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Dream Memo

The climate change memorandum we can only hope for.


To: Member Companies
From: Association for Corporate America
Subject: Advantages of a Carbon Tax

Date: January 10, 2009

Consistent with promises made during the campaign, and motivated by the need for revenue, the Obama transition team has made enactment of a cap-and-trade system for greenhouse gas emissions a top priority. After careful deliberation, our policy development committee recommends that we conditionally support a carbon tax as an alternative to cap-and-trade. This will be at the top of the agenda for our annual meeting next week.

Both of the president-elect's former electoral rivals, Sens. Hillary Rodham Clinton and John McCain, back a cap-and-trade system for limited greenhouse gas emissions. And there is strong momentum for cap-and-trade in the newly elected Congress, which is concerned not only about global warming but also about energy security. Under the plan Obama is likely to propose, the federal government would annually auction a fixed number of CO2 emission allowances. Expected proceeds are in the neighborhood of $50 billion, although the amount is highly uncertain.

It is important for our members who may be familiar with the European Union's cap-and-trade system to understand that the president-elect's proposal would be vastly different from the EU plan. In Europe, "grandfathered" permits were granted free of charge to incumbent greenhouse gas emitters. (And for our members, such a system would clearly be preferable to a carbon tax.) But that is not the type of cap-and-trade plan now under consideration. The president-elect and congressional leaders are insisting on the auctioning of all permits.

Economic Benefits
A cap-and-trade system with auctioned permits is in many respects equivalent to a carbon tax. But for business there are two major advantages of a carbon tax over a cap-and-trade system.

1. Reduction in uncertainty. Unlike an actual carbon tax, a cap-and-trade system would impose costs that would fluctuate with market conditions. Permits would be traded on commodity exchanges and would be subject to considerable short- and long-term price volatility. (Between 2004 and 2007, the market price of sulfur dioxide emission permits issued under current EU law spiked from $200 to $1,600 and then dropped to $600.) Almost every business would benefit from a reduction in uncertainty provided by a carbon tax. But for some of our members — such as electric utilities that must choose generating technologies for plants that must operate for decades — the reduction of uncertainty is critical. And predictability also improves the investment climate for research and development in new energy technology.
For reasons like these, Duke Energy has been an advocate of a carbon tax since 2005. In a July 2005 speech, Duke Energy's Richard Osborne, vice president of public and regulatory policy, told his audience:

"Tax" has become a four-letter word in American politics, but if the federal government is going to influence behavior, it should do so through the most efficient means; and in this case, a carbon tax is a better approach than alternatives such as a cap-and-trade regime.

2. Trade advantages. To protect U.S. industry from unfair competition, Congress will almost certainly try to impose restrictions on importers not subject to similar carbon reduction burdens. Unlike taxes that have well-established norms for border adjustments, a cap-and-trade could lead to trade disadvantages if industry protections are not included, or alternatively, to trade-impairing conflict with our trading partners.

In March 2008 widely respected trade expert Gary Hufbauer told the House Committee on Energy and Commerce:

Until international negotiations are conducted, it is difficult to say which approach will best encourage developing countries to adopt their own GHG [greenhouse gas] emission controls while simultaneously protecting U.S. industry. From an administrative standpoint, the simplest approach would be a uniform carbon tax, imposed at the border on imports from countries that do not adopt and enforce the same uniform rate.

Hufbauer fears that complications resulting from cap-and-trade could lead to a drawn-out period of trade skirmishes and even a trade war:

Sauce for the goose is sauce for the gander. Any restriction the United States imposes on imports, citing climate change as justification, can just as easily be imposed by other countries on U.S. exports. Any performance standards that the United States imposes on foreign firms, and any "comparability" tests the United States imposes on foreign GHG control systems, can be turned around and imposed on the United States. [Emphasis in the original.]

We anticipate many will interpret election results as a mandate to challenge free trade. A cap-and-trade system runs a greater risk than a carbon tax of adding to trade tensions at exactly the wrong time.

Political Advantages
In addition to the favorable economic benefits, there may be political benefits as well.

Rep. John D. Dingell, D-Mich., chair of the House Committee on Energy and Commerce (which would have jurisdiction over cap-and-trade legislation), is a close ally of the auto industry and one of the most reluctant Democratic supporters of restraining carbon emissions. In a 2007 Washington Post op-ed, he expressed his support for a carbon tax over a cap-and-trade system. He believes that a tax will make the costs of emission limits easier to comprehend and consequently weaken political support for imposing new environmental costs on American industry.

Although anything can happen, it is our assessment at this time that — unlike in 1993 when the proposed Btu tax was defeated in Congress — the new president will be able to carry through on his plan to combine revenue raising and environmental policy.
While not precluding the possibility of reducing support for costly emissions limitations, the Dingell strategy can also work to our advantage in gaining concessions from Congress. By making costs and damage to competitiveness explicit (that is, they are anticompetitive taxes), it would be easier to make the case for offsetting business tax cuts. These cuts could take the form of corporate rate cuts, expensing the purchase price of capital equipment, or expanding the research credit (or some combination of these).

Existing Support for a Carbon Tax
Some environmental groups favor a cap-and-trade system over a carbon tax because they like the certainty of strict limits on emissions (no matter what the cost). They also believe they can avoid some of the wrath of antitax conservatives by shunning the use of the word "tax." It is our view that those objections would likely melt away if business, which would be paying the tax, supported a carbon tax over cap-and-trade with equivalent environmental benefits.

Although it has not received nearly as much attention as cap-and-trade plans, a carbon tax is a widely respected policy option. In the United Kingdom, Conservative Party leader David Cameron — the odds-on favorite to become the next prime minister —favors a carbon tax as a replacement for the U.K.'s complex energy tax known as the "climate change levy."

Most economists argue in favor of a carbon tax over cap-and-trade, including Alan Greenspan, Paul Volcker, and President Bush's former chief economist, Greg Mankiw. Lawrence Summers, Treasury secretary during the Clinton administration, wrote in March 2008 that he prefers "carbon and/or gasoline tax measures to permit systems or heavy regulatory approaches because the latter are more likely to be economically inefficient and to be regressive." And in April 2008, Congressional Budget Office Director Peter Orszag told Congress that "a tax on emissions is generally more efficient than a cap-and-trade system."

Broad-based business support of the carbon tax would be a seemingly bold move. It would get considerable press attention — mostly favorable. And it would earn the gratitude of the tax-writing committees that would gain jurisdiction over what would become the major U.S. policy response to climate change. We are putting out feelers through back channels about our willingness to support the tax on the condition that most of the revenue raised be used for improving the competitiveness of U.S. business. This is not only good for our membership, but it is also good for the economy. As economists repeatedly point out, the best way to minimize the negative impact of carbon limits on the U.S. economy is to use revenue gains to reduce taxes on corporate capital.

The text of this article first appeared in Tax Notes.

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