Huge Economic Costs of the Lieberman-Warner Climate Change Legislation

Whenever an issue gets wide political notice, Americans can count on Congress to “do something” about it. That’s certainly the case with global warming. But while the science on it is unclear, lawmakers aren’t: They intend to act.

The leading measure is Senate bill 2191 — America’s Climate Security Act of 2007 — spearheaded by Joseph Lieberman (I-Conn.) and John Warner (R-Va.). This bill would limit the emissions of greenhouse gases, mainly carbon dioxide from the combustion of coal, oil and natural gas. Since energy is the lifeblood of the American economy, and 85 percent of it comes from these fossil fuels, the bill represents an extraordinary level of economic interference by the federal government.

Before they act, it’s important for policymakers to have a sense of the economic impacts of S. 2191 that would accompany any possible environmental benefits. The Heritage Foundation’s Center for Data Analysis (CDA) has run the numbers, and they’re sobering.
Our analysis makes clear that S. 2191 promises extraordinary perils for the American economy.

It’s a cap-and-trade bill, capping greenhouse-gas emissions from regulated entities beginning in 2012. At first, each power plant, factory, refinery and other regulated entity would be allocated allowances (rights to emit) for six greenhouse gases. However, only 40 percent of the allowances would be allocated to these entities. The remaining 60 percent would be auctioned off or distributed to other entities. Most emitters would need to purchase at least some allowances at auction. For instance, firms who reduce their CO2 emissions in order to meet the S. 2191 targets would still have to purchase 60 percent of the needed allowances in 2012, and an even higher fraction in subsequent years.

Such arbitrary restrictions predicated on multiple, untested and undeveloped technologies would lead to severe restrictions on energy use and large increases in energy costs. In addition to the direct impact on consumers’ budgets, these higher energy costs would spread through the economy and inject unnecessary inefficiencies at virtually every stage of production and consumption — adding still more financial burdens for American taxpayers.
The recent experience with ethanol mandates illustrates some of the costs and risks created when a government imposes significant new regulations on the energy market. Ethanol production has been bedeviled by unintended impacts on world food prices; unexpected environmental degradation from expanding acres under cultivation; and frustratingly slow progress in commercializing cellulosic ethanol production. In spite of tremendous expense, the production goals set for ethanol are unlikely to be met, and the hoped-for environmental improvements are even less likely to occur. Yet the challenges of the ethanol program are a small fraction of those S. 2191 poses.

One problem is that S. 2191 imposes strict upper limits on the emission of six greenhouse gases (GHG) with the primary emphasis on carbon dioxide (CO2). The mechanism for capping these emissions requires emitters to acquire federally created permits (allowances) for each ton emitted. The cost of the allowances would be significant and lead to large increases in the cost of energy. Because the allowances have an economic effect much like an energy tax, the increase in energy costs creates correspondingly large transfers of income from private energy consumers to special interests.

Over the life of the bill, cumulative gross domestic product (GDP) losses are at least $1.7 trillion and could reach $4.8 trillion by 2030 (in inflation-adjusted 2006 dollars).
In addition to taking a bite out of consumers’ pocketbooks, higher energy prices throw a monkey wrench into the production side of the economy. Contrary to the claims of an economic boost from “green investment” and “green-collar” job creation, S. 2191 reduces economic growth, GDP and employment opportunities.

The Lieberman-Warner bill affects the economy directly through higher prices for carbon-based energy, which reduces demand and, thus, the supply of energy from carbon sources. Energy prices rise because energy producers must pay a fee for each ton of carbon they emit. The fee structure is intended to create an incentive for producers to invest in technologies that reduce carbon emissions during energy production. The bill’s sponsors and supporters hope that the fees are sufficiently high to create a strong incentive and demand for cleaner energy production and for the widespread adoption of carbon capture and sequestration technology.

Generally speaking, the carbon fees reduce the amount of energy used in producing goods and services, which slows the demand for labor and capital and reduces the rate of return on productive capital. This “supply-side” impact exerts the predictable secondary effects on labor and capital income, which depresses consumption.

These are not unexpected effects. Carbon-reduction schemes that depend on fees or taxes attain their goals of lower atmospheric carbon by slowing carbon-based economic activity. Of course, advocates of this approach hope that other energy sources would arise that can be used as perfect substitutes for the reduced carbon-based energy.

Sens. Lieberman and Warner’s climate change bill is, in many respects, an unprecedented proposal. Its limits on CO2 and other greenhouse gas emissions would impose significant costs on virtually the entire American economy. In addition, complicated tariff rules, dependent on evaluating the GHG restrictions of all trading partners, add another unknowable dimension to the costs, fueling the overall uncertainty.

The problems for our economy are increased by S. 2191’s reliance on complex and costly technologies that have yet to be developed. The fact that this large-scale transformation of the economy must occur over relatively tight timeframes only amplifies the costs and uncertainties. The impacts would be felt by every citizen.

Even under a fairly optimistic set of assumptions, the economic impact of S. 2191 is likely to be serious — on the job market, on household budgets, on energy prices, on the economy overall. The burden would be shouldered by the average American. The bill would have the same effect as a major new energy tax — only worse. In the case of S. 2191, increases in the tax rate are set by forces beyond legislative control.

Under a more realistic set of assumptions, the impact would be considerably more severe. More significant than the wealth destroyed by S. 2191 is the wealth transferred, from the energy-using public to a list of selected special interests.

Overall, S. 2191 would likely be — by far — the most expensive environmental undertaking in history.