By Steve Valk  

When policy wonks start talking about carbon pricing, it’s difficult for mere mortals to follow the conversation. There’s a dizzying array of options – cap and trade, cap and dividend, fee and dividend. How do these various systems work and which one is most effective?  

Last Saturday, members of Citizens Climate Lobby had the benefit of picking one of the best brains on this issue – economist Robert Shapiro, who was Undersecretary of Commerce for Economics during the Clinton Administration. You can listen to the conference call with Shapiro here.  

Shapiro now chairs the U.S. Climate Task Force, and for several years he’s advocated for a carbon tax – or fee, if you prefer – to put a price on fossil fuels that will make clean energy competitive. He explained, more clearly and convincingly than anyone I’ve heard, why the fee and dividend approach would work better than cap and trade.  

Before I get into that, some folks may be wondering why we’re still talking about cap and trade. Didn’t congressional leaders declare cap and trade was dead and they were coming up with a new plan on climate legislation?  

Well, the phrase “cap and trade” may have been stricken from the climate change lexicon, but the system of buying and selling permits to emit carbon-dioxide is still very much on the table. The proposal in the works from senators John Kerry, Lindsey Graham and Joe Lieberman would employ such a permitting system in the utilities sector. I assume the reason it’s taken so long to draft their legislation is because they’re having a hard time coming up with another name for cap and trade.  

Back to Shapiro and the cap and trade vs. fee and dividend debate.  

“Cap and trade,” as Shapiro explains, “is a quantity-based regulatory regime. You’re going to control something by controlling its quantity.”  

This would be the cap, which on the surface sounds good. We want less CO2. Therefore, we set a limit on the amount of it we allow to be emitted. Right? The problem starts, however, when policy-makers attempt to determine the cap.  

“The cap will be set with a set of assumptions about how much energy the country will consume in the year of the cap.”  

And there are numerous factors, quite unpredictable, that will affect energy demand – economic growth, how cold the winter is, how hot the summer is. If the economy grows faster than anticipated or the winter is colder, energy demand will exceed what the cap allows.  

“As energy demand bumps up against the cap… the price of the permits will soar. So what you get is price volatility in the permits, and that volatility is then transmitted through the permits to the price of energy,” said Shapiro.  

“This is not only bad for the economy, to introduce this additional volatility into energy prices, but it’s also bad for the environment. The reason is that the only way we’re going to succeed in containing the damage from global warming is through the development of new technologies and new fuels. The ones we have today will not be sufficient… We have to go beyond that and produce new forms of energy which are not only climate-friendly but cheaper than the ones we have today. And to do that, for businesses to undertake the sustained investments required to develop these technologies and these fuels, they have to know what the price of carbon is going to be.”  

If a predictable price on carbon is the driving force for investments in clean energy, as Shapiro argues, then a direct fee or tax applied to carbon is the way to go. Eliminate the volatility, and investors will open their wallets.  

The other great advantage of a fee and dividend system is the recycling of the revenue back to the people.  

“The hardest thing to do in politics is to get people to accept a short-term cost in order to avoid a larger long-term cost… Cap and trade in the House tried to deal with this by trying to reduce the short-term costs at the cost of the environmental effectiveness of the program. They gave all kinds of exemptions and offsets and they weakened the environmental center of the program. A carbon-based tax can largely eliminate the short-term costs by recycling the revenues. After all, the goal of this is not to make people poorer. It’s to change the relative price of different forms of energy based on their impact on the climate. And that’s exactly what a carbon-based tax does.”  

What about the Cantwell-Collins CLEAR Act? Their bill employs a cap and dividend approach that sets a limit on emissions, auctions off the permits and then recycles 75 percent of the revenue in the form of a monthly payment.  

Shapiro labeled the CLEAR Act “cap and trade light.” Though CLEAR uses a price collar with a floor and a ceiling, there is still uncertainty in the price of carbon.  

“First of all, it doesn’t eliminate the volatility. It limits it. The way it’s designed, the spread between the floor and the collar top would expand over time, so the volatility would increase. And the fact is, the only way to enforce a cap on the price would be to issue more permits, and then you have blown the cap, which is the only advantage of cap and trade.”  

If Shapiro’s made a believer out of you for a carbon-based tax, check out CCL’s proposal for a Carbon Fee and Dividend Act. Everything’s on the table with climate legislation at this point, but we need to choose the solution that will actually work. 

Steve Valk is communications director for Citizens Climate Lobby.