TCS Daily

If You Build It, They Will Come

By Marlo Lewis - September 10, 2002 12:00 AM

Which climate-related initiative poses the biggest threat to America's economic future? Is it (a) the Kyoto Protocol, with its growth-chilling restrictions on carbon-based energy use, (b) Senator Jim Jeffords' (VT-I) "Clean Power Act," which would impose Kyoto-like carbon dioxide (CO2) controls on the electric power industry, or (c) the recent Kyoto-inspired California law to regulate CO2 from automobiles?

Actually, the most pernicious climate policy is none of these headline grabbers but one most people have never heard of. Although it will not directly suppress energy use, it will mobilize corporate lobbying for Kyoto and dozens of kindred energy rationing schemes like the Jeffords bill and the California law. Surprisingly, the chief sponsor of this political force-multiplier for the Kyoto agenda is Mr. Anti-Kyoto, President George W. Bush.

On February 14, 2002 President Bush directed various agencies to transform the Department of Energy's Voluntary Reporting of Greenhouse Gases program into a program awarding "transferable credits" for "voluntary" emission reductions. The bureaucracy is now moving swiftly to implement Bush's directive.

The President's plan may seem like a technical change in a minor program. In reality - and apparently unbeknownst to Mr. Bush - transferable credits are a recipe for fundamentally corrupting the politics of U.S. energy policy. Transferable credits will grow the greenhouse lobby - the coalition of politicians, advocacy groups, and corporations supporting political controls on energy use.

Mr. Bush's advisors ought to know this, because the Clinton-Gore Administration flogged the idea for years as part its global warming policy.

Originally known as "credit for early action," transferable credits began as a strategy to win corporate and congressional support for Kyoto-style regulation. The pro-Kyoto activist group Environmental Defense was the strategy's chief architect. President Clinton officially endorsed the proposal in October 1997. The Pew Center on Global Climate Change, headed by former Clinton-Gore Kyoto negotiator Eileen Claussen, marketed the plan to corporate America. Kyoto-leaning Senators John Chafee (R-RI) and Joe Lieberman (D-CT) introduced early credit legislation in the 105th and 106th Congresses.

The basic idea was simple: Award credits to companies that begin to comply with Kyoto before it is even ratified, and allow those companies to sell or use the credits to offset future regulatory obligations. In effect, participating companies acquire Kyoto stock that bears dividends if - but only if - Kyoto or similar regulation is ratified or enacted. Credit-holders thus acquire cash incentives to support Kyoto, or lobby for its domestic equivalent.

Although touted as "voluntary" and "win-win" (good for business, good for the environment), transferable credits create a coercive system in which one company's gain is another's loss.

Tradable credits only have value in relation to an emissions reduction target or "cap." If the cap is not to be broken, then every credit awarded for "voluntary" reductions in the "early action" period must be subtracted from the total available in the mandatory period. Thus, for every company that gains a credit in early action period, there must be another that loses a credit in the compliance period. And, consequently, companies that do not "volunteer" will be penalized - forced in the mandatory period to make deeper reductions than the cap itself would require, or to purchase additional credits from early reducers.

The real mischief goes deeper. Since the scheme penalizes non-participants, many businesses will "volunteer" just to avoid getting stuck in the shallow end of the credit pool later on. The intended political result is a critical mass of companies holding carbon coupons - assets that mature only under Kyoto or comparable regulation.

The Bush Administration's rationale for transferable credits is the same as that offered in previous years by Environmental Defense, Clinton-Gore, and Chafee-Lieberman. Without a crediting program, we are told, early reducers will be "punished" under Kyoto - forced to cut emissions from already lowered emissions baselines. Fear of having to do double duty under a future climate policy discourages firms from reducing emissions today. Credits will protect companies' baselines, removing the "disincentive" to voluntary reductions.

This tirelessly repeated rationale fails on three counts. First, there has been no lack of voluntary action to reduce emissions. Reducing emissions relative to economic output is what businesses in market settings do. Emissions are a reflection of material and energy inputs, and competition spurs firms to do more with less. The carbon intensity of the U.S. economy (emissions per dollar of GDP) fell by 15 percent in the 1990s and nearly 50 percent since 1970.

Second, if there is a disincentive to voluntary action, it is created by the presence of Kyoto and other CO2-control proposals, not by the absence of a crediting program. Kyoto and its ilk are what threaten to punish firms that have invested the most in energy efficiency. Those genuinely seeking to promote voluntary action should lobby against Kyoto, not for Son-of-Kyoto crediting schemes.

Third, many of the politicians (Senator Lieberman, Senator Jeffords, Al Gore), advocacy groups (Environmental Defense, Natural Resources Defense Council, Pew Center on Global Climate Change), and companies (British Petroleum, Royal Dutch Shell, Trigen Energy) calling for transferable credits also support CO2 controls. They are in the odd position of demanding "baseline protection" from the very policies they promote. These worthies might as well plead, "We have met the enemy, and it is us!" All Senator Lieberman, Environmental Defense, and BP need do to ensure voluntary reductions are not penalized is renounce their support for the Kyoto Protocol.

"The carbon intensity of the U.S. economy (emissions per dollar of GDP) fell by 15 percent in the 1990s and nearly 50 percent since 1970."
Finally, Bush's transferable credit plan will not only build up the greenhouse lobby, it will also demoralize the friends of energy abundance. After all, why would the President offer credits to protect companies' baselines unless he believes Kyoto or something like it is the wave of the future? Few corporations will resolutely oppose energy rationing if they sense defeatism in the White House.

Confronted with the case against transferable credits, Administration officials offer the following apologia. The President, as an alternative to Kyoto, has proposed to reduce U.S. carbon intensity by 18 percent over the next ten years - 4.5 percentage points more, and 30 percent faster, than the reduction otherwise projected to occur. Only a crediting program can motivate companies to make the extra effort required to reach the goal.

This is all wrong. First, the proposed 18 percent carbon intensity reduction provides no alternative to Kyoto if, as in the President's policy, it is coupled with a crediting plan that fosters pro-Kyoto lobbying.

Second, rather than hail Bush's emphasis on carbon intensity as a bold new approach, environmental lobbying groups uniformly condemn it as an excuse for "inaction." The Administration has yet to learn that when government creates "voluntary" climate programs, it does not assuage demands for regulation. Rather, it legitimizes the alarmism fueling such demands.

Third, and most importantly, there is a better way to decrease carbon intensity: reduce the tax code's bias against capital investment.

Business investment in new capital assets like plant, buildings, and equipment boosts worker productivity and, thus, raises real wages. Productivity gains also enable firms to decrease material and energy inputs - and their associated emissions - per unit of output. In addition, newer equipment tends to be cleaner and more energy efficient than older equipment.

If President Bush feels he must "do something" about global warming, then he ought to champion a true "no regrets" policy - one that reduces emissions intensity by lowering tax barriers to new investment. Perhaps no single reform would deliver more environmental bang for the buck than ending the tax code's use of depreciation rather than expensing to calculate a firm's taxable income.

The tax code does not allow firms to "expense," or deduct from current-year revenues, the full cost of capital investment. Rather, it forces firms to write off capital costs by dribs and drabs, over multi-year periods, based on more or less arbitrary depreciation schedules - guesstimates of how long it takes particular types of assets to wear out or lose value. By allowing firms to deduct only a small fraction of capital costs in the first year, depreciation inflates a firm's taxable income when it hurts most - when the firm actually incurs major expenses for new assets. Replacing depreciation with expensing would eliminate this barrier to economically efficient capital turnover.

A recent study commissioned by the American Council for Capital Formation shows that the United States lags behind many of its trade partners in capital cost recovery allowances for investment in electric power plants, other energy assets, and pollution control technology. "For example," explains ACCF economist Margot Thorning, "after five years, a U.S. company recovers only 29 percent of its investment in a combined heat and power generation facility compared to 51 percent in Germany, 53 percent in Japan, 100 percent in the Netherlands, and 105 percent in China."

Expensing as a means to a greener economy ought to be a no-brainer for Mr. Bush. In March, he signed into a law a "stimulus package" that provides partial (30 percent) expensing for capital investment, on a temporary (three year) basis. But if temporary partial expensing is good, then why not go all the way and propose full permanent expensing?

One caveat is in order, however. Eligibility for expensing should be as broad and non-discriminatory as possible, not restricted to investment in politically correct assets like wind turbines, solar panels, and biomass burners. The tax code is already riddled with too many special preferences. An expensing policy that merely empowered Kyoto partisans to pick winners and losers would be only slightly less toxic than transferable credits.

In March 2001, President Bush honored his campaign pledge to oppose Kyoto by recanting an ill-considered campaign proposal to regulate CO2 from power plants. As the energy battle in Washington builds to climax, the President again needs to act with courage and consistency. Expensing is pro-growth. Transferable credits are anti-growth. If Mr. Bush implements transferable credits and builds the greenhouse lobby, he may well go down in history as "the Kyoto President."

Marlo Lewis is a senior fellow at the Competitive Enterprise Institute.

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