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65–230—PDF 2009

S. HRG. 111–936 

CLIMATE CHANGE LEGISLATION: 

TAX CONSIDERATIONS 

HEARING 

BEFORE THE

COMMITTEE ON FINANCE 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

JUNE 16, 2009 

( 

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 

BILL NELSON, Florida 

ROBERT MENENDEZ, New Jersey 

THOMAS R. CARPER, Delaware 

CHUCK GRASSLEY, Iowa 

ORRIN G. HATCH, Utah 

OLYMPIA J. SNOWE, Maine 

JON KYL, Arizona 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

PAT ROBERTS, Kansas 

JOHN ENSIGN, Nevada 

MICHAEL B. ENZI, Wyoming 

JOHN CORNYN, Texas 

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 

Grassley, Hon. Chuck, a U.S. Senator from Iowa ................................................. 3 

WITNESSES 

Hufbauer, Gary, Reginald Jones senior fellow, Peterson Institute for International Economics, Washington, DC ................................................................ 4 

Price, Mark, principal-in-charge, financial institutions and products, Washington National Tax, KPMG LLP, Washington, DC ......................................... 6 

Butler, Keith, senior vice president of tax, Duke Energy, Charlotte, NC .......... 8 

ALPHABETICAL LISTING AND APPENDIX MATERIAL 

Baucus, Hon. Max: 

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

Prepared statement .......................................................................................... 15 

Butler, Keith: 

Testimony .......................................................................................................... 8 

Prepared statement .......................................................................................... 17 

Responses to questions from committee members ......................................... 24 

Grassley, Hon. Chuck: 

Opening statement ........................................................................................... 3 

Prepared statement .......................................................................................... 26 

Hufbauer, Gary: 

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

Prepared statement .......................................................................................... 28 

Responses to questions from committee members ......................................... 32 

Price, Mark: 

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

Prepared statement .......................................................................................... 37 

COMMUNICATIONS

Large Public Power Council (LPPC) ...................................................................... 45 

National Association of Real Estate Investment Trusts (NAREIT) .................... 48 

(III) 

(1) 

CLIMATE CHANGE LEGISLATION: 

TAX CONSIDERATIONS 

TUESDAY, JUNE 16, 2009 

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

The hearing was convened, pursuant to notice, at 10:20 a.m., in 

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

(chairman of the committee) presiding. 

Present: Senators Conrad, Cantwell, Nelson, Grassley, Snowe, 

and Crapo. 

Also present: Democratic Staff: Bill Dauster, Deputy Staff Director and General Counsel; Pat Bousliman, Natural Resource Advisor; David Hughes, Senior Business and Accounting Advisor; and 

Jo-Ellen Darcy, Senior Environmental Advisor. Republican Staff: 

Jim Lyons, Tax Counsel; and Mark Prater, Deputy Staff Director 

and Chief Tax Counsel. 

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

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE 

The CHAIRMAN. The committee will come to order. 

First, I apologize for starting so late. I think this is a record. I 

think never since I have chaired this committee have I ever commenced a meeting, a hearing, as late as this, and I apologize to all 

of you. Something came up we had to attend to. 

The author Theodore Roszak wrote, ‘‘Nature composes some of 

our loveliest poems for the microscope and the telescope.’’ Today we 

consider one of the broadest subjects in nature, that of climate 

change, and we are going to look at it through a particular microscope, that of tax policy. 

Today, we will look at the tax implications of legislation on global 

warming. We will consider the narrow question: How should the 

tax law treat allowances? 

The answer will have broad implications. Most major climate 

change proposals set an emissions target on greenhouse gas emissions. For example, the Obama administration proposes capping 

greenhouse gases in 2020 at 14 percent below the level emitted in 

2005. The cap is then divided into emission allowances. An allowance is the right to emit one-ton of carbon dioxide or its equivalent. 

People can then buy or sell those allowances or folks can hold onto 

them for the future. 

Some proposals would distribute allowances free of charge, other 

proposals would sell the allowances through an auction, still others 

would combine distributing and auctioning. 

2 

*See ‘‘Climate Change Legislation: Tax Considerations,’’ Joint Committee on Taxation staff report, June 11, 2009 (JCX–29–09), http://www.jct.gov/publications.html?func=startdown&id= 

3559. 

Today, we will put questions like these under the microscope. If 

allocations are distributed for free, should the tax law treat them 

as income to the recipient? Should the tax code treat an emission 

allowance as a capital asset subject to depreciation over time, or 

should the law allow buyers to deduct the cost of buying an allowance as a cost of doing business? 

How should the law treat gains and losses associated with allowances? Should the law treat them as capital gains or ordinary income from a sale? And should the system allow emission allowances to be banked and carried forward to future years? 

The Treasury Department has provided some approaches to some 

of these questions through guidance on legislation to eliminate acid 

rain. The Clean Air Act amendments of 1990 successfully cut sulfur 

dioxide emissions in the least costly way, and Treasury’s guidance 

was important in determining how the exchange of allowances 

should be considered from a tax prospective. 

Should Congress abide by this same guidance in considering legislation to reduce carbon emissions? It may be appropriate to adopt 

some past practices on tax treatment allowances, but the scope of 

the Clean Air Act amendments is much smaller than legislation to 

cut carbon emissions. 

For example, the acid rain program applied to fewer than 120 facilities nationwide; the cap and trade will apply to over 7,000. 

Moreover, the law has changed since 1992. Congress has enacted 

major tax legislation, including legislation affecting the amortization of intangible assets, since the Treasury issued its 1992 guidance. I support legislation to reduce carbon emissions. The Finance 

Committee will play a key role in that law’s development. 

In a recent hearing, we explored the implications of a carbon auction. In another hearing next month we will look at what climate 

change legislation means to our trade-exposed industries. We have 

also been working hard to smooth the transition to a low-carbon 

economy through other means, especially energy tax incentives. 

In the last year we passed more than $38 billion in energy tax 

incentives for areas ranging from fuels to efficiency to cleaner electricity. We have a great deal more to do, and we will continue our 

efforts in the coming weeks and months. 

I appreciate our distinguished witnesses being here today and I 

also appreciate the Joint Committee on Taxation for providing yet 

another solid background pamphlet for today’s hearing.* 

Now, the tax law is certainly not among the world’s loveliest 

poems, but every now and then it is important to take a look at 

it under a microscope, and by doing so today we will try to advance 

one of the broadest goals in nature—that of slowing climate 

change. 

Senator Grassley? 

3 

OPENING STATEMENT OF HON. CHUCK GRASSLEY, 

A U.S. SENATOR FROM IOWA 

Senator GRASSLEY. Yes. Thank you, Mr. Chairman. 

There are, of course, many technical tax questions that will be 

addressed. The first point that I should make is that, if cap and 

trade is not enacted, then we are worrying about these questions 

for nothing. However, if it is enacted, then a bunch of tax issues 

need to be dealt with. 

For example, if allowances to emit carbon dioxide are given away 

free, should the corporations that receive these valuable allowances 

be taxed upon receipt of them? There are various opinions about 

whether allowances should be given away or auctioned off. 

Waxman-Markey initially gives away 85 percent of its allowances 

for free. These 85 percent of allowances are estimated by CBO to 

be worth about $693 billion over 10 years. 

However, Peter Orszag, the administration’s OMB Director, 

when he was CBO Director in 2007, testified before Congress that, 

‘‘If you didn’t auction the permits, it would represent the largest 

corporate welfare program that has ever been enacted in the history of the United States.’’ 

Similarly, in response to my question for the record from the 

March 4, 2009 hearing on the administration’s budget, Secretary 

Geithner wrote, ‘‘The program will be implemented through an 

economy-wide cap-and-trade program in which all emission allowances will be auctioned to ensure that the biggest polluters do not 

enjoy windfall profits.’’ 

So, if the administration has its way, we will not even need to 

consider the tax treatment of allowances given away for free. One 

thing that concerns me with cap and trade is that the current 

version appears to be pain and no gain. In other words, the American consumer will pay higher energy prices as well as higher 

prices for all goods and services. That is the pain part. 

But unless there is an agreement with China, which is the largest emitter of greenhouse gases, as well as, for instance, Russia 

and India, and other large emitters, then there is no gain. We 

could reduce our greenhouse gas emissions while the rest of the 

world continues to increase its emissions, resulting in increasing 

emissions worldwide. 

Meanwhile, our consumers and economy then would suffer from 

our own cap-and-trade program. I have a June 13th Washington 

Post article stating, ‘‘Instead, the Special U.S. envoy for climate 

change said yesterday, he would press for China to reduce the rate 

at which its emissions grow. Envoy Todd D. Stern said at a news 

conference that he wants China’s emissions to increase less than 

projected. ‘So that’s not an absolute reduction below where they are 

right now,’ Stern said, ‘because they’re not quite at that point to 

be able to do that.’ ’’ 

Of course, that sounds a lot like President George Bush’s proposal to limit greenhouse gas intensity relative to GDP, which was 

roundly panned by environmental groups. I am also concerned 

about the fact that the speculators from Wall Street, Chicago, and 

San Francisco have been all too eager to embrace cap and trade. 

Cap and trade would represent a huge new market that hedge 

4 

funds and private equity firms are salivating over. In fact, Enron 

and AIG were two of the early proponents of cap and trade. 

Four years ago this committee held a hearing on the activities 

of the Nature Conservancy. These activities included the organization’s receipt of contributions in exchange for emissions credits. The 

staff report on these arrangements raised a number of tax issues 

for both the exempt organizations as well as polluters that also 

need to be addressed. 

We will hear today how all of these exotic derivatives on allowances should be taxed. We know if cap and trade is enacted, of 

course, Wall Street people will be happy to help in designing derivatives based on allowances. Some of these derivatives will be futures, forwards, options, collars, swaps, call spreads, swaptions, 

and hybrids of the above derivatives. I worry about Wall Street 

speculators making fortunes off the back of the American taxpayer. 

Thank you Mr. Chairman. 

THE CHAIRMAN. Thank you, Senator. We will now turn to our 

witnesses. 

The first is Mr. Gary Hufbauer, the Reginald Jones senior fellow 

at the Peterson Institute for International Economics. Welcome 

back, Gary. Good to see you. Next, Mark Price, principal-in-charge 

of financial institutions and products in the Washington National 

Tax Group at KPMG. And finally, Keith Butler, senior vice president of tax at Duke Energy. 

I will ask each of you to summarize your statements. It will all 

automatically be included in the record. 

So why don’t you begin, Mr. Hufbauer? 

STATEMENT OF GARY HUFBAUER, REGINALD JONES SENIOR 

FELLOW, PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS, WASHINGTON, DC 

Mr. HUFBAUER. I thank you very much, Mr. Chairman and members of the committee. 

Recently, I was a co-author of a book, ‘‘Global Warming in the 

World Trading System.’’ I am going to leave some copies. That book 

does not deal with these tax issues, but it does deal with a lot of 

the important trading issues which you will be addressing later. 

As you have said, Mr. Chairman, this is a very serious problem. 

In my personal view, a carbon tax system would be vastly superior 

to a cap-and-trade system on transparency, uniformity, revenue 

raising, and administration. It could more readily be adjusted at 

the border. I think the Waxman-Markey bill illustrates the enormous complexity, opacity, and rent-seeking inherent in a permit 

system. 

But that said, the political forces are favoring the cap-and-trade 

system, so my purpose today is to comment on the tax and trade 

aspects of this system. And, when I use the word carbon permits, 

I am referring to all greenhouse gas permits on a carbon dioxideequivalent basis. 

So let me quickly run through some questions and answers in my 

testimony. Are free allowances of carbon permits income? This is 

the threshold question. My answer is a very decisive yes. I think 

it would be an enormous travesty, on top of bills which propose to 

give away free allowances, and which do not even get to a 50- 

5 

percent auction (in the Waxman-Markey bill) until 2029, to then 

make the allowances tax-exempt. 

I think, Mr. Chairman, you have summarized the differences between the SO2 allowances and the carbon permits in terms of size. 

In terms of dimension, they are completely different. Further, we 

learn a lot over time, and I think we have learned about markets 

for things like these kind of permits. So to draw heavily on the SO2

analogy, I think, would be quite inappropriate. 

And in line with that, I would say that another task for this committee, working with other committees, is to ensure that the permits are tradable and easy to manage so we do not get into the 

opacity of semi-tradable permits, which would then slide into the 

realm of non-taxation. Should permits be a business deduction 

when used? Well, by all means, they should be; I would say in the 

year purchased and used, as an ordinary and necessary business 

expense. I would hope that the taxation of permits does not get into 

the capitalization realm and all of the complexities there. 

On trading in carbon permits, I would not make a distinction between the type of holder. As for the type of income, I would hope 

they would be all treated as ordinary income, again, to get away 

from any kind of capital gains complexities. 

Now let me turn to the oversight and regulation of trading and 

carbon permits. I am a real believer in financial markets, but I am 

a very strong disbeliever, an objector, to unregulated over-thecounter markets which got us into so much trouble as part of this 

financial crisis. 

So, if we create a system in this country of tradable permits, 

there should be a simultaneous authorization of exchanges that 

handle the permits. All transactions should take place on those exchanges. They should post prices, volumes, and also the parties 

doing the trading should be disclosed. 

One final point I will make, and that is on collars. I think that 

collars would be a very good idea in a permit system, that is, floors 

and ceilings. Collars will smooth out price fluctuations and allow 

a longer horizon for firms to anticipate the prices they are going 

to face, and therefore the adjustments they have to make. Collars 

also will enable spikes to be avoided. In my view, the EPA should 

be the administrator which proposes the collars, but I think carbon 

will be such an important price for the American economy that 

Congress should review, and possibly disapprove, anything proposed by way of collars. 

Just one final comment. I did have a chance over the weekend 

to read the Joint Committee’s excellent pamphlet, and what I 

would say is this. The pamphlet points out all sorts of room for 

complexity in the taxation of offsets and taxation of allowances and 

deductions and so forth and so on. I do hope that the committee 

goes for simplicity, not complexity. 

Thank you very much. 

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

Senator GRASSLEY. All right, now we will call on Mr. Price. 

6 

STATEMENT OF MARK PRICE, PRINCIPAL-IN-CHARGE, FINANCIAL INSTITUTIONS AND PRODUCTS, WASHINGTON NATIONAL TAX GROUP, KPMG LLP, WASHINGTON, DC 

Mr. PRICE. Mr. Chairman, Ranking Member Grassley, members 

of the committee, good morning. My name is Mark Price. I am a 

principal at KPMG LLP, a major U.S. accounting firm. 

I am pleased to have the opportunity to testify as an invited witness before the committee this morning on the topic of the tax considerations associated with climate change legislation. During my 

testimony, I will take the next several minutes to summarize the 

points in the written testimony submitted to the committee. During 

this summary, I would like to highlight the following points. 

First, current law does offer an approach to taxing allowances 

and offsets, but current law may lack certainty on several issues 

of significance to the various participants in the cap-and-trade system and to the Internal Revenue Service. Second, current law is 

based on authorities that have not been updated for changes in tax 

legislation. And finally, the allowances and offsets in the cap-andtrade proposals raise issues that may be more appropriately addressed through legislation. 

The two significant issues raised by cap and trade for covered entities are likely to be the character and timing of gain or loss. 

Character, because the current rule that corporations can only 

apply capital losses against capital gains and not ordinary business 

income may create cash flow issues from any set of rules that could 

produce ordinary income and capital loss, and timing, because the 

recognition of income in advance of expense could also affect an entity’s cash flow. 

The tax treatment of the transactions is fact-dependent. As the 

chairman has noted, the tax treatment of cap and trade under current law would be based primarily on authorities issued by the Internal Revenue Service on the treatment of sulfur dioxide emissions under the Clean Air Act amendments of 1990. This guidance 

must be considered in conjunction with current law on other topics. 

Now I would like to summarize briefly what I believe is the current tax treatment under current law. First, what happens on acquisition? The covered entities that are granted allowances from 

the Federal Government likely, under current law, do not have income on the date of grant. That is consistent with the 1992 ruling 

by the IRS on sulfur dioxide emissions allowances. 

Second, what happens when a covered entity uses the allowance 

in its trader business? Although the answer is not entirely clear, 

the strongest answer under current law is that the amount paid for 

the expense, if any, is allowed as an expense in the year the allowance would be used. 

Third, if an entity sells an allowance, what is the character of 

the gain or loss? Now, interestingly, the answer to this will depend 

on whether or not the allowance is considered depreciable. Allowances not intended to be used in the business are generally going 

to produce capital gain or loss, but allowances that are intended to 

be used to satisfy emissions requirements may produce capital 

gain—may produce ordinary gain or loss—depending on, first, 

whether those allowances are depreciable and, second, the period 

of time for which the allowances are held. This uncertainty is creVerDate Nov 24 2008 15:27 Apr 04, 2011 Jkt 000000 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 R:\DOCS\65230.000 TIMD
7 

ated in part by the fact that the IRS’s guidance on the topic relating to sulfur dioxide emissions, as Mr. Hufbauer and as the chairman noted, predates the enactment of legislation regarding the amortization of intangibles. 

Another category of character uncertainty relates to what happens to entities that are considered ‘‘dealers’’ in allowances. I would 

first note that, under current law, what is a dealer is an uncertain 

concept. Second, I would say those dealers would have ordinary income or loss, assuming that they qualify as a dealer. 

The final thing under current law I would like to point out is 

what happens to those entities that have to purchase emissions allowances. Entities that purchase emissions allowances will be required, most likely, to manage their price risk for the purchase of 

these allowances. They will likely have to do this through entering 

the derivatives market, and in entering the derivatives market 

there exists an age-old question as to the character of gain or loss 

from the derivatives. 

Obviously, it would be unreasonable for the law to produce capital loss or capital gain on the derivative while producing ordinary 

gain or loss on the commission’s allowance. Unfortunately, under 

current law, it would appear the likely answer is that those emissions allowances would be capital, creating a character mismatch 

between the risk management policies that the users will need to 

undertake and the assets that they will need to purchase to satisfy 

this new regulatory requirement. 

I would also like to take a few minutes, just briefly, to comment 

on some considerations for tax legislation. First, I think it is appropriate for the committee to consider whether or not the current law 

rules are appropriate. I have stated that I believe they are. It is 

still a second question as to whether the right tax policy answer 

is the answers that I have suggested. 

Second, what should the committee do about the borrowing of allowances? This is a new concept not seen in the sulfur dioxide allowance rules. It is also a new concept that has not been developed 

in great detail, and the tax treatment of it is going to depend on 

the form and, as the form evolves, it would be appropriate to consider the taxation. 

Third, the fees for noncompliance. Are these fees going to be 

deductable or not? And finally, an oddball comment, whether or not 

these allowances are characterized as commodities creates a whole 

web of issues for taxpayers. It affects whether financiers can mark 

to market, it affects whether or not they are amortizable, and it affects the international tax implications. It would be reasonable for 

any tax-writing committee to consider whether: (a) it is appropriate 

to link all of these to the concept of the commodity, and (b) whether 

the right answer is produced by the conclusion that it is or is not 

a commodity. 

Thank you for the opportunity to testify. 

Senator GRASSLEY. Thank you Mr. Price. 

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

Senator GRASSLEY. Mr. Butler? 

8 

STATEMENT OF KEITH BUTLER, SENIOR VICE PRESIDENT 

OF TAX, DUKE ENERGY, CHARLOTTE, NC 

Mr. BUTLER. Good morning, Chairman Baucus, Ranking Member 

Grassley, and other distinguished members of the committee. 

Thank you for the opportunity to appear before you today to discuss the tax considerations related to climate change. 

My name is Keith Butler, and I am senior vice president of tax 

for Duke Energy Corporation, one of the largest electric utility companies in the United States, supplying and delivering electricity to 

approximately 4 million U.S. customers in our regulated jurisdictions of North and South Carolina, Indiana, Kentucky, and Ohio. 

Duke Energy is also an active developer and owner of an expanding portfolio of renewable energy assets. In considering the direction for the tax treatment of CO2 allowances, the most logical place 

to start is with the current treatment for SO2 and NOX allowances. 

These allowances were established under title 4 of the Clean Air 

Act amendments of 1990. These new and unique allowances at the 

time opened the door to tax directors and the Internal Revenue 

Service to establish guidelines, regulations, and interpretations of 

how these allowances should be treated for tax purposes. The tax 

treatment for these allowances became dependent on the nature 

and character of how the taxpayer handled these allowances within 

their company. 

The initial issue that had to be addressed by taxpayers was the 

tax basis of the allowance. This was the least challenging issue in 

the sense that, if the allowances were received during allocation 

from the EPA, these were considered to be at no cost to the taxpayer, and thus the tax basis was zero. As with most acquired assets, if the allowance was obtained through a purchase by the taxpayer, the tax basis is the cost paid plus any incidental costs such 

as fees to brokers, legal costs, et cetera. With respect to the proposed CO2 allowances, there are no material issues that would call 

for a change in this treatment. 

A more challenging issue is centered on the recovery of the cost 

or tax basis of the allowance itself. The least controversial recovery 

consideration centers on the allowances allocated by the EPA to the 

taxpayer. Since the taxpayer has a zero basis on these allowances, 

the taxpayer would not have, or need, the benefit of a tax deduction at the time the allowance is utilized. 

The more complex issues center on the treatment when the recovery of the basis is through the sale of the allowance and the determination of the nature of the gain or loss as to whether it is capital or ordinary. The treatment is determined by the characterization of the allowance by the taxpayer and the nature of the activity 

by the taxpayer with respect to these allowances. This is where 

there seems to be some ambiguity in the tax guidance. 

A typical holder of allowances that is using the allowances for 

their own offset purposes, and may have the occasional opportunity 

to sell an allowance, would generally treat the sale as capital, thus 

resulting in a capital gain or loss. 

This is supported by the IRS’s Guidance and Revenue Procedure 

9291. The taxpayer can have a mismatch in cash flow due to the 

inability to offset capital losses if the taxpayer does not have sufficient capital gains within the specific tax period. If, however, the 

9 

taxpayer, in their ordinary course of business, is regularly dealing 

in allowances by buying and selling allowances as part of their 

business, the IRS guidance would imply ordinary treatment in the 

resulting gains and losses, although there is some lack of clarity in 

the tax guidance. 

And last, if the taxpayer is treating the allowance as a commodity in trading these securities, capital treatment would tend to 

rule, although, this again is less clear. Clearly, this is one of the 

areas in which more clarity from the IRS could be useful to the taxpayers, especially if the CO2 allowance has introduced broader recovery initiatives, including the introduction of international markets, restrictions to transactions only through commodity exchanges, or the consideration of offsets. 

Another area to be addressed further is the one method for a taxpayer to recover its basis through a ‘‘like-kind’’ exchange. The guidance under section 1031 of the code is clear on the treatment; the 

issue is, is an emission an emission or are there unique differences 

between an SO2, NOX, or a CO2? As you can see from these comments, although the current program of SO2 and NOX allowances 

is working well, there are issues of ambiguity in the tax treatment 

introduced by the broadness of how these allowances are used, exchanged, and recovered. Flexibility is important, as different taxpayers have varying needs and uses for the allowances, and as the 

markets evolve over time. 

A balance of clarity and flexibility is important to well-functioning markets. The IRS, Department of Treasury, your committee, and other key governmental agencies, working hand in 

hand with affected taxpayers, will need to factor in past, current, 

and future activities centering on emission allowances and related 

programs when formulating the tax treatment. 

Thank you, Chairman Baucus, Ranking Member Grassley, and 

other members of the committee for the opportunity to share these 

remarks. Duke Energy stands ready to work with you and your colleagues with these initiatives. 

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

Senator GRASSLEY. I will start by asking questions of Mr. Price 

and Mr. Butler, at least the first question. I refer to the nonpartisan Joint Committee on Taxation writing in their pamphlet 

referred to so far: giving away pre-allowances and not taxing these 

allowances upon receipt, is in effect, compensating those who receive free allowances, and doing it twice. With the exception of the 

entities with a regulated rate of return such as utilities, Joint Tax 

says, ‘‘The argument that there is no accession to wealth from the 

receipt of free allowances is more difficult to sustain.’’ 

So, Mr. Price, Mr. Butler, do you believe that there is an accession to wealth from the receipt of tax-free allowances? Or I should 

say free allowances, not tax-free allowances. That is the question. 

Mr. PRICE. Senator Grassely, I agree with the statement in the 

Joint Committee report that, as an economic matter, there is an accession to wealth as a result of the allocation of allowances. I would 

note that under current law similar accession to wealth has existed 

for sulfur dioxide allowances and in other cases involving the allocation of favorable leases to oil and gas companies to mine for oil 

and gas or other mineral rights, and so it seems, at least under 

10 

current law, that the policy has been, notwithstanding the fact that 

as an economic matter there is an accession to wealth, the better 

answer from perhaps an administrability perspective is not to tax 

it. As far as whether it ought to be taxed as a tax matter, that is 

a policy question that I leave for the committee to consider. 

Senator GRASSLEY. Mr. Butler? 

Mr. BUTLER. Thank you, Senator Grassley. I agree with Mr. 

Price’s response. The issue is, if you tax the allocation as a recognition of wealth, it simply comes back as a deduction, and it potentially could add, ultimately, cost to the end customer. 

Senator GRASSLEY. My second question is that we have Wall 

Streeters lobbying for Congress to enact a cap-and-trade tax regime. This is for all of you. Do you think the speculators from 

hedge funds and private equity firms should be allowed to participate in the cap-and-trade tax regime? 

I will start with you, Mr. Hufbauer. 

Mr. HUFBAUER. Thank you. Yes, I do, but only under the condition outlined in my testimony, which is, trading takes place on an 

organized exchange. For any derivatives, margin and variation 

margin must be set by the exchange. All participants are revealed, 

no street names. Quantities are revealed, and there can be no 

transactions outside the exchange. If there is going to be a market, 

let’s make it a real market that can then provide the basis for taxation, and also prevent all the financial hanky panky which you 

are so familiar with. 

Senator GRASSLEY. All right. 

Mr. Price? 

Mr. PRICE. Again, I am not in a position necessarily to comment 

on the regulatory conclusions. I would say as a tax matter, as a 

general matter, I would observe that to some degree these third 

party participants will be necessary to ensure some liquidity to the 

market, and, if one is going to adopt the system of cap and ‘‘trade,’’ 

that one needs to make sure that the trading works efficiently. As 

a tax matter, I think it is a question that the Joint Committee 

raised as to how one taxes it, whether one wants to tax that group 

punitively. Under current law, I think that there are uncertainties 

that may make those participants uncertain as to how to enter the 

market in a tax-efficient way. 

Senator GRASSLEY. All right, Mr. Butler, do you have anything 

to add? 

Mr. BUTLER. No sir. 

Senator GRASSLEY. All right. 

My third question to the panel is—well probably my last question because of the time—President Obama has proposed a large 

number of tax increases in the budget. For example, his carried interest revenue raiser is broader than previous carried interest proposals. Also, he has proposed to repeal the favorable treatment for 

dealers and traders for futures and options on commodities. 

If enacted, how would these proposals affect the tax treatment of 

allowances and derivatives based on allowances? 

Mr. Price? Mr. Butler? Any of you can respond, please. 

Mr. PRICE. Well, it is not entirely clear, based on the description 

the administration put forth on the commodities dealer provision, 

exactly the scope of it. As best I can tell, it would ensure that entiVerDate Nov 24 2008 15:27 Apr 04, 2011 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 R:\DOCS\65230.000 TIMD
11 

ties that trade and deal in commodities would end up with ordinary income on all of their commodities dealing in trading activities, which goes back to the question, or the comment I raised in 

my testimony. Under current law, these allowances would not be 

considered commodities and, therefore, all of that proposed legislation would be inapplicable. Again, whether that is right is a question I think is worth considering. 

Mr. HUFBAUER. Mr. Chairman, my view on that very interesting 

question is that the committee should start with a white slate on 

this carbon thing. I mean, this is so big, and the numbers are so 

large, that I do not think that you should be affected by all this 

SO2, and what I would regard as these lousy decisions by the IRS 

in the past, not to be too polite about it. You should start with a 

blank slate and just write the tax law for carbon, including the derivatives, and do not go on all these old analogies which are inappropriate. 

Thank you. 

Senator GRASSLEY. Do you have anything to add, Mr. Butler? 

All right, I will call on Mr. Conrad. 

Senator CONRAD. Thank you. 

Senator GRASSLEY. Senator Conrad. [Laughter.] 

Senator CONRAD. Thank you, Senator Grassley. 

And by the way, Mr. Hufbauer, you are the first person in all 

the time I have been on this committee who have suggested that 

Senator Grassley is familiar with hanky panky. [Laughter.] 

If there was ever a guy who is not familiar with hanky panky, 

it is Senator Grassley. 

Senator GRASSLEY. I assume that is a compliment. [Laughter.] 

Senator CONRAD. It is the highest compliment in North Dakota. 

I would like to ask each of the witnesses, have you heard something from the other witnesses that you strongly agree with or 

strongly disagree with? 

I would start with you, Mr. Hufbauer. 

Mr. HUFBAUER. Well, as you heard from my remarks, I strongly 

disagree with Mr. Butler that we ought to resort to these old rulings on SO2, which is a much smaller market—I will not go 

through it again—or rely on some of these old revenue rulings on 

capital treatment, and so on and so forth. I mean, just to use that 

distant stuff from the past for this new market which is so vast, 

is, I think, inappropriate. Why not bring over the laws from Amsterdam and apply then in New York today? 

Senator CONRAD. All right. Mr. Butler? 

Mr. BUTLER. I am not advocating that we look to the old rules 

and just carry those forward. I am advocating that we look to those 

rules, and, as I pointed out in my discussion, there is some ambiguity, there is some lack of clarity, this distinguishment of what 

are these, are these capital or are they ordinary, and I think that 

needs to be dealt with. I do believe though that these allowances 

should be granted with zero tax basis and they should not be taxed 

upon granting, because that just creates an ultimate cost that I do 

not think we need to create. 

Senator CONRAD. Mr. Price? 

Mr. PRICE. I guess I agree to some extent with Mr. Butler and 

disagree with Mr. Hufbauer on the issue of character. I do not 

12 

think under current law, whether you are looking at the emissions 

allowance legislation guidance in particular, or more broadly, at 

the question of what the character of these assets is, is at all crystal clear. I think there are businesses for which it is appropriate 

probably as a tax policy matter, as well as just as a matter of tax 

law, to get capital gain on the disposition. I also think that there 

are other situations where ordinary is the appropriate answer. So, 

I guess the item that I may take the most issue with is sort of the 

black-and-white portrayal of the character. 

Senator CONRAD. All right. 

Mr. Hufbauer, what would you see as the consequences to the 

Federal Treasury of following the SO2 treatment, carrying that 

over to CO2? 

Mr. HUFBAUER. Thank you, Senator. 

The result would be that, not only do we have an inappropriate 

and excessive system of free allowances in the Waxman-Markey 

bill going up to 2029, but then you would not get any tax revenue 

from it. In this time, when the fiscal problems of our Nation are 

so clear, it is just mind-boggling that we would go down that path. 

I mean, you look at President Obama’s initial budget, at a $600- 

billion rate, then, when you go through the Waxman-Markey proposal, most of that is consumed by offsets and allowances as far as 

the eye can see. Then not to have any taxes on that, well, what you 

are going to do is throw out a couple hundred billion dollars, two 

or three hundred, who knows, and it is over a period of time when 

we have extreme fiscal stress. So I just think it is amazing to even 

be contemplated. 

Senator CONRAD. Mr. Price, following up on Mr. Hufbauer’s comment, what do you see as the implications for the Federal Treasury 

of treating CO2 in the same way SO2 has been treated? 

Mr. PRICE. A lot of it is going to depend on which entities are 

allocated the allowances. I think if users are allocated the allowances, at least the historic practice of users of SO2 has been to use 

those allowances in the same year of grant. So, say their income 

today means they include income in 2012 or 2014, and then, when 

they use the allowance to satisfy their obligation, they would end 

up with a deduction in an equal amount in the same tax year. So 

I am not sure that the revenue impact would be that great assuming that the allowances are allocated to users of those allowances. 

Senator CONRAD. And to the extent that is not the case? 

Mr. PRICE. To the extent that is not the case, it depends on who 

those entities are. If those entities were to sell them, which presumably is the intention of giving them to non-users, they would 

want to sell them immediately to generate revenue for some purpose, then they would again have a tax consequence in the year in 

which they were granted. I am not sure there is much incentive for 

them to bank their allowances and to defer the time at which they 

would actually recognize the income and pay the tax. 

Senator CONRAD. Mr. Butler. How would you respond? 

Mr. BUTLER. I think that is the issue. The issue is, is this a timing matter to the Treasury of generating revenue through having 

them taxed versus the timing of when the deduction is taken? And 

also the other issue is the nature of the capital versus ordinary. Do 

you generate capital losses in which you do not have capital gains 

13 

and you ultimately have to write off those losses and not be able 

to utilize them? Well, that could be a revenue generator, but I do 

not think that is the right answer of what we are looking for in 

these allowances. 

Senator CONRAD. All right. 

I thank the Chair. 

Senator GRASSLEY. Senator Nelson, it is now your turn. 

Senator NELSON. Thank you, Mr. Co-chairman. 

What do you think we ought to do to the tax treatment of allowances to keep out the speculators? 

Mr. HUFBAUER. Well, Senator, my viewpoint on that, maybe to 

start with, is that I do not think that speculation is necessarily a 

bad thing. It can be market smoothing, but I think it is just critical 

to set the conditions in which markets operate. And I put those in 

my suggestions, as outlined in my testimony. I do think that, if it 

turns out to be an over-the-counter type of market, and section 

1031-type exchanges were mentioned—that again, is an amazing 

proposition to me—well then, you are going to get all the kind of 

nonsense we had in the financial markets recently. So, if it is open, 

transparent, for example, as the oil market is under the Chicago 

exchange, then I think it can serve a useful purpose, but if it is 

a kind of an underground CDO-type of market or one of these credit default types of markets, then all kinds of mischief is going to 

occur. 

Mr. PRICE. I am not sure there is a straightforward way to accomplish that through tax policy, because you will find that many 

entities that have the need for allowances will also be either optimizing the price for allowances or will have their own separate operations that one might perceive as speculation and one might perceive as trading. It is a matter of, perhaps, semantics. 

So it is hard to figure out a way to craft a rule that just says 

speculators are punished. In terms of things one might mechanically do in a tax code, the only real things you can play with without some form of penalty tax would be character and timing, and 

it will be hard to draw the line between those entities that are 

speculators and those entities that are users. 

I am not really sure which answer is better. To say they are capital means speculators could have capital losses which are undesirable. To say they are ordinary income means the individuals or the 

speculators might pay higher taxes, but they can apply it against 

losses they have on other investments. So it is a very difficult question to resolve through tax policy. 

Senator NELSON. A penalty tax, Mr. Butler, for speculators? 

Mr. BUTLER. I do not think that is the right answer. I do not 

think tax policy is the way to achieve it. If speculation is an issue 

that this committee is trying to deal with and the legislation is trying to deal with, I do not think tax policy is the right way to do 

it. 

Senator NELSON. With regard to the sulfur dioxide trading program, traders and investors are generally treated the same for tax 

purposes as the users of the credits. There are some exceptions for 

depreciation, involuntary conversion, and penalties. Under a capand-trade carbon program, should we alter the general tax rules 

that apply under the sulfur emissions trading program? 

14 

Mr. BUTLER. As I pointed out in my testimony, I think this is an 

issue that really needs to be dealt with. It is not clear in the current tax policy as to whether these are treated as ordinary or capital income and can change depending upon how these are dealt 

with by the taxpayer itself. So I think this is the area that probably is most important to put some real clarity around. 

Senator NELSON. Thank you, Senator. 

Senator GRASSLEY. I have no further questions. There are other 

members who cannot come who may submit questions for answer 

in writing, so the record will stay open for a little while. We would 

ask you folks, if you get questions, to cooperate by answering them. 

And I want to apologize for the chairman, Senator Baucus. He had 

an emergency and had to go and will not be back, so he asked me 

if I would close the meeting. So we do that by thanking you once 

again for your expert testimony and your cooperation. 

Thank you very much. 

Hearing adjourned. 

[Whereupon, at 11:02 a.m., the hearing was concluded.] 

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A P P E N D I X 

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