stuff with less carbon and selling the carbon, for example, hits

home to management. That is the thing to do and that is the way

to——

Senator KERRY. So the target is critical?

Mr. DERWENT. I believe so.

Senator KERRY. I agree. I totally agree. I do not see how you do

it without it, but I just wanted to reinforce that.

Thank you very much, Mr. Chairman.

Senator BINGAMAN. Yes.

Senator Bunning, did you have questions?

Senator BUNNING. Yes, I do.

Mr. Greenstein, you insist that a cap-and-trade program will

focus on the most economical solutions. I am concerned that we are

missing the big picture. Have you considered that the most efficient

market outcome may not be the most desirable? For example, utilities will be able to pass through much of their costs to consumers

and therefore engage in significant emission reductions, but a manufacturer will still compete with products made in other places, like

in China, or India, or anyplace else in the world, and would be

forced to go abroad unless they could afford allowances.

While this creative destruction would be efficient under cap and

trade, do you think it makes sense to force American companies to

move jobs abroad to stay competitive? Does it limit the areas in

which we can expect technology to improve rapidly?

Mr. GREENSTEIN. Let me say that both of the other members of

the panel, I think, probably have more expertise than I do on the

international question. But there is a conundrum here. There is the

risk that, if we do not take action and we simply wait, that we do

not create enough incentives for those countries that also need to

act to do anything and we move further down the path, where significant economic damage from global warming may be irreversible.

Obviously part of your analysis of how to design a cap-and-trade

system or a carbon tax will necessarily, and should, involve these

international questions. There are a variety of mechanisms—I

think the other two members of the panel probably know them in

far more depth than I—that could be looked at as to whether there

are certain border adjustments that might be made, for example,

for products that are imported from countries that do not take any

action that is comparable to what Europe, or under this the United

States, would do. All these things obviously should be looked at.

But I think we have to find the answer for how to move forward,

and how to move forward in a way that incentivizes China and

India and those countries to move as well.

What we cannot afford to do, I think, is to sort of say we cannot

take strong action because they are not taking strong action. What

the best mechanisms are, either in a cap-and-trade regime or under

24

international treaties, to make progress internationally, other panelists probably could answer better than I.

Senator BUNNING. Dr. Orszag, I will ask you. You testified a capand-trade program would increase the prices of energy and energyrelated products, and the consequences would be investors losing

money in the stock market and workers losing their jobs.

Just looking at our economy today and the people in Kentucky who are struggling to pay for gas at the pump—$3.53 yesterday,

and diesel, $4.28 at the pump per gallon—I cannot imagine a worse

time to deliberate passage of legislation to devalue stock and force

people out of their jobs.

Could you explain more about the consequences of higher energy

costs?

Dr. ORSZAG. Sure. And I think, just to put it in context, again,

the reason that policymakers would adopt this kind of approach is

to try to minimize or reduce the risk of potentially catastrophic

greenhouse gas emissions and global climate change. Against that,

though, there is some short-term economic costs. That economic

cost is both——

Senator BUNNING. Now, how long is short-term?

Dr. ORSZAG. That depends on what you do, and it depends on the

evolution of technology and what have you. But this is fundamental

to the nature of the problem that we face. We have to pay up front

for a long-term benefit.

Senator BUNNING. We understand that. But it is just a question

of, how much can the economy tolerate up front?

Dr. ORSZAG. Well, the macroeconomic effects, while they are

there, are not overwhelming.

Senator BUNNING. Well, this economy is not overwhelming right

now.

Dr. ORSZAG. That is true, also. But even the things that I was

talking about, with regard to the permit prices, were for 2015, they

are not for today. Almost all of these programs would be gradually

phased in and the macroeconomic consequences would not be felt

immediately.

Senator BUNNING. Thank you, Mr. Chairman.

Senator KERRY. Mr. Chairman, would it be possible just to say

to Senator Bunning that, as one of the authors working on this bill

with Senators Boxer, Lieberman, Warner, et al., those are legitimate questions? But the bill puts literally hundreds of billions of

dollars over the next years specifically at the disposal of those

kinds of impacted industries. I think the Senator needs to take a

look.

We were working yesterday, for instance, with Senator Levin and

Senator Stabenow, who are trying to deal with some of the manufacturing cost increase impacts. There are major mitigation efforts

in this legislation, I mean, literally in the billions of dollars, that

are going to go out into manufacturing and into industry, combined

with incentives to try to balance that. The impacts are, there will

be increased costs in energy in certain areas, inevitably. There are

going to be, anyway.

Senator BUNNING. I do not want to get into a debate. We bailed

out Bear-Stearns because it was too big to fail. The consequences

of a Lehman Brothers or someone like that failing because we put

25

on a cap-and-trade piece of legislation that makes Lehman Brothers insolvent, or Citicorp insolvent, what happens to the U.S. economy under those circumstances if, in fact, we impose a cap-andtrade bill?

Senator KERRY. Well, in fact, we have imposed a cap-and-trade

bill previously, Senator, and we heard these same arguments back

in 1990 and 1989.

Senator BUNNING. But you will admit, Senator Kerry, that comparatively speaking, it was a 10-percenter compared to a 100-

percenter.

Senator KERRY. Well, it was a targeted area of the economy.

What it proved, however—and this is a targeted area of the economy, as a matter of fact. This is not economy-wide. There are many

people who thought we should have made this economy-wide. But

in effect, this is not. This is beginning as sector-specific—utilities,

manufacturing—and then moving down the economy over time.

But you have to look at the other costs and consequences at the

same time. Europe just did this. Europe has cap and trade in place.

They had some dislocated. Now, there are a number of reasons.

When we were in Kyoto, I remember negotiating with the Europeans then to get them into it. We just had Stu Eizenstat in front

of our committee the other day talking about this. They did not

want to take part in the cap and trade. They did not believe in cap

and trade. They fought against it.

Ultimately, they did sign on and bought into it and they put it

in place, but they did not do it with the kind of experience that we

had through the Clean Air Act, and generally speaking in our economy, so that they made some mistakes. The cement industry got

hit, and there were some sectors where they did not make adequate

allowances. But now I think they have learned. There is a general

acceptance of this in Europe. You can look at the euro versus the

dollar today and you can look at their economy, which, generally

speaking, did not take an enormous hit as a consequence. But

there are all kinds of costs, as Senator Rockefeller and Senator

Bingaman and others would agree, to not doing this. I mean, the

costs are going to be far——

Senator BINGAMAN. Before we get into too elaborate a discussion

about the costs of not doing this, let me ask the witnesses a couple

of questions here.

Your chart there. Let me ask you about the middle part of that

chart, Dr. Orszag. You have there, ‘‘Allowances Sold and Corporate

Taxes Cut’’ as one of the options. You say that has the least macroeconomic adverse effects on the economy, as I understand it, of the

three options.

Dr. ORSZAG. Of those three. The results would be similar if you

reduced payroll taxes, too.

Senator BINGAMAN. Well, how does that relate to Mr. Greenstein’s proposals, which are that we take up to half, or whatever

amount, of the revenues and use those to cut taxes, essentially, for

the average consumer? So we are cutting taxes for corporations and

we are cutting taxes for the average consumer. How do we fit those

all into one bill? I mean, we are talking about a bill here where

you have all these allowances. If we do what you are suggesting

and sell them all as one option——

26

Dr. ORSZAG. I did not suggest that. I just pointed that out as one

of the options.

Senator BINGAMAN. That is one of the options.

Dr. ORSZAG. Yes.

Senator BINGAMAN. How much of that goes to corporate tax cuts,

how much of that goes to individual tax cuts? To what extent are

we doubling up, if we are?

Dr. ORSZAG. And I would just note, some of the proposals that

Mr. Greenstein and others have put forward, for example, that relate to the Earned Income Tax Credit, do get you potentially two

benefits. They have a distributional effect. They tilt towards the

bottom. They also are the kinds of tax changes that encourage

work. That is the key here. The corporate income tax change or the

payroll tax change has positive economic incentives, and, if you can

combine positive economic incentives and a distributional effect

that you may or may not favor, you can kind of double dip to some

degree.

Senator BINGAMAN. Mr. Greenstein?

Mr. GREENSTEIN. Could I also note, looking at the charts up

there, that the first set, ‘‘allowances sold and lump sum rebates

provided to households,’’ under that scenario all of the money that

is available from the auction proceeds goes in the form of rebates

to households. I am suggesting that part of the money—not all of

the money—go to households.

The other thing I would note——

Senator BINGAMAN. But are you also suggesting we cut corporate

taxes? I understood you to be saying we should take some of it and

give it to households and to average Americans to offset the increased cost of energy and the rest we should use for things like

Senator Rockefeller was talking about, where we invest in research

and we do all these good things. I did not hear you suggesting we

cut corporate taxes. I think that is what Dr. Orszag says is the

most efficient thing to do, from the macroeconomic perspective.

Mr. GREENSTEIN. One could. It would not be my priority for the

remaining use of the money. To help explain why, let me just note

that on this chart, note that the part where all of the money is

used for corporate taxes, compared to the other scenario, the one

where all the money is given to consumers, the difference in—your

year, Peter, is 2020? 2015? The difference in overall efficiency cost

is very small for a 15-percent reduction in emissions, which is probably where you would get in roughly the 2015 to 2020 period with

something like the Lieberman-Warner targets.

The difference is equal to three-tenths of a percent of GDP. In

other words, what that would mean, if you take the CBO baseline,

the CBO baseline would suggest that in 2017 we do not do anything in this area, just baseline. The economy, that is $14 trillion

today, would be something like $22 trillion. Under the scenario in

which all the allowances are given to the households, it is $21.9

trillion instead of $22 trillion. Under the corporate tax cut scenario

in the middle, it is $21.96 trillion instead of $21.9 trillion.

Senator BINGAMAN. You are saying the macroeconomic difference

is——

Mr. GREENSTEIN. The difference is small.

27

Senator BINGAMAN [continuing]. So small that we ought to go

with option one instead of option two.

Mr. GREENSTEIN. I am actually not suggesting option one either.

I am suggesting a combination. To make sure we do not push lowincome people deeper into poverty, that is 14 percent of the allowances. You can dial up or down the middle-income consumer relief.

You do not have to offset 100 percent of the consumer impact.

That is, frankly, in part a political choice as well as a substantive

choice. You want to make sure you have an adequate portion of the

new proceeds going into basic research, although the amount you

need is affected, in part, by how much you can clean out of the base

of things that are in there today the ones that are inefficient or

would no longer be needed.

You clearly are going to want to—and need to, politically—spend

some money to mitigate effects on hard-hit sectors of the economy,

like coal mining communities. There are other areas: adaptation,

international effects, wildlife. I am getting beyond things I know

well. You will have to weigh all of those against each other. I am

not against, in principle, the corporate piece, but I think the differential impact on economic growth is small and there are a lot

of other priorities for the money as well. For me, it would not be

high on the priority list.

Senator BINGAMAN. Senator Rockefeller?

Senator ROCKEFELLER. Thank you.

Let me clarify. I need to break the shackles that are on Dr.

Orszag and his loyalty to pay-go.

Dr. ORSZAG. Thank you.

Senator ROCKEFELLER. Because that is what he is paid to defend.

I think in the living world, you know that, so I am free to say

something like that and you are not unhappy about it.

I think that, first of all, there was not anything in my suggestion

which said that you stop any of the things that have been talked

about: cap and trade, tax incentives. We had a big tax incentive

thing, as I recall, in our bill last year, and it was just killed on the

other side. So I foresee, this is the reason for my taking the research. You know, talking nuclear in West Virginia is not very popular. But the fact is, we have to do everything. So, please hold that

as part of what I say.

What I am proposing has nothing to do with what all of you were

talking about. What I am talking about relates only to the research

on the largest chunk of what is going to affect climate change,

which happens to be coal. Sure, I come from a coal State. That has

nothing to do with my thinking, it really does not, because we will

be affected by the uptick in prices like everybody else will be.

But I want the research. I mean, I can just see us. I know this

institution well enough that I can just see us cross-referencing

amendments that fail and are filibustered on the floor, barely get

through the Finance Committee or through the Environment and

Public Works Committee, and fail on the floor. Then back we go to

work and we talk and we talk and we talk. We have been talking

for 3 or 4 years, and yet nothing has really happened.

I think the way to start getting out of this is not to necessarily

create—but I think we have to create, as I just said—the public

policy, cap and trade, the Bingaman approach, the Lieberman apVerDate 11-MAY-2000 14:40 Jun 11, 2010 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 56384.000 TIMD PsN: TIMD
28

proach, whatever you want, but that in the meantime somebody

has to be doing the research, specifically on coal because it is going

to be 58 percent of what we are talking about.

We have to get that down to virtually, or literally, zero emissions. Now, there is no way in the world that you can convince me

that we cannot get people from across our country and across the

world, scientists, into what—Jim Bunning and I now have a patent

fight because we both referred to the Manhattan Project, but that

is just to make it dramatic, and we will drop our patent fight.

But you just totally emphasize getting the smartest people in the

world, 150 of the smartest scientists in the world on this subject

from all over the world, some of whom will come from China, some

of whom will come from South Korea, from Sweden, from other

places, and a lot from this country, and that you simply focus on

doing that research so that, while you are worrying about all these

other things, that the research for cleaning up coal—whether it is

from Gillette, WY, which needs lots of attention, or from deep

southern West Virginia, which needs attention but not nearly as

much—that you get the research going now. I would almost suggest

that the research will make some of the other problems easier to

put into effect, because nobody now has confidence that you can do

it. I mean, I know a couple of chemical companies and coal companies that are doing their level best to achieve this.

But there is also a great timidity across that world about this

subject. The subject simply has nothing to do with cap and trade,

it has nothing to do with tax incentives, it has nothing to do with

all the rest of it, it is simply to get the research going on cleaning

up something called coal, which is now 51, and will be 58, percent

of the problem in a number of years.

I just do not see anything wrong with that. I just do not see anything wrong with keeping pay-go for virtually all of our budget, and

to keep you happy, Dr. Orszag, but then pick out four things—and

I just do that so you do not just make it one, but, if I have to go

down to one I will do one—and I think a couple of other things.

Mr. Greenstein, you worry about problems. One that you should

be worrying about, and you are, is Medicaid and Medicare. Well,

what are we going to do about those? Where is the money for

those? Those have been cut to ribbons, and rural clinics and hospitals are in trouble all over the country. I mean, there is an endless number of things that we have to do. All I am saying is, we

go ahead with everything that Jeff and John, Senator Bingaman

and Senator Kerry, have suggested and that you have suggested,

but that behind the scenes in the meantime we create this caveat

of research opportunity and start doing it. Votes for that will be

hard, and I understand that. But that is the way I think this ought

to work.

Senator BINGAMAN. Do any of the witnesses want to comment on

that? Then, Senator Kerry.

Mr. Derwent?

Mr. DERWENT. Thank you. I would like to comment on that. I

agree entirely with the Senator’s perspective on the huge importance of research, but I have a little bit of a caveat on the particular industry and the particular technique that he uses to illustrate his argument. I think that carbon capture and sequestration

29

is just around the corner as the salvation for the coal industry as

a means of ensuring that the coal reserves that are available in

this country, in China, and elsewhere can be used, consistently

with the achievements of emissions reduction of the type that we

need to see.

There is an enormous amount going on in Canada, there is an

enormous amount going on in Australia, there is a fair amount

going on in Europe. What is needed for that industry at the moment is a series of demonstrations and a price signal to deploy. It

is generally spoken of in Europe that, at 45 euros a ton, which if

people thought it would sustain, you would get CCS as a viable economic proposition. Some people have said, yes, that is just to begin

with. After a while, as the learning effect happens across the world

and other countries, including the United States, come in, that

price will crash and you will see CCS as a real technique.

But until somebody actually says that what CCS produces—

which is lower carbon—has actually got an elemental value, it is

not going to happen. Research, by all means, but also identify those

areas where you need an economic stimulus and not just the production of research.

Mr. Chairman, if I may take the opportunity of making a point

of information. I know that Senator Bunning has gone, but he

spoke of a position of Lehman Brothers and Citigroup. I would just

like to point out that, far from being the sorts of organizations

which could be destroyed by cap and trade, they both are members

of the International Emissions Trading Association because they

see that this is a major new market that they want a part of.

Frankly, at the time after Kyoto and after the change-around in

positions when the United States turned its back on emissions

trading and Europe decided to go forward, the city of London took

the bread out of the mouth of New York. Well, you may think that

it is pay-back time now, and I would not blame you. As one door

closes, perhaps, in these businesses, another opens. That applies

not just in the financial sector, but also in some of the manufacturing sectors that we heard about today.

Senator BINGAMAN. Well, Senator Kerry, did you want to go

ahead?

Senator KERRY. Thanks.

That is a good point, Mr. Derwent. I appreciate your making it.

I am sorry Senator Bunning was not here to hear it.

Dr. Orszag, in your written testimony you talk about how cap

and trade can be designed to avoid large fluctuations in the price

allowances. The notion of a safety valve has been kicked around

here a little bit. I understand the inclination to want to do that,

but I am very apprehensive that that just becomes a way of avoiding the target. The environmental goals get completely subsumed

as a consequence.

Can you share with us, are there other features of a cap-andtrade program that we should consider to limit price fluctuations,

but without losing or limiting the emissions reduction itself that

can be achieved?

Dr. ORSZAG. Yes. You can allow, as the Lieberman-Warner legislation does, banking and borrowing, that is, for firms to be able to

save allowances for future years or to borrow from future years,

30

and that can help smooth price fluctuations. But in general, you

would still face this fundamental conflict between certainty over

price and certainty over emission levels. That is just unavoidable.

There is uncertainty about what is going to happen in the future,

and you can kind of choose a little bit more certainty on one dimension at the cost of a little less certainty on another.

Senator KERRY. But, if you decide to do this, you are making the

decision to do it fundamentally because of the scientific imperative,

the down side. I mean, if you accept Jim Hansen and Bob Correll

and the other scientists involved in this, that there is a tipping

point, if we get to the tipping point it is going to be catastrophic,

and we have to avoid the tipping point.

If suddenly the costs are going up, do you not have to meet those

costs in some other way than to let people out from their responsibility to avoid the tipping point?

Dr. ORSZAG. Well, I think the problem is, we do not know where

the tipping point is. I do think the best way of thinking about climate change is that we have some small, but nonetheless real, risk

of very high damages, of catastrophic costs, and that what you are

doing through these kinds of policies is, you are purchasing insurance to reduce that risk.

You might imagine from that analogy that how much you are

paying for insurance would be one part of the calculation you wanted to do, and that you would want to balance the risk that you are

reducing against the premium that you are paying, and things like

a safety valve or trying to limit the price fluctuations are aimed at

kind of reorienting that balance, to some degree.

Senator KERRY. Does that not play——

Dr. ORSZAG. If we knew exactly where the tipping point is, the

calculation could change. That is a different situation.

Senator KERRY. Well, we do not know exactly where it is, but

what we do know is that all of the evidence is coming back faster

and to a greater degree than had been predicted, in every instance.

We know that scientists, who are by nature and discipline conservative in their predictions and have to submit to peer review, we

know that those scientists have revised downward the levels that

we can tolerate of temperature increase from 3 degrees Centigrade

to 2, they have revised downward the parts-per-million of greenhouse gases we can tolerate from 550 parts-per-million to 450,

which ought to set a lot of alarm bells off because we are currently

at 370.

It took us from the Industrial Revolution until now to go from

270 to 370. But with China and India and the United States itself

promising some 280 pulverized coal-fired power plants coming online in the next few years, we are looking at the prospect of going

from 600 to 900 parts-per-million.

So, it is pretty hard for me to see how, within that context, you

start creating an ‘‘out’’ and not forcing the process to find the most

efficient, effective, cheapest, productive means. If you create sort of

an off-ramp, or whatever you want to call it, everybody knows, hey,

we can get off of this. Let us let the other guys see how much it

costs. They will start to do it, and we will sit back and we will wait

and see what the impact is, and then we will catch up based on

the new technology, and you will never get the benefit of pushing

31

your whole economy in the same direction with the capital values

being assigned to the reductions that you want.

Dr. ORSZAG. And I would just say, first, with regard to the

science, we are running an unprecedented experiment and we are

running a very substantial risk, or at least a significant risk of substantial damages, and addressing that is among the Nation’s, and

the world’s, highest priorities.

I think the question becomes, hypothetically, if it turned out that

the cost per ton—just to make a ridiculous number—were $1,000

a ton, it may affect the amount of reductions that we would want

to undertake, and obviously if you did a safety valve, where you

chose it would matter a lot. If it were very low——

Senator KERRY. See, I disagree with that. Maybe if you left that

price there, what it will do is it will drive a reality about what we

ought to be doing. I mean, maybe it forces people to say, all right,

we have to get solar/thermal out there a hell of a lot faster. I know

some companies that are taking positions on land in Arizona and

New Mexico and other places who are prepared to build like crazy,

and when the price gets set right, you bet they will. But you cannot

be half pregnant on this. You cannot decide, oh, we have to do this

because global climate change is coming, and here is the time

frame we are operating in, and then all of a sudden, create a whole

bunch of avoidance mechanisms.

Dr. ORSZAG. Well, you are absolutely right. I mean, the safety

valve is geared to balancing the economic costs and the environmental benefits. If you think that balances, it is up to you to either

reach that balance or not.

Senator KERRY. The balance makes an equally presumptuous—

it makes a more presumptuous, arrogant kind of debt that is all

right to avoid doing which everybody in the scientific community

is telling us we cannot avoid doing. That is what it does. That is

the balance. I think we are going down the wrong road.

Does anybody else want to comment on that?

Mr. DERWENT. Thank you, Senator. At the risk of introducing a

controversial additional element into this, I think you can find an

alternative to a safety valve which does not simply offer people a

complete way out. That is to allow into your system, under the

rules to the extent that you are happy with, emissions reductions

that occur in cheaper places in the world. That is how a number,

for example, of State schemes have been going.

Use the possibility of offsets as a means of introducing a lower

cost alternative if the cost of doing it domestically rises just too

high. Many people talk about this in terms of, oh, we do not believe

that those offsets are real, or we do not like the countries which

they come from, or we do not like the sorts of projects which have

produced them. All those are——

Senator KERRY. Which offsets are you talking about?

Mr. DERWENT. Those which have been criticized, those in particular that are ozone-depleting, but also greenhouse gas emissions

in China, in chemical plants in China. But there are many, many

good offsets in India, South Africa, and Brazil which are available

at lower cost simply because of economic factors, like across the

world, which can be brought in and which, if people pay for them,

32

emissions get reduced and the atmosphere feels the effect just the

same as if that were happening in Baltimore or San Francisco.

Senator KERRY. Yes.

If you give away free allowances to impacted industries, which

is under discussion right now, I think—I am not sure who, either

you, Mr. Greenstein or Dr. Orszag, testified that a lot of these costs

are just going to be passed on by businesses. I mean, that is just

the way it usually happens, and it is the way the economy works.

If that is true, are these allowances going to become windfall profits or just plain windfalls to those industries if they are passing on,

plus we are giving them the big mitigation, and as a result they—

does more have to be asked? Does there have to be some other kind

of accountability scheme here?

Dr. ORSZAG. If you gave away all the permits, there would be a

very substantial increase in profits, which would be a windfall to

the companies that received them. You do not have to, obviously,

give away all the permits. Even when the companies can pass costs

along, there can still be some effect on their operations because the

cost increases then diminish demand for their products. You could

essentially try to just offset that cost.

Mr. GREENSTEIN. I think there is general agreement among

economists—Dr. Orszag said this earlier, and it is also in my testimony—that the impacts on consumers are going to be essentially

the same whether the permits are given away free or are auctioned. That clearly suggests that, to the degree that permits are

given away in excess of what may be needed to offset what would

otherwise be net financial losses to companies, that these would be

windfall gains. CBO’s analysis suggests that something less than

15 percent of the value of the permits would be needed to offset the

net financial losses.

You might find of interest, on the website of Greg Mankiw, who

is a distinguished Harvard economist—he was the chairman of the

Council of Economic Advisors for President George W. Bush several

years ago—he discusses this on his website and essentially says

that, if there is a cap and trade whereby allowances are given away

free in excess of what it would need to offset losses, that the result

would be—these are Greg Mankiw’s words—‘‘corporate welfare.’’

Senator KERRY. So how we structure them is pretty important,

obviously.

The last question on the regional cap-and-trade regimes that

have been created voluntarily in both New England, the Midwest,

and California. How do those get impacted when we set a national

system? Do they just get subsumed? Do they continue down the

road they are going, and somehow you have two tracks? What happens? Does anybody know?

Dr. ORSZAG. That is a significant issue. I saw some past discussions of that this morning, and we have a Federal system. I think

I would just say I do not know the answer to that, and it would

depend on what you do in the legislation.

Senator KERRY. I.e., preemption versus——

Dr. ORSZAG. Correct.

Senator KERRY. Got you.

Mr. DERWENT. Just to state an obvious point of economic principle, markets are more effective, basically, the larger they are. The

33

transaction costs for companies which are national, or even

globalized, are dealing with lots and lots of different cap-and-trade

schemes with different principles and different rewards and incentives. Those transaction costs can be pretty high.

Senator KERRY. Yes.

Mr. DERWENT. But there is some learning, I think.

Senator KERRY. Well, I agree with that. I think that my basic instinct is that you want to have a national standard and you want

to have a national structure to manage it. I think the market will

respond more effectively and with greater clarity. I think that certainty is important. But then you have the question, well, what

happens if somebody wants to, because they are expressing leadership as they have in the past on this, go to a higher level and

thinks the standard ought to be higher?

Dr. ORSZAG. Again, that is an issue for you to decide.

Senator KERRY. Just a policy issue.

Dr. ORSZAG. It is a policy issue. I mean, there is an efficiency

cost to having fragmented systems across the United States, but

that would be weighed against any potential environmental benefits that would be perceived or real.

Senator KERRY. I guess I would answer that by saying that the

policy would be impacted, from where we sit, by whatever the level

is that we establish as our mandate. If we establish a sufficiently

realistic sort of scale here that we are trying to achieve, then I

think you could make a strong argument that that ought to be the

standard.

Mr. DERWENT. Can I add just one piece of experience from the

U.K.?

Senator KERRY. Certainly.

Mr. DERWENT. We have run a national target for CO2 reduction,

which is considerably stronger than our part of the international

target which was given to us through the Kyoto negotiations. We

have met the international one with ease. The national one has

proved to be much more stringent, but that does not mean it is not

doing a lot of good.

Senator KERRY. Well, it is interesting. I think these experiments

have been very important. For instance, in Portland, I do know

that Portland moved on its own to address the Kyoto standards,

and they are at or below the 1990 Kyoto standard, and they did

it by building LEEDs, building standards, building codes, fleet purchases, recycling, transportation grid, a whole bunch of a different

mix, very creatively, and they have proven that you can get there.

California is obviously light-years way ahead of other States with

respect to their base, what they rely on. Now, they have some advantages in geothermal and other things, but nevertheless, it is an

example of what can be done.

Just a last thought. I think if we could get our grid opened up

and more effectively managed, we could facilitate enormously the

ability to be able to meet those lower costs. There is a lot of resistance on that just from certain special interests at this point, and

we need to fight it.

Any other thoughts, last things before we close out here?

[No response.]

34

Senator KERRY. Well, I thank you very, very much for being

here. It is an interesting subject, and very timely. We are going to

have this debate very shortly, so we really appreciate your input.

We stand adjourned.

[Whereupon, at 12:05 p.m., the hearing was concluded.]

(35)

A P P E N D I X

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

36

37

38

39

40

41

42

43

44

45

46

47

48

49

50

51

52

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

68

69

70

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

Æ