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How a carbon permit system could work

As envisioned by President Obama’s budget proposal unveiled Thursday, the federal government will soon begin tapping into a new source of revenue by requiring companies to pay for the permission to emit greenhouse gasses.
Image: Coal Mining And Rail Traffic In  Wyoming
A shovel operator loads a hauling truck from a coal face wall at the Buckskin Coal Mine, near Gillette, Wyo. Coal companies would be among those most affected by a carbon emissions permit system if Congress enacts one this year.Robert Nickelsberg / Getty Images
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As envisioned by President Barack Obama’s budget proposal unveiled Thursday, the federal government will soon begin tapping into a huge new source of revenue by requiring companies to pay for the permission to emit so-called greenhouse gasses linked to global warming.

The Obama budget blueprint assumes that by 2012, the Treasury will be collecting $78.6 billion in new revenue from carbon emissions permits. From 2012 to 2019, it envisions that a total of $645.7 billion would be raised from auctioning of such emission allowances.

Obama proposes using about 80 percent of that anticipated revenue — or $526 billion — to pay for tax credits for low- and middle-income people to help offset higher energy costs. The rest of the money would subsidize alternative energy projects and firms.

While many details of the program will not become clear until Congress acts, the basic idea outlined during Obama’s presidential campaign would be to require large sources of greenhouse gasses, such as electric utilities to purchase permits from the government for the gasses they emit, including carbon dioxide.

A “cap-and-trade system” would be created, under which the government would place a cap, or limit, on the total amount of greenhouse gasses that can be emitted. Companies that need to exceed their allotted level must buy offsetting permits from those that emit less.

Here are some commonly asked questions about how such a program would work and what might become of the revenue:

Would Congress need to pass legislation to establish this system?Yes. Several members of Congress have introduced bills in previous sessions of Congress to do that.

A greenhouse gas bill sponsored by Sen. Joe Lieberman, I-Conn., and Sen. John Warner, R-Va., got 48 votes last year in the Senate, falling short of the 60 needed.

But with expanded Democratic majorities in both House and Senate this year, an emissions permit bill will have more support.

Will this legislation pass this year?Powerful Democrats such as House Energy and Commerce Committee Chairman Henry Waxman, D-Calif., have said they would work hard to get legislation passed by this summer.

But Steve McMillen, a lawyer at Baker Botts in Austin, Texas, who specializes in environmental and climate change law, has his doubts, given the complexity surrounding the creation of such a system.

“There are so many details to be worked out in any bill, it’s hard to imagine that one would necessarily be signed by the end of this year,” he said. “But I believe both houses of Congress are going to make a big push to get a bill out of their respective chambers.”

How would the emissions permits be priced and what companies would be required to buy them?It remains to be seen how the bill that Congress eventually debates will handle the details of allocating the permits, which can be auctioned or given away (allocated to specific firms and industries) or some combination of the two.

Under last year’s Warner-Lieberman bill, a fixed number of permits would have been available from the Environmental Protection Agency starting in 2012, with fewer permits issued each year until 2050. The firms required to buy permits included electric utilities, owners of any facility that annually used more than 5,000 tons of coal, any facility that produced or imported petroleum, and manufacturing facilities that emitted at least 10,000 tons of CO2 per year.

In general, according to Kyle Danish, an attorney with Van Ness Feldman in Washington and an expert on climate change legislation and emissions trading, in a cap-and-trade system the level of the cap on emissions sets the price. “Because emission rights (allowances) will be scarce, they will have value,” he said. “The more stringent the emissions cap, the higher the value of the allowances.”

How would the new revenue be used?Obama's proposal would use most of the new revenue to provide a tax credit to offset the higher costs of energy that would result from a carbon emissions permit system.

The New York Times reported Thursday that low-wage and middle-income workers would receive a $500 tax credit, or $1,000 to couples; but the credit would be phased out for single people with incomes above $75,000 a year and for couples with incomes of more than $150,000, it said.

But ultimately it will up to Congress to decide how the money will be used.

Clint Stretch, a tax analyst at Deloitte Tax LLP in Washington, D.C., and former legislation counsel to the joint congressional Committee on Taxation, said Thursday that the revenues that would be raised would all go into the Treasury. The money is “fungible," he said. "You can say it’s set aside” for a particular tax credit “but at the end of the day, dollars are dollars.”

What impact would the emissions curbs have on consumers?Congressional Budget Office director Peter Orszag, who is now head of the Office of Management and Budget under Obama, testified last year that the firms that were required to buy permits would pass the costs along to their customers in the form of higher prices. The price increases, he said, would “be essential to the success of a cap-and-trade program” because they would be the mechanism by which businesses and households would be forced find ways to cut their greenhouse gas emissions.

Won’t that harm consumers, especially the poor?A recent study by the Center on Budget and Policy Priorities, a liberal think tank, said, “Low-income consumers are the most vulnerable (under such a system) because they spend a larger share of their budgets on necessities like energy than do better-off consumers.”

They also are “least able to afford purchases of new, more energy-efficient automobiles, heating systems and appliances,” it said.

The center advocates protecting low-income consumers through a system of rebates and tax credits. And Obama, at least in part seems to have adopted this approach with his proposed tax credits for middle-income and low-income people.

How would a “climate rebate” system work?Under one scenario offered by Center on Budget and Policy Priorities, the U.S. Department of Energy “would set the size of the rebate each year, based on the impact of the emissions cap on consumers’ purchasing power.”

Married couples earning $70,000 or less and single filers earning $30,000 or less would receive a full rebate of their increased energy costs.

Married couples earning more than $70,000 but less than $110,000 and single filers earning between $30,000 and $50,000 would receive a partial rebate.

People above those income levels would get no rebate, on the theory that they could afford the increased energy costs.

What other approaches have been suggested for spending the new revenue?An idea that seems to be gaining momentum is one offered by a leading House Democrat, Rep. Chris Van Hollen of Maryland, who also is assistant to House Speaker Nancy Pelosi. This week Van Hollen introduced a bill that would return 90 percent of the proceeds of the emissions permit auctions to consumers — a concept called “cap and dividend.”

“The strength of cap and dividend lies in its simplicity, transparency and durability,” he said in a letter to fellow House members recruiting their support for his bill.

Rather than monitoring factory smokestacks and other emissions sources, Van Hollen’s bill would put the burden on “the first sellers” of fossil fuels. 

For example, a coal company would report each year how much coal it sold in the United States and then would be required to purchase a carbon permit for each metric ton of carbon emitted by the coal.

Isn’t it likely that Congress would use the new revenue in ways it chooses, rather than simply sending it out as dividend checks to consumers?“It’s tempting for Congress to spend the carbon revenue, but if they did so instead of returning that money to consumers it would amount to a vast reduction of consumer purchasing power, which would be a disastrous thing to do in a recession,” said Peter Barnes, an environmental activist who testified last September to the House Ways and Means Committee in support of the cap-and-dividend concept.

Would passage of a federal carbon emissions law pre-empt already existing state carbon trading schemes?Not necessarily, said Danish. “That's a political decision,” he said.

But, he said, “There is not a strong environmental rationale for continuing those (state) programs if a federal cap-and-trade program comes into place.”