Robert Murphy

Recently Congress took a break from nationalizing corporations and discussed the Waxman-Markey “cap and trade” bill in which the federal government would auction off permits to businesses giving them legal permission to emit carbon dioxide.  During the four days of hearings, one of the most contentious issues was how much the plan would cost.  Some (Republican) opponents cited an MIT study and announced that the average household would pay $3,100 in higher prices because of the program.

To the delight of liberals such as Keith Olbermann, the MIT professor denounced this interpretation as being “wrong in so many ways it’s hard to begin.”  The professor went on to say that households would only pay only $800 per year because of cap and trade, which was certainly much less than the $3,100 figure.  Yet a closer analysis of the professor’s clarification shows that this isn’t a quibble over arithmetic.  His figure of $800 refers to a very subtle economic concept, and is not what most voters probably have in mind when they ask, “How will a cap and trade program affect my family budget?”

Let’s start with the way Republicans came up with the $3,100 figure.  They relied on the MIT study which said that a generic cap and trade program (not the specific Waxman-Markey proposal) would raise an average of $366 billion per year in auction revenues for the federal government over the period 2015 to 2050.

Under a cap and trade scheme, the government sets an absolute cap on how much carbon dioxide industries can emit in the United States, and it enforces this cap by selling a limited number of allowances.  All of the operations (utilities, factories, etc.) covered by the law must turn in the appropriate number of allowances based on how much carbon dioxide they release into the atmosphere each year.  The government gets its revenues from auctioning off these allowances to the highest bidder.  (The “trade” occurs because the allowances can be bought and sold in the market based on the needs of particular firms.)

Naturally, if businesses have a huge new cost imposed on them—they now need to spend $366 billion per year buying emission allowances from Washington—they will ultimately pass this cost onto their customers in the form of higher prices.  To get a ballpark figure of what this would mean, the Republican critics of the plan took the MIT study’s estimate of $366 billion in annual auction revenues, divided by 117 million U.S. households, and came up with the estimate of $3,100 per household in higher prices because of cap and trade.

Robert Murphy

Robert Murphy has a Ph.D. in economics and is the author of The Politically Incorrect Guide to Capitalism (Regnery 2007).

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