While out today doing our part for the economy (our slang for spending at the mall), the wife and I passed the local coal-fired power plant and got into a discussion about Cap and Trade.  It occurred to me that most of us have heard of it in the media, but may not know what it is.  Here goes:

The idea behind Cap and Trade is that we “cap” the amount of CO2 that companies may emit into the atmosphere, and then we allow them to “trade” with others for permits to exceed their caps.  Pretty straight-forward idea.  But you know what they say about economists and “all other things being equal”.  So there are (un)intended consequences.  Let’s talk about the economics.

Assumption 1:  The government sets an initial price of $10 per ton of CO2.
Assumption 2:  The government sets a “cap” of 100 tons per day on each of 2 power plants for year 1.
Assumption 3:  Each plant emits 120 tons per day today.
Assumption 4:  The government reduces the “cap” for each plant by 10 tons per day for year 2.
Assumption 5:  There are 10 electric customers for each power plant (just to keep the math simple).

Now, let’s examine what happens to revenues, taxes, and, most of all, your money.

Day 1:  Board meetings at both power plants.  Boards wonder how they are going to meet the caps.
Day 2:  Each company “trades” $200 to the government for the right to emit the extra 20 tons per day.

Now the government has $400, the companies are lighter by $200 each.  What do you do if you’re one of the companies?  Well, first thing is you raise your rates to your customers by $20 each (to cover the increased cost of generating electricity).  You don’t have any competition, so you go to the State Public Utilities Commission and add the new “cost” into your rate base.  Voila, your costs are now passed on to the customer.

Meanwhile, customers raise the prices of their goods to cover the increase in their costs.  Hint:  this is called inflation, and we’ve just witnessed one way for it to start.

Now, let’s say one of the power plants reduces its emissions down to the 100 ton per day level.  Wow, they don’t have to pay for any additional “trade” permits.  So they’ve saved $200, right?

Not so fast.  How did the plant reduce its emissions?  Did it build a new smokestack that removes CO2?  Did it cut back on a shift or two of workers, thereby reducing its emissions?  Each of these choices have costs.  Building a new smokestack for, say, $600, would increase costs now by that amount, but in year 4 and in the future would keep their costs from going up by $200.  But someone has to pay that $600.  Guess who?  There are only 2 choices:  the stockholders or the customers.  Someone has to pay.  And what happens in the out years (years 4-10) when the government reduces the allowed “cap” on emissions by, say, 20 tons per year?  You and the board of directors better get cracking on a way to pay for it.  Oh, wait, you really don’t have to worry about it…you get to pass the costs on to your customers.  Don’t worry, be happy.

Moral of the story:  Cap and Trade is a tax…period.  You can’t call it anything else.  If the government mandates it, and it increases costs, then it’s a tax.

YOUR TAXES WILL GO UP WITH CAP AND TRADE.  And the cost of living will go up…remember, inflation.  If you’re okay with that, then you should support C&T.  Just remember…as costs go up, economic activity will be reduced by some amount.  So we’ll get lower growth, or no growth, or a new recession, or a continuation of a current recession, plus inflation, if we implement Cap and Trade.

Oh yeah…what about the $400 the government received in year one, plus all that extra money in the following years?  You think they’ll give it back to us as tax credits?  Doubt it…I suspect spending will go up.  But those tax credits could happen.

PS.  There are several other alternate universes here.  What if the states don’t allow the power plants to pass the “Cap and Trade” costs on to their customers in the form of increase rates?  That money then either comes directly and solely from stockholders (in the form of reduced dividends), or the company goes out of business.  And remember unintended consequences?  What happens to granny when you reduce the dividend?  The price of the stock goes down, and the owners (stockholders) lose investment income as well as the value of the stock.

And in case you say, “too bad for the stockholders”, remember:  your 401(k) might hold some of those utility stocks.  So your retirement is in jeopardy.

Well, don’t worry.  All things aren’t equal.  Your tax increase may vary.