Thursday, March 5, 2009

Obama's Green Offensive against Investors

The Obama budget aims to raise $645.7 billion dollars through 2019 by selling green-house gas permits to emitters. The administration calls this plan a "cap and trade" program for the control of greenhouse gas emissions. But the Obama plan is quite different from the cap and trade program in force in Europe or that proposed in 2007 for the United States by Joe Lieberman (and endorsed in principle by John McCain). The European system and the Lieberman plan allocate rights to emit greenhouse gases to existing emitters. Such plans reduce emissions by reducing in subsequent years the amount of greenhouse gases these certificates permit.

The Obama plan, by contrast, calls for one hundred percent of the rights to emit to be auctioned off by the government. The industrial plant of emitters, therefore, whether we are speaking of coal-fired power plants, steel factories, or oil refineries, will be worthless without the permits.

The effect of the Obama scheme will thus be to auction off the investments in existing emitters to the purchasers of emissions permits. Obama's scheme for "a hundred percent auction," as he called it during the campaign, is in fact an expropriation of the capital invested in emitting plants. Obama wants to expropriate capital for the benefit of the government, which gains the revenue from the sale of permits.

Such a capital levy is bad economics, destructive of investors' confidence not only in the prospects of emitting corporations but in the Obama administration's attitude toward investment capital as a whole.

A capital levy of this kind is bad economics because it poses the threat of subsequent capital levies in future years. The problem was demonstrated by the economists Finn Kydland and Edward Prescott in a 1977 paper which helped win them the 2004 Nobel Prize. If auctioning off the industrial plant of "carbon polluters" is a good idea in 2009, Kydland and Prescott teach us to ask, why not do it again in 2010? All one has to do is auction off a new set of required permits and raise further revenue in 2010. True, such a move would expropriate those who bought permits in the 2009 auction, but if expropriating the original owners didn't bother us back in 2009, why should expropriating the new owners in 2010?

Stock markets have declined precipitously since the inauguration in good part because of the threat that something like Obama’s “one-hundred percent auction” will be implemented. Stocks of carbon emitters, especially utilities, have taken a big hit because of the threat of government seizure of the value of their assets. Moreover, investors fear that similar "one hundred percent auctions" are in store for other sectors of the economy as well. Imagine how much revenue can be raised by expropriating the value of nuclear power plants if the government auctions off the right to store nuclear waste, or from the HMO industry if the government auctions off the right to bill Medicare, or from the pharmaceutical industry if the government auctions off the right to sell FDA-approved drugs.

Of course, this path paved with capital levies is the road to ruin for investors, that is to say pretty much everybody with a pension plan, 401-K, IRA or life insurance policy. What is bad for investors is bad for the American economy as a whole. Avoiding such policies, as Prescott says in his 2004 Nobel lecture, is the most important thing the government can do to produce economic success, or in America's current plight, economic recovery.

Because the Obama plan is bad economics, it also violates the economic reasoning embodied in the Fifth Amendment of the Constitution, which forbids the taking of private property for public use, "without just compensation." The Obama plan takes the private property of investors in emitting plants, and raises revenue precisely to the extent that it denies these investors just compensation. If the relevant public purpose is control of greenhouse gas emissions, a genuine cap and trade program as proposed by Senator Lieberman answers the purpose without engaging in unconstitutional raids on our savings.

Fortunately there are effective steps that legislators can take to stop the Obama scheme before it does any more harm. The first step is for enough Democrats to join with Republicans to keep the Obama plan from being rammed through in the budget process, which does not allow for debate sufficient to air the economic and constitutional difficulties with the Obama plan.

When control of greenhouse gas emissions comes up in the ordinary legislative process, it is the duty of legislators to consider some variant of the Lieberman scheme. That plan at least avoids expropriating capital, because it gives the emission rights largely to the existing emitters. Some of those existing emitters would doubtless shut their plants, finding it more profitable to sell their emission rights to more efficient emitters. A coal-fired power plant, for example, might turn off the boilers and sell its allocation of permits to a natural gas-fired power plant, because natural gas-fired power plants produce about twice the amount of electricity that coal-fired power plants do for the same emission of greenhouse gases. But the lost investment in the coal-fired plant would be compensated by the resale value of the emissions permits.

As the Europeans have learned through hard experience, any cap and trade scheme will impose large burdens on consumers through higher prices for electricity, gasoline, and pretty much the whole range of manufactured products. This is reasonable if greenhouse gas caps will indeed do enough to mitigate climate change to outweigh the caps' very large costs.

But however that scientific and economic debate should go, allocating the right to emit to existing emitters, along the lines of the Lieberman scheme, accomplishes the putative public purpose of reducing greenhouse gas emissions without threatening investors or the Constitution.

Levis A. Kochin, Department of Economics, University of Washington
Michael S. Kochin, Department of Political Science, Tel Aviv University (corresponding author)