Although President Obama has not suggested specific legislation to regulate greenhouse gas emissions, his proposed budget clearly signals that he will be pushing for a cap and trade program. This is no surprise as President Obama supported cap and trade legislation as a Senator. However, there is a twist. Analysts and pundits have long touted cap and trade programs as a way to control greenhouse gas emissions by creating a regulated marketplace that will encourage greenhouse gas emissons through economic incentives as opposed to a straight regulatory approach or a taxation approach. However, the budget projections by the Obama Administration foresee tax revenues from the cap and trade program beginning in 2012 that total $80 billion per year or $646 billion over eight years. This estimate clearly makes several assumptions:

1. As allowed emissions are “ramped down,” there will be a sellers market for allowances. At some point it will be cheaper to pay a tax than to buy the allowance. The Administration is obviously counting on this happening in order to generate the $80 billion in revenue per year.

2. The allowed emissions can be set each year to extract a certain amount of revenue. This may be true as emission controls are currently highly regulated and this is an inelastic market. It takes more than one year from inception to flipping the switch to make any modifications to existing emission control equipment. This is especially true of major utility plants. It could easily take four to six years in order to implement major changes. The Administration may end up in the perverse situation of needing industry to fail to comply in order to generate needed tax revenues.

3. A break-even point exists not only on the question of buying allowances vs. paying the tax, but also on adding the greenhouse gas capture equipment in order to avoid either the allowance or the tax.

Warren Buffet, whose investment company owns MidAmerican Energy, a major Midwestern utility, has of course criticized the proposed cap and trade program as “regressive.” He has a point. Major utilities are regulated by each state. The profit they are allowed to keep and the expenses they can pass through to consumers is set by utility boards and commissions (at least for the regulated side of the business). As noted above, it can take a long time to add pollution control equipment given the regulatory hurdles faced by utilities. It is quite likely that major utilities will be forced to either buy allowances (or “credits”) or pay the tax. This especially true for the majority of those utilities as they rely on coal for power generation. It is likely that the need for major utility companies to bring their emissions into compliance will outstrip both their ability to reduce those emissions and the market’s ability to generate allowances. Therefore, paying a tax will be the only reasonable outcome for those utilities, at least for the first five or six years. Those taxes will be immediately passed through as operating expenses to the consumers. Although people may believe that the big coal-burning power plants are “finally paying for it” that belief will evaporate when they open their utility bill.

Is this all bad? An economist might point out that ultimately, all economic activity is driven by the consumer. If consumers are given the bill for greenhouse gas emission reduction, then that consumer can make a decision. The consumer can reduce power consumption or seek alternative “greener” sources of power. The consumer can decide that the cost exceeds the risk of global warming and vote in politicians willing to favor cheap coal-based power. Or, the consumer may support research and development of alternative power sources, including nuclear, wind, and solar energy, whether through taxes or the redirection of some of those tax revenues. In fact, the Administration’s budget projections assuem that $150 billion of revenue will be returned to industry for exactly that purpose.

Some people contend that we have long subsidized cheap power at the cost of the environment. If this is true, then passing those “regressive” costs down to the consumer will take a step toward putting some balance back into energy use decisions. If false, then we have a way to pay for the bailout.

James L. Pray