Currently, U.S. companies face no limits on their emissions of greenhouse gases. A lack of any constraint means that U.S. industry has been able to choose manufacturing methods and technologies that minimize their costs without consideration of their impact on atmospheric greenhouse gas concentrations. In economic terms, greenhouse gas emissions have been external to the internal decision-making processes of companies. Having companies put a non-zero weight on emissions is the first step in cutting emissions.
The fairest policy would seem to be one that requires all companies to reduce their emissions by the same percentage. But economists have shown that such a uniform policy can greatly increase the total cost of meeting a target reduction. It makes more sense for companies that can most easily reduce greenhouse gas emissions to do the greatest share of the cutting, thereby allowing other companies to continue to emit, as long as the overall target is met.
Two policies can achieve efficient emission reductions: a carbon tax and a cap-and-trade program. Under a carbon tax (or a carbon dioxide equivalent tax for nitrous oxide and methane), companies choose to either emit and pay the tax or cut emissions. A straightforward calculation will reveal the best alternative. Companies that can easily cut their emissions will do so. Those that cannot easily cut emissions will pay the tax. The tax is set at a level that increases the price of carbon enough to induce companies to cut their emissions enough to meet the overall targeted reduction.
Under a cap-and-trade program, overall emissions are capped. Companies are free to emit as much as they want as long as they have a permit for each ton of emissions. The trade part of the program allows companies to buy and sell the permits. Those companies that can easily reduce emissions can make money by cutting their emissions and selling their excess permits. Companies that find it too expensive to cut emissions can buy permits and continue to emit.
The key for either policy option is to increase the price of emission, which automatically creates a profit incentive for companies to figure out whether it is better to cut emissions or pay to emit. Thus, it doesn't really matter which option is adopted. What does matter is increasing the cost of emitting greenhouse gases, which in turn will automatically increase the cost of producing those goods that currently result in large greenhouse gas emissions.
The industries that are targeted by the House bill are electric utilities, oil refiners, natural gas producers, and some manufacturers that produce energy on site. This means that the price of electricity, gasoline, diesel fuel, home heating oil, and natural gas will increase. It naturally follows that products that rely heavily on these energy sources will also become more expensive.
Although agriculture contributes about 6.7 percent of total U.S. greenhouse gas emissions, it faces no future emissions cap under the House bill. This does not mean that agriculture will be unaffected by the cap-and-trade program in the energy sector. Higher energy costs will translate directly into higher prices for electricity, propane, and diesel fuel, and domestically produced fertilizer and pesticides. The cost of producing fertilizer and pesticides in other countries will not be directly affected by U.S. legislation, but if other countries limit their greenhouse gas emissions, then their production costs will also increase.
Source: Bruce A. Babcock, babcock@iastate.edu, 515-294-6785