Beware the Uncertainty Tax

The buzz on Capitol Hill and among administration insiders is that the House may ultimately pass some form of cap and trade legislation. It won’t be as effective as most leading climate change advocates had hoped; it’s likely to be full of the free allocations and offsets that are the price of gaining political support. The swing votes here are the likes of Virginia’s Rick Boucher, a long-term Democratic representative of that state’s coal country. The problem is going to be in the Senate, where Republicans are railing on against what they are characterizing as a weak-economy crushing “electricity tax” and some centrist Dems are worried about their own states’ dependency on coal. 

As a consequence, although the administration has sent a clear message that progress on setting a price on carbon is a central concern for them and that they want a bill this year, there is some concern it might be punted off until next year…or, given that next year is an election year which means that anything that even looks like a tax will be semi-radioactive, until 2011. While opponents of the legislation may breathe a sigh of relief they should be careful what they wish for. Because leaving this issue hanging is very likely to prove to be more of a drag on the economy than actually putting a cap and trade system in place. 

The arguments of the anti-cap and trade, anti-carbon tax crowd actually fail on several levels. 

First, it is easy to reduce your exposure to such a proposed tax: use less carbon. That’s the point of the tax, actually, to change behavior. The average family can save nearly $1000 a year simply by embracing some basic conservation and efficiency measures like improving insulation, weather-stripping windows and doors, using more efficient light bulbs and lowering water temperature a few degrees. Credible estimates (which is to say those from the EPA, MIT, and Peter Orszag and not wildly inflated ones from John Boehner) of the cost of implementing cap and trade range from $50 a family to $1300 a family.

Which leads to the second point, which is that only by creating such a tax can we ensure organic growth in the new green energy industry that will help stimulate job creation and growth at a time when traditional sectors are failing to do so. 

Third, of course, the government can send the revenues from the tax right back into the economy, thus setting up a stimulus to directly offset any possible negative impacts of the tax. 

But perhaps most importantly, given the fact that one way or another we like the rest of the world will have to find a way to limit carbon emissions, failing to come up with a legislative approach to managing the problem may actually have worse economic consequences than introducing this modest tax. Because the market knows change is coming but until it gets a signal as to what its nature will be, it is going to sit on its hands and not invest in new projects. We’ve already seen this happen. Would you invest your money in a coal fired plant right now? Would you lend money to one? Not knowing what the costs will be when we charge a price for carbon? Not knowing what the liabilities would be? Well, neither would most people.  Which is why between 2008 and 2009 the U.S. Energy Information Administration drastically reduced its forecast for investments in new coal-fired generation capacity through 2030, from 104 GW to 46 GW. That is equivalent to a reduction in the estimate of approximately 100 new coal plants representing investment in perhaps the $600 billion-$1 trillion range. 

At the end of its press release, the EIA noted that this change “reflects the behavior of investors and regulators who, in their investment evaluation process, are implicitly (or explicitly) adding a cost to many proposed power plants that employ GHG-intensive technologies. Additions of new coal-fired power plants are significantly reduced from earlier projections.”

Much of what might have gone to coal plants may go to other technologies, of course. Estimates, for example, for natural gas powered plants are up.  Which is a good thing that  indicates that the threat of a tax has some beneficial aspects, as well. But even so, uncertainty is taking its toll on all power plant investment. A Reuters article last month framed the problem by noting:

Lack of clarity on future power prices makes it difficult for lenders to evaluate a new power plant’s prospects.

The potential for renewable power mandates, carbon limits and the return of electric demand growth as the economy recovers ‘create a huge capital formation need,’ said Terence Darby, managing partner of Energy Investors Funds Group, a private equity company.

As regional power surpluses decline, ‘it creates a huge need for capital with no clear way to get it,’ Darby said.”

Not passing a cap and trade provision in the energy bill this year won’t solve this problem. It will be expected in the future or regulatory steps will be expected to have a similar impact on fuel and technology choices. So the result will be an uncertainty tax that may be more damaging than any carbon tax currently envisioned. New investment will not flow. New projects won’t get built. New jobs will not be created. It is these considerations that have led so many major utility executives to support cap and trade.  Their industry literally cannot stand a period of prolonged doubt about the regulatory, investment and market environment they are going to face in the years ahead.

In short, when you add together the benefits coming from restoring investment flows and creating the conditions needed for the real job creation, innovation and growth a green revolution may support, passing cap and trade may very well be much more stimulative than fumbling the issue as the Congress currently looks like it might do.   

JIM WATSON/AFP/Getty Images