International Cap-and-Trade Taxation: U.S. Beware!

The American Clean Energy and Security Act (H.R. 2454, aka the Waxman-Markey climate bill) and the American Power Act (aka Kerry-Lieberman climate bill) both contained explicit provisions to create not just a U.S.-side cap-and-trade program for carbon dioxide (CO2) but also a single, transatlantic emissions trading scheme.

The problem is that even if cap-and-trade is dead in the U.S. Senate, its advocates remain committed and have options for international action. The more this can be understood, the more the electorate can reject U.S.-side help for a futile, costly international scheme to regulate CO2 in the name of “stabilizing” climate.

A clear warning that supranational cap and trade was planned beyond the EU’s borders came in a speech last May by the European Commission official Jos Delbeke, Deputy Director General DG Environment. He told an audience in Berlin that:

“We are confident that we now have a solid system from which we can link up to similar schemes elsewhere in the world. The EU’s goal is indeed a global carbon market.…

The EU ETS and the future U.S. cap-and-trade system – integrated into a transatlantic carbon market – can be the twin engines driving the OECD-wide carbon market. The progress on domestic legislation in the U.S. is an essential step in this regard and we are encouraged by Congressional timetables for getting draft legislation to a floor vote in the coming months.”

I recently spoke to Adam C. T. Matthews, the Secretary General of an organisation called GLOBE International – an environmental policy talking shop for parliamentarians, who told me that this this is something “which Europe was desperate for”. They think that the carbon market could be in serious trouble without it.

Those drafting cap and trade legislation in the United States haven’t let their European counterparts down. In Waxman-Markey there is explicit provision to link with other cap and trade schemes. The conditions are set out in Section 728. International Emission Allowances:

“The Administrator, in consultation with the Secretary of State, may by rule designate an international climate change program as a qualifying international program if—

(1) the program is run by a national or supranational foreign government, and imposes a mandatory absolute tonnage limit on greenhouse gas emissions from 1 or more foreign countries, or from 1 or more economic sectors in such a country or countries; and

(2) the program is at least as stringent as the program established by this title, including provisions to ensure at least comparable monitoring, compliance, enforcement, quality of offsets, and restrictions on the use of offsets.”

For approved programmes – and the intention is clearly that the European Union Emissions Trading Scheme (EU ETS), at least, would qualify – emissions allowances from abroad are interchangeable with those granted in the US. Section 722. Prohibition of Excess Emissions makes that clear:

“To demonstrate compliance, a covered entity may hold an international emission allowance in lieu of an emission allowance, except as modified under section 728(d).”

The American Power Act includes very similar provisions for international emission allowances in Section 728. International Emissions Allowances:

“The Administrator, in consultation with the Secretary of State, may by rule designate an international climate change program as a qualifying international program if—

(1) the program is run by a national or supranational foreign government, and imposes a mandatory absolute tonnage limit on greenhouse gas emissions from 1 or more foreign countries, or from 1 or more economic sectors in the 1 or more countries; and

(2) the program is at least as stringent as the program established by this title, including provisions to ensure at least comparable monitoring, compliance, enforcement, quality of offsets, and restrictions on the use of offsets.”

And for them to be used in place of other allowances in Section 722. Prohibition of Excess Emissions:

“To demonstrate compliance, a covered entity may hold an international emission allowance in lieu of an emission allowance.”

Once the EU ETS was declared a qualifying international program there would be no functional difference between allowances under the two schemes. That would produce a single carbon market with prices the result of decisions made on both sides of the Atlantic. The idea is that other countries like Canada, Australia and Japan would follow suit and we would soon have a single developed world cap, with the developing world involved through the Clean Development Mechanism.

Cap and trade for CO₂ has always been a very different beast to the US SO₂ trading scheme that inspired it. There are around 11,500 installations regulated by the EU ETS against a few hundred involved in SO₂ trading. Carbon dioxide is a far more essential part of the combustion process that has driven modern industrial economies since the Industrial Revolution.

And of course the SO₂ trading scheme itself has recently proved susceptible to the instability that plagues any artificial market, as changes in SO₂ regulation have caused prices to crash.

But the advent of transatlantic emissions trading takes us even further beyond the limited experience we have of a reasonably effective cap and trade scheme. Trying to ration fossil fuel energy across different countries brings entirely new challenges. The experience of the EU ETS, itself a supranational scheme, makes some of those challenges clear.

It creates opportunities for criminals. In the EU carbon trading has made possible huge Value Added Tax (VAT) carousel fraud schemes. Europol reported late last year that fraudsters had ripped off governments to the tune of €5 billion. They estimated that “in some countries, up to 90% of the whole market volume was caused by fraudulent activities.” It probably won’t be that particular fraud that we see in a transatlantic scheme – unless the US adopts a VAT of its own, but it is widely thought that criminals will find other opportunities with an artificial product that can be created and traded across a number of jurisdictions and moved so easily.

More importantly, in any supranational cap and trade scheme one member can profit at the expense of the others by creating more allowances. They can give those valuable allowances to their companies or auction them to raise revenue. That creates a transfer from other countries that have instituted a tighter cap. As Iain Murray and I explained in the Washington Times, that is exactly what happened to Britain in the first Phase of the EU ETS. As other countries were more generous with their allocations of allowances, British firms made an unjustified transfer of £500 billion a year to their rivals on the Continent.

It is hard to predict who would lose out in a transatlantic ETS. Europe has generally put in place tougher targets. But the way the US is governed would make it much harder to be flexible in the event of, for example, a spike in prices as the economy recovers and demand for permits leaves supply behind. The European Commission has already failed to stop countries allocating what it felt to be an excessive number of allowances once. It argued that the National Allocation Plans of Estonia, Poland and the Czech Republic were a combined 102.9 Mt CO₂ too high but lost in the European Court of First Instance.

Of course, if they felt the Europeans were taking advantage of them, those running US cap and trade could remove the status of the EU ETS as a qualifying international programme. But it is hard to see much appetite among politicians keen on cap and trade for such a nuclear option that would cause enormous disruption in the carbon market.

The most likely casualty is democratic control over the cap. Targets would either become much more inflexible and might even be much more closely defined in international treaties. Or control could be handed to some budding international equivalent of the European Commission.

U.S. Beware

It is really important that the U.S. doesn’t sleepwalk into a supranational ration on fossil fuel energy that would have huge implications for its economy and democracy. Hopefully the opponents of cap and trade have done enough to stop that happening.