Congress Plots to Cap and Spend

Congress is working on a piece of legislation that would increase taxes by almost $750 billion over the next ten years and would then spend virtually all that money, ostensibly in pursuit of a key public policy goal.

You might think I am referring to the health care bills that have been dominating the headlines. Those bills do include substantial tax increases, but not even the House bill gets up to $750 billion. No, the biggest tax-and-spend item on the agenda is the effort to reduce the threat of climate change.

A few months ago, the House of Representatives passed, by a narrow margin, a bill to limit the emissions that cause climate change. The bill’s key feature is a cap-and-trade system for greenhouse gases, such as the carbon dioxide emitted by coal-fired power plants and oil refineries. That system would set a national cap on greenhouse gas emissions and would require emitters to own permits (called allowances) to cover their emissions. Emitters would be free to trade these allowances among themselves, thus encouraging them to pursue the most cost-effective ways of reducing emissions.

The allowances are worth big money. According to the Congressional Budget Office (CBO), the allowances created by the House bill would be worth almost $1 trillion over the next decade, and presumably even more in subsequent decades.

The creation of a cap-and-trade system would thus impose $1 trillion in new taxes on the U.S. economy over the next ten years. And I don’t just mean that rhetorically. The CBO itself characterizes the creation of the allowances as a new source of tax revenue. And it’s right to do so. If Congress created these allowances and then auctioned them off, it would generate $1 trillion in new revenue for the government.

The need to pay for those allowances would, however, put a dent in corporate profits. And some firms would cut back production and either lay off workers or reduce their pay. As a result, the government would receive lower revenues from income taxes (both individual and corporate) and payroll taxes. So the $1 trillion in new allowance revenue would be partly offset by a reduction in other taxes. CBO estimates this effect at about $250 billion over ten years.

The creation of a cap-and-trade system would thus net about $750 billion in additional tax revenues. Not quite a trillion dollars, but still serious money, even in Washington.

I have no objection to the government raising that kind of money through a cap-and-trade system. Climate change is a serious problem and a well-designed system could reduce environmental harm while minimizing costs to our economy.

My concern is what Congress plans to do with those revenues. In principle, the money could be put to many beneficial uses. Our government is bleeding red ink; perhaps we could use it to reduce out-of-control deficits? Or to pay for expanding health coverage? Or maybe, as many economists have suggested, to reduce payroll taxes and corporate income taxes in order to offset the economic costs of limiting greenhouse gases?

Choosing among those options would be a worthy policy debate. Unfortunately, the House bill has taken a completely different path. Rather than help taxpayers or boost the economy, House lawmakers want to give away most of the allowances for free. Electric utilities, oil refiners, and a host of other well-connected special interests would each get a share of more than $750 billion in free allowances, a truly remarkable return on their lobbying dollars.

And the problems don’t end there. The House bill would auction the remaining allowances, raising about $275 billion. Some of those revenues — $116 billion — are needed to offset the reduction in income and payroll taxes that comes from the introduction of a cap-and-trade program. So Congress is left with about $160 billion in additional revenue to work with.

One might hope that Congress would at least use this money to reduce the deficit or boost the economy. But no. Instead, the House bill includes $150 billion of new spending, leaving a net gain to taxpayers of only $9 billion.

In short, a $1 trillion cap-and-trade program would net about $750 billion in new revenues over the next ten years, almost all of which would then be given away or spent. As a result, the budget hawks, health expanders, and pro-growth forces have only crumbs to bargain over. From a budget perspective, the House bill is a disaster.

The Senate is now in the midst of developing its own version of this legislation. The preliminary ideas released last week were noticeably silent on the single biggest issue: how the allowances would be allocated. Taxpayers should encourage the Senate to take a more responsible course and make sure that the resulting tax revenues don’t get entirely frittered away through giveaways and new spending.

In making that recommendation, I should emphasize that auctioning all of the allowances is likely impossible as a political matter. Affected industries have enough clout to oppose anything quite that ambitious. And, indeed, one of the beauties of a cap-and-trade system (from an environmental point of view) is that politicians can use free allowances as currency to reduce opposition to the policies. In addition, it is appropriate that the bill takes some steps to help the poor adjust to the higher cost of energy that would result from the bill.

Neither of those caveats, however, takes away from my larger point that the bill does nothing to address our larger budget or economic problems. Compensating the legitimate concerns of industry and the poor might require that the government give away some allowances. But there is no way it can justify giving away or spending 99% of the allowance value.

Some political horse-trading is inevitable when bills of this magnitude come before the Congress. Unfortunately, as the House bill shows, such horse-trading can easily transform into the pure politics of pork. When the deal-making gets done, it’s important that the taxpayer have a voice at the table. But when you see so much money going out the door, you have to wonder whether the taxpayer is even in the same building as the table. Let’s hope the Senate does better.