EPA’s New Analysis Of Cap And Trade Same Old Faulty Logic

Posted on Fri 06/18/2010 by


By Nicolas Loris.

The Environmental Protection Agency released its economic analysis of the Kerry-Lieberman cap and trade legislation, the latest cap and trade bill to be released in the Senate. The result was nearly the same as the EPA’s analysis of the Waxman-Markey cap and trade bill passed in the House of Representatives last year: postage stamp per day costs. Instead of $176 per household for Waxman-Markey, Kerry-Lieberman would cost households $146 by 2050. Unfortunately for Americans, nothing substantial in the EPA analysis has changed; it is still unreasonable, faulty, and fragile. The reality remains that cap and trade is a substantial energy tax that will cause trillions of dollars in economic damage and kill jobs.

Inappropriate Use of Discounting

Most misleading in the EPA analyses of cap and trade is the use of discounting. A discount rate is an interest rate used to find present value of an amount to be paid or received in the future. In other words, present value analysis answers the question: How much would I have to have today in order to meet my financial obligations or pay certain costs in the future? Discounting is a legitimate tool in finance and for cost-benefit calculations. But discounting can give a much distorted view of costs, as is done by those misrepresenting the EPA analysis. Here’s an example to help clarify:

Imagine that a time machine takes analysts back to 1969 — a time when the average price of a new car was about $3,500. Once back in 1969, the exercise is to explain to Congress how much a new car will cost 40 years later in 2009. Having already lived to see 2009, we know the average price for a new car is about $23,000. But telling the Congress of 1969 that in 40 years cars will cost $23,000 would give an exaggerated notion of the cost increase, because inflation alone will have increased prices by a factor of 5.8. If inflation is taken into account, the price of a new car in 2009 is about $4,000 in 1969 dollars. This conveys the most meaningful measure of the cost.

Taking this inflation-adjusted (1969 dollars) $4,000 price of the average new car in 2009 and discounting it in the EPA fashion would generate a present value in 1969 of $562. This is clearly much less than the cost of an average car in 2009, even after adjusting for inflation.

What then is this $562? It is the amount when invested for 40 years, at an interest rate guaranteed to be 5 percent above inflation that would buy the $23,000 car. In other words, if a person in 1969 invested $562 at 9.72 percent interest (5 percent above inflation), letting the entire interest compound and paying no taxes, it would now amount to $23,000, enough to buy a new car.

The same holds true for the EPA’s use of discounting. The discounted value is not the amount households will have to pay each year, even with discounting. In the most generous case, the present value is the amount that would have to be paid for one year, right now, if the present value for each of the 40 years were paid in one lump sum right now — that is, if the cost for all 40 years were paid at once. So no matter how it is sliced, there is no sense in which a postage stamp (or even one dollar) per day reflects the annual cost of the cap-and-trade legislation.

Doesn’t Fully Measure Costs

The EPA uses household figures and measures consumption changes only. First, a household is not necessarily a family. The average household size is 2.6 people. Adjusting household size to a family-of-four standard adds another 53 percent.

Secondly, consumption changes are typically less than income changes, as families respond to income losses by saving less. When income drops, people prevent consumption from dropping by dipping into savings. In turn, lower savings reduces the ability of families to cope with other shocks and reduces their future income. Further, consumption comes from after-tax dollars, so losses in tax revenue do not show up in data on household consumption. The real economic cost is the loss of income. Change in national income, as measured by gross domestic product (GDP), is a better measure of the overall economic impact of a policy.

In the end, Americans will be much poorer and the economy would be trillions of dollars weaker with climate change legislation in place than without it, as Heritage Foundation analyses of past cap-and-trade bills have shown.

Generous Assumptions

The EPA reports that “The APA is estimated to lead to a significant decline in electricity generation from non-CCS fossil fuels — a 23% decrease from 2010 levels by 2030 and an 81% decrease by 2050. This is in stark contrast to the expected steady increase in non-CCS fossil fuel electricity generation without the APA policy – a 22% increase by 2030 and a 56% increase by 2050.”

To get there, the EPA includes generous assumptions, specifically on the use of carbon capture and sequestration (CCS), the use of offsets and the increase in nuclear power. With CCS, even after extraordinary technological and economic hurdles have been cleared, there are more political and environmental obstacles to storing 15 supertanker’s worth of liquid CO2 every day. The considerable regulatory and legal hurdles to CCS have been noted by the Congressional Budget Office :

“Similarly, generators would be unlikely to adopt technologies for the capture of CO2 and its sequestration in the ground unless an extensive regulatory structure was put in place to address issues involving property rights, rights-of-way for pipelines, and liability for emissions that escape from the ground.”

Anyway, it’s no surprise the costs are higher in the EPA’s model where CCS is delayed.
The use of offsets is another highly contentious program that is subject to fraud and will produce dubious results. With offsets a coal plant operator can forego cutting CO2 emission and, instead, pay someone else to do so. For instance, a company could pay a logger not to cut down trees, or they could pay someone to grow trees since trees absorb carbon. Or a developing country can build a cleaner coal plant saying they were going to build a dirtier one while cashing a check from a developed country for the alleged carbon offset. Laurie Williams and Allan Zabel, two lawyers working for the EPA who oversaw California’s cap and trade and offsets programs, have serious doubts about the effectiveness of the offset provision. They make a similar case with forest owners:

“[I]f the landowner wasn’t planning to cut his forest, he just received a bonus for doing what he would have done anyway. Even if he was planning to cut his forest and doesn’t, demand for wood isn’t reduced. A different forest will be cut. Either way, there is no net reduction in production of greenhouse gases. The result of this carbon “offset” is not a decrease but an increase — coal burning above the cap at the power plant.”

Another sign of problems with domestic and international offsets is that the Kerry-Boxer bill devoted 90 pages to outlining the regulatory structure for certifying and handling offsets.

Furthermore, trying to increase the production of nuclear energy in the United States, without proper regulatory and waste management reform, will stick us with only a handful of reactors—just the ones the government subsidizes through loan guarantees.  Although the nuclear title in Kerry-Lieberman is strong on regulatory reform, it does little to address waste management and includes a host of subsidies for nuclear. This doesn’t get us the nuclear renaissance assumed in the EPA economic analysis.

No Green Stimulus, No Environmental Benefit, Minimal Oil Reduction

Even the most generous scenario in this EPA report shows that costs will be forced on the economy—higher energy prices and lost income. For every year reported, household consumption drops compared to a world without Boxer-Kerry. This is a climate bill and, even according to the EPA, it will reduce economic activity. Spinning this as a job-creating, green stimulus bill is simply untrue. Regardless of whether the lower cost estimates are true, this bill provides negligible environmental benefit. Global temperature reduction from Kerry-Lieberman would be .077 degrees Fahrenheit by 2050 and 0.200 degrees by 2100. And despite the best attempt for politicians to marry the Gulf oil spill and cap and trade legislation, even the EPA analysis shows cap and trade will do very little to cut petroleum use (page 31). Yet, after President Obama’s speech in the Oval Office, former Vice President Al Gore said, “Placing a limit on global warming pollution and accelerating the deployment of clean energy technologies is the only truly effective long-term solution to this crisis.” Cap and trade is an effective solution to raise energy prices for years to come and choke our economy, but that’s about it.

David Kreutzer, Senior Research Fellow in Energy Economics and Climate Change, co-authored this post.

Nicolas Loris is a Research Assistant at The Heritage Foundation’s Roe Institute for Economic Policy Studies. Loris studies energy, environment and regulation issues such as the economic impacts of climate change legislation, a free market approach to nuclear energy and the effects of environmental policy on energy prices and the economy.

Read more informative articles at Heritage – The Foundry

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