Revenge of the Oligopolists

Two proposals to reduce climate change risk, "cap and trade" and a carbon tax, have floated to the top. Others, like "tax and dividend," fight for recognition. Properly administered, both of the frontrunners will reduce emissions. Both will also impose a multi-trillion dollar burden on energy consumers. What distinguishes the two from their lesser known competitors is what happens to the cash that is taken out of the consumer's pocket.

Under "cap and trade," the money outflow separates into two competing streams. To the extent that CO2 pollution rights are auctioned off, the money goes into government coffers. To the extent that they are given away, the money ends up in the pockets of current industry players who have "lobbied up." Under the carbon tax, the money will flow to the government. As distasteful as either of those flows may be to many of us, economic theory tells us that there will be a third stream. Much if not most of the cash will be siphoned into the already well-lined pockets of fossil fuel producers.

Fossil fuel producers are seasoned oligopolists and have long displayed both monopolistic and politically astute behaviors. That won't change under either "cap and trade" or a carbon tax. For example, under a cap and trade program, if oil sells for $75 per barrel and allowances are being auctioned at $65 per barrel, the market is telling everyone, including the oligopolists, that $140 per barrel is the price brings consumption down to the targeted level. They will know that an immediate increase in oil prices to $100 per barrel won't reduce their sales. It will just will push allowance values down to $40 (assuming that the allowances are freely-tradable and short-lived). The same calculus will continue to apply until the price of oil begins to approach $140. As producers push their prices up to $140, allowance values will fall to near zero, and producers will count their extra trillions.

A carbon tax will be little different. Oil producers have already intimated that if the U.S. tries to impose a carbon tax, they will preemptively raise their prices to bring consumption down to the targeted level before the tax even goes into effect. The producers are clearly relying on Congress' fear of citizen ire if the new tax is imposed hard on the heels of significant "market" price increases. They are convinced that Congress will react to a preemptive price increase with no tax or a tax with a "roll back" mechanism. Either will transform almost all of the hoped-for tax proceeds into more oil profits.

There is, however, one proposal that can keep the trillions out of the pockets of oil producers. It has two components—a fee imposed on producers of greenhouse gases and an identically-sized rebate that will be split among all U.S. citizens (ideally per capita). Some call this "tax and dividend," but the proposal entails neither a tax (a payment that supports government) nor a dividend (a share of the profits of a fund or enterprise). Calling it a tax runs the risk that government will at some point decide that the fee "belongs" to it. Calling it a dividend might encourage the government to hold back the money, establish a fund and dole out small annual dividends (which is what Alaska now does with its Permanent Fund). More accurately it a "producer fee rebated to citizens" or more simply a "citizen rebate."

A citizen rebate reduces emissions just as well as a cap and trade program or a carbon tax, but it takes NO dollars from U.S. citizens as a group. The only transfer of dollars is from those citizens who consume more than their pro rata share of fossil fuels to those who consume less.

A citizen rebate effectively appoints the U.S. as the fee setter for all of its citizens, making it the exclusive representative of a citizen cartel. Fossil fuel producers will still want to reduce the fee to zero and replace it with higher oil prices, but they will now have a worthy monopsonist adversary.

For a real world example, we need look no further than Alaska. Despite the fact that its Permanent Fund lost billions in 2008 and had no real profits, Alaskans will still be receiving their cash "dividend" this year, because neither Governor Palin and the Alaskan legislature was willing to tell them no. Because the oligopolists will know that no one wants to be the "politician who stole the rebate," they won't be nearly as likely to test the resolve of our elected officials as they would have been if the money had been flowing anywhere else.

A citizen rebate also gives the U.S. its best opportunity for energy independence. Since our country began, the engine of U.S. innovation and creativity has been private citizens using their own money to make their own investment choices. Both cap and trade and a carbon tax will place the lion's share of the money taken from fossil fuel consumers into the hands of a tiny group of energy barons and government bureaucrats. A citizen rebate will spread that same money amongst us all. Our heritage proves that inventors, investors and implementers spread across our country will be far more likely to find the path to energy independence than a few barons and bureaucrats bivouacked in their taxpayer-supported bastions and bunkers.

A cap and trade program is not the only mechanism that addresses increasing greenhouse gas levels, but it may be the most efficient at transferring money from fossil fuel consumers to fossil fuel producers. A carbon tax is a close second. Fortunately, a citizen rebate provides the same reduction in emissions, and it allows us to keep our collective money in our collective pockets. That money, our brains, and the freedom to get it done provide the best route to a cooler planet and a warmer economy.