Contents of the "Inflation Reduction Act"

Please let me know how this so-called "Inflation Reduction Act" reduces inflation.  Here's what's actually in it:

Major items

• Alternative minimum tax for corporations Sec 10101
• This raises the level of business taxation, which reduces real wages.
• IF it reduced the dispersion of business taxation, that would be a force toward increasing real wages to help offset the level effect.  BUT see below on the dozens of IRA provisions that increase the dispersion of business taxation.
• Gives the Treasury Secretary the authority to determine an individual corporation's tax liability!  Sec 10101 (a)(2)(C), (a)(13)
• [I changed my mind: I want to be Treasury Secretary!]
• Close the "carried interest loophole" Sec 10201
• $80B for IRS Sec 10301


• 3 types of drug price controls
• Prices set by HHS for selected Medicare drugs Sec 1191 [I think the Senate typist meant Sec 11091]
• Inflation rate cap for Part B drugs (obtained at hospitals and clinics rather than pharmacies) Sec 11101
• Inflation rate cap for Part D drugs (obtained at pharmacies) Sec 11102
• Medicare Part D (i.e., drug plans for seniors) insurance-benefit floors and reduced subsidy rates Secs 11201-11202, 11401
• Both benefit floors and subsidy-rate cuts will increase Medicare Part D premiums.  The net result could be more subsidy $ and more drug-plan expenses for most seniors.
• One insurance-benefit floor (Sec 11201) requires that enrollees have 100% of their pharmacy bill covered after they have spent $2k for the year.  Another (Sec 11202) does the same on a monthly basis (roughly $150 per month).
• A third insurance-benefit floor is for vaccines Sec 11401
• Zero is a dangerous number for a price!
• The 80% Medicare subsidy associated with these transactions is cut sharply.  This by itself would reduce distortions in the program.
• Remember that Part D premiums are already about 75% subsidized.  At that rate (which will increase -- see below), the government expense for Part D could well increase.  
• Increases in subsidies for Medicare Part D premiums Sec 11404
• Specifically, expanding eligibility for "low-income" premium subsidies
• Budget gimmick courtesy of Alex Azar: repeal rebate rule Sec 11301
• This rule would have prevented drug manufacturers from competing for Medicare Part D business by offering rebates, thereby sharply increasing Medicare Part D premiums and the government's Part D expenses.
• On paper, repealing this rule would reduce the federal deficit.  However, many expect that the rule would be struck down in court (regardless of whether the IRA repeals it), especially now that agencies have less latitude in reinterpreting statutes.  Hence this savings is a budget gimmick.
• I explain in Chapter 10 of yourehiredtrump.com how HHS Secretary Azar concocted this rule.  We warned him and Trump that Democrats would, via a budget gimmick like this, use the rule to "fund" their big-government programs.
• Extend the "temporary" Obamacare expansions that were put in place during the pandemic Sec 12001


• Clean energy tax credits Secs 13101-13802
• 291 pages of the Green Dream!
• Interestingly, Sec 13105 increases credit for nuclear power plants, but just those already built.  Intended to slow down nuke-plant closures?
• Otherwise "clean" refers to the various technologies that are in vogue, including bio fuels and battery manufacturing
• Get a tax credit for purchasing a used Electric Vehicle Sec 13402
• $4K or %30 of sale price
• But only for households with AGI less than $150K and EVs selling for less than $25K
• Must go through a car dealer
• Limit of one credit per vehicle lifetime
• Limit of one credit per taxpayer per 3 years
• As a result, the federal government will be granted EV credits when:
• EVs are produced,
• EVs are sold new, and
• EVs are sold used
• $20B for agricultural conservation programs Secs 21001 and 21002
• Appropriations for clean energy programs ($80-85B total)
• Another 100+ pages of the Green Dream, not to be confused with clean energy tax credits (291pp).
• $2B subsidies for "Electric loans for renewable energy" Sec 22001
• Biofuel subsidies Sec 22003
• $10B for rural electric cooperatives Secs 22004 and 22005
• $15B for Greenhouse Gas Reduction Fund Sec 60103
• $1B for HUD clean energy projects Sec 30002
• $3B for NOAA climate resilience projects Secs 40001-40007
• $10B to subsidize switching from natural gas appliances to electric Secs 50111-50123
• $1B to subsidize zero building energy code adoption Sec 50131
• $14B for DOE loans and grants Secs 50141-50145
• $3B for electricity transmission subsidies Secs 50151-50153
• $6B for the Office of Clean Energy Demonstrations Sec 50161
• $2B various other DOE Secs 50171-50173
• $1B for clean heavy-duty vehicles Sec 60101
• $3B for clean energy programs for ports Sec 60102
• $6B for various pollution-reduction programs Secs 60113-60116
• $3B for Environmental and Climate Justice Grants Sec 60201
• $5.5B for various other clean energy/environment Secs 60502-60506
• $3B for USPS clean fleet Sec 70002
• Taxing fossil fuels
• Increase royalty rate on offshore oil and gas by about 4 percentage points Sec 50261
• Increase royalty rate on onshore oil and gas by about 4 percentage points Sec 50262
• Both royalty rates are expanded to flared gas Sec 50263
• Methane Emissions Charge Sec 60113
• Permanent extension of tax on coal Sec 13901
• Roughly $1 per ton.  For context, coal prices were sometimes below $50/ton before the pandemic

Smaller items

• Eliminating cost sharing for vaccines in Medicaid and CHIP Sec 11405
• Changes to Medicare payments for biosimilars (Secs 11402 and 11403)
• Reinstate superfund Sec 13601
• Research credit for small businesses Sec 13902
• $5B for forestry subsidies Secs 23001-23005
• $0.5B to further carry out the 1950 Defense Production Act Sec 30001
• $1B for National Park Service and Bureau of Land Management Secs 50221-50223
• $0.6B various water Secs 50231-50241
• Regulation of offshore wind leasing Sec 50251
• Some kind of extension of offshore leasing program Sec 50264
• Limit encroachment of offshore windmills onto areas under lease for offshore drilling Sec 50265
• Various other DOE and DOI Secs 50271-50303
• Various other EPA programs (less than $1B) Secs 60104-60112
• Small amounts for Council on Environmental Quality Secs 60401-60402
• $4B for Endangered species programs Secs 60301-60302
• $2B for Neighborhood Access and Equity Grant Program Sec 60501
• Various other Sec 70001, 70003-80004

The Hidden Increase in Capital Taxation

The taxation of business income is now increasing significantly, without any action from Congress.  The increase can be understood as two forces acting through one simple formula.

For tax purposes, depreciation is a statutory time path of deductions from a business' taxable income for each dollar invested in a real asset.  The path is called "depreciation" because the undiscounted present value of that time path is equal to one.  That is, 100 percent of every dollar invested will someday be available as a deduction.

One simple formula representing two shocks: D/(D+R)

An important reason that business-income taxation distorts investment is that business owners  evaluate time paths at a discount rate R > 0.  Therefore, in present value, only a fraction (z, in the usual notation) of investment is deductible from taxable income.

With constant depreciation (D) and discount (R) rates, z = D/(D+R) <= 1.  This simple formula captures two things going on right now in the U.S.: the sunsetting of TCJA's bonus depreciation and inflation.  (The former is specific to the U.S. but the latter is relevant for those nations that also tax business income while allowing depreciation deductions).

TCJA allowed the expensing of some investment, which makes z = 1 (think of expensing either as R = 0 or infinite D).  Expiration of expensing pushes z below one.

The depreciation schedule is a nominal time path; depreciation allowances are not indexed for inflation.  Therefore the appropriate discount rate R is a nominal interest rate.  Clearly nominal interest rates have increased over the past year and a half (inflation!), which reduces z in all but the expensing case.  Indeed we can ignore the expensing case if we take the sunsetting first and then add in inflation.

Quantitative results

In order to translate reductions in z into increases in the effective real price of investment, I use a special case of the Hall-Jorgenson formula, where the pre-tax real price is inflated by the tax factor (1-tz)/(1-t) <= 1, were t is the statutory rate of taxation of business income (Cohen, Hassett, and Hubbard consider the more realistic, but also more complicated, cases).  The equality holds only when z = 1 (i.e., expensing).

The chart below shows the relation between the nominal interest rate R and the tax factor.  We start close to the origin with low inflation and bonus depreciation.  Sunsetting by itself moves off the origin to (pre-inflation) R of, say, 2-3%/yr.  That is about a 7 percent increase in the real price of investment.

Next inflation increases R.  So far annualized R appears to have increased about 2 percentage points although there are concerns that it could increase more (presumably it would increase close to 1-for-1 with inflation if inflation were expected to be permanent).  That increases the real price of investment another 4 percent or so.

Inflation further increases the real price of investment due to personal income taxation, especially to the extent that personal income is taxed at higher personal rates than business income is.  On the other hand, the sunsetting of expensing is not relevant for structures because they did not get bonus depreciation.  So perhaps all three effects combined increase the price of investment 15 percent, with about half specific to TCJA.

Oil and gas

Oil and gas extraction is particularly capital intensive.  Using a capital share of 71 percent, that suggests an 11 percent shift (upward) in the marginal cost for that industry, with about half due to TCJA subset and therefore not shared by foreign producers of oil and gas.

Comparing the period of the Biden presidency (Feb 2021 - Feb 2022, which is latest available) to 2018-19, inflation-adjusted world oil prices have increased 20-25 percent while US O&G industry marginal cost has shifted up 11 percent.  That by itself would blunt much of the supply response.  Then add:

• new threats of federal energy and banking regulation,
• threats to increase the statutory rate on business income, and
• the effects of ESG investing that increasingly stigmatizes investment in fossil fuels,

and it should be no surprise that U.S. supply hardly responded in 2021 to high oil prices while suppliers in Canada, Russia, China, Norway, and even OPEC did.

New Emissions Regulations are Coercive Paternalism, not Environmental Science, or even Benevolent Paternalism

Trump's CEA showed, based on credit transactions among manufacturers, that vehicle standards to abate a ton of CO2 cost about $163 on the margin, while even Obama said the abatement was worth only $50.  i.e., tightening emissions regulations fails a cost-benefit test by a wide margin.

Now Biden claims that new stricter standards pass a cost benefit test.  Although this will be cast as an environmental issue, the new conclusion is driven by assumptions unrelated to environmental economics or climate science:

(1) Consumer fuel savings get (mostly) double counted because "behavioral economics."  Specifically, 

"The agency’s analysis assumes that potential car and light truck buyers value only the savings in fuel costs from purchasing a higher-MPG model they expect to realize over the first 30 months they own it. Depending on the discount rate buyers are assumed to apply, this amounts to 25-30 percent of the expected savings in fuel costs over its entire lifetime." (p. 420 of DOT's final rule)

This double counting (100 - 27.5% = 72.5% of $98 billion in fuel savings) is more than quadruple the purported $16 billion net benefit shown in Table VI-11 of the final rule.

[I call it double counting because, by the principle of revealed prevalence, fuel savings is already built into the price and sales of fuel-efficient vehicles; many consumers do not purchase such vehicles because of the relative price and characteristics of competing vehicles.  Alternatively, you could say that DOT ignores benefit of low-MPG vehicles, but the revealed-preference result is the same. 

Following an Economics 301 homework solution from October 2019, in December 2020 Trump's CEA provided a vector proof -- that the market price for GHG credits (i) reflects fuel savings as consumers perceive them and (ii) fully quantifies the industry-level real GDP effects of changing GHG standards, without any additional term for fuel savings -- on the White House website.  See the appendix of this document.]

By comparison, the gross climate benefit is purportedly $27.5 billion.  i.e., they would have to more than double their already inflated "social cost of carbon" to push their thumb on the scale as vigorously as they did with "behavioral economics."  See below for more on paternalism.

(2) Biden says that some tightening comes for free because 5 manufacturers had already signed a pledge with California EPA to so tighten

But this ignores that California rules, when followed by just a subset of manufacturers, do not reduce the supply of federal credits, whereas changes in federal rules do even if the federal rules are not as strict as California's.  The equilibrium credit price is built into the prices paid by purchasers of new cars.

(3) When the above are enough to tilt the scale, all costs and benefits are discounted 3%/yr.  When an extra push is needed, Biden discounts environmental benefits at 2.5% per year while everything else is discounted 3%/yr.

"the use of the social rate of return on capital ... inappropriately underestimates the impacts of climate change for the purposes of estimating the SC-GHG. ... the consumption rate of interest is the theoretically appropriate discount rate in an intergenerational context." (p. 547 of the Technical Support Document.  See also p. 573 of the final rule.)

More on coercive paternalism

Trump's DOT and EPA spoke forcefully against paternalism as a justification for fuel standards.  If people lack knowledge, give them the knowledge rather than imposing a decision on them.  Here is how they said it

"the idea that regulating fuel economy and CO2 emissions can mitigate the consequences of inadequate access to information by placing decisions that depend on access to complete information in the hands of regulators rather than buyers has superficial appeal. Yet commenters do not establish that such a drastic step is necessary to overcome any inadequacy of information, or that requiring manufacturers to supply higher fuel economy will be more effective than less intrusive approaches such as expanding the range of information available to buyers." (85 FR 24608, italics added) 

In contrast, Biden's DOT and EPA say nothing like this, but instead extol the purported virtues of "behavioral economics."  They do not mention less intrusive approaches, let alone show why they would have fewer net benefits.

Revised Build Back Better: Cliffnotes

Hidden Work Disincentives

I had been tracking 13 types.  Three disappeared from today's revised bill.  The Medicaid expansions appear to be less.  Affordable housing was cut in half (still at $150B).  Dems once aspired to allow union dues to be tax deductible but that was cut.  Many other pro-union provisions remain.

The new childcare program has now replaced an income phaseout above 250% median income with a cliff.  This change from last month's bill to lastest draft has little effect on the average marginal tax rate because the same funds are being phased out over a narrower range.  I.e., a few people see very large additions to their marginal tax rate while others disincentivized with a phaseout now see no addition.

The "green energy" provisions have a lot of producer-protectionist elements in them, which add to the labor wedge much like excise taxes do.  However, the green energy provisions were scaled back in today's revision.

The Obamacare expansion (pp. 1458ff) is a bit more aggressive than last month's BBB bill.  The revision stops indexing -- ie health insurance gets more expensive over time and it is 100% taxpayer problem rather than plan members'.

My summary of marginal-tax-rate and employment effects are shown in the table below.  More derivations are available in my report although that report refers to last-month version.

Hidden Marriage Disincentives

Replacing the childcare phaseout with a cliff increases the (already remarkably large) marriage disincentive because even a father with moderate earnings will, if he joins the family, push them beyond the range of eligibility.  I.e., the family with married parents will likely be paying full price.  The various, and extreme, provisions to inflate the full price of childcare remain in the revised bill.

Pharma scores two wins

The news came out early that this bill would not have prescription-drug price controls.  But it also allows Trump's terrible rebate rule to continue.  Even Biden was expecting the revised bill to contain a repeal, with much savings in corporate welfare that could be put toward "transforming America."  Should I start calling it "Biden's terrible rebate rule"?

Employers are still the enemy

The revision maintains the directive for OSHA to increase employer fines by at least 10X (Section 21004).  Among other things, a private-sector employer with an unvaccinated employee on the payroll will be punishable by a fine of up to $1,365,320 PLUS up to $136,532 per day that employment continues (yes, $51 million per employee per year; note that the statute dictates specific amounts and that the amounts be annually indexed).  This far exceeds the social cost, if any, of employing such a person.

However, revised bill does not mandate employers to provide retirement accounts.  I am expecting this onerous mandate to show up in the new retirement bills introduced this week in House and Senate, but for now this element of freedom remains in employer-employee relations.

"They desperately tried to prevent the truth..."

"They desperately tried to prevent the truth about the Famine from reaching the ears of the higher ups."

Raleigh, Helen. Confucius Never Said (p. 25).

Raleigh and others have described the problems in Mao's China and Stalin's USSR with communication up the political hierarchy.  But of course for Americans that history is hardly relevant.  In the USA, truth reaches the higher ups because we have democracy, a free press, and modern technology.  And we don't have famines.

But we do have an opioid epidemic.  Below we see how it took almost 20 years for the U.S. government to pay attention, as measured by word frequencies ("opioid" or "opioids") in the Federal Register.

Only in 2017 did the opioid epidemic get as much attention as climate change.

Alternatively, we could look at the Congressional record, where the words "opioid" or "opioids" appeared exactly zero times as recently as 2014 (a year in which "climate change" appeared over 300 times).

Species Protection and Technology

Copyright, The New York Times Company

Advances in genetics may change aspects of environmental policy in the future.

Protecting endangered species is a legitimate goal for public policy. But we cannot expect that public policy will prevent all species extinctions, because scientists estimate that hundreds of species, if not thousands, become extinct every year, many without our knowledge.

A rational approach to protecting endangered species would balance costs and benefits. Landowners bear many of the costs, because they can lose title to land that is home to an endangered species or be restricted in how they can use their land. Businesses bear some costs, too, as they are sometimes required to alter their activities to protect an endangered species.

Our planet benefits from biodiversity, and there can be a large “option value” to helping an endangered species live another generation. We can change our minds at some later date and no longer try to prevent a species’ extinction. But it would seem impossible to change our minds in the other direction — once a species is gone, it would seem too late to decide that we wish we had protected it.

But technology may be changing the option-value calculation, because scientists are learning how to clone extinct animals. The time will come when scientists will produce living versions of previously extinct animals. With enough time, they would probably be able to do so cheaply.

To the extent that cloning will someday be possible, the option value of preserving an endangered species is a lot less. In some cases, it may be cheaper to save some DNA, and let a future, richer and perhaps more enthusiastic generation make its own copy of the species.

One objection to the cloning approach is that cloning is itself too expensive. That’s true with today’s technology, but future genetic technologies will invariably be more efficient (cheaper for what they produce).

Another objection is that a cloned species would not be genetically diverse enough to survive, because it would be cloned from just a few DNA samples. But that objection also springs from today’s technology. Scientists may learn to save a genetically diverse DNA sample or even to produce genetic diversity themselves.

Yet another objection is whether we would have room in the future to house a cloned species. But it would seem to me more space intensive to protect each endangered species’ habitat for hundreds of consecutive years than it would to store some DNA and find space when the time comes for cloning.

The fact is that species go extinct all of the time, while we incur real economic costs protecting others. By bringing cloning into the set of public policy instruments, we can protect more species, reduce economic costs of protection, or both.

Preparing for Disaster

Copyright, The New York Times Company

Hurricane Irene traveled the East Coast last weekend and was expected to be one of the rare hurricanes to hit New York (by the time it reached there, it had been downgraded to a tropical storm). Although many thousands of people in the region may be without electricity for days to come, New Yorkers are glad that Irene did little damage as hurricanes go.

The storm began to receive media attention the weekend before it arrived, and people in the New York area used the time to prepare themselves. Forecasters have been criticized for overestimating the amount of wind that New York would experience, but the winds and tides were plenty strong. Preparation was an important reason that damage was limited.

For example, the eye of the storm passed right over Kennedy International and LaGuardia Airports, but planes did not crash because the airports were shut during the storm. Few lives and little cargo was lost from ships in the area because the ports were closed, and vessels moved out of the area.

Hundreds of thousands of people were left without power, and many homes were flooded. But, clearly, the damage would have been much worse if Hurricane Irene had hit with no warning.

I have no expertise in climate, weather, physics or aerodynamics, but one of the lessons of economics that environmental changes are less harmful when they can be anticipated. With only a few days of preparation, as with Hurricane Irene, people and mobile capital can be moved out of harm’s way. Protective barriers can be constructed for the immobile capital like homes.

New York was not given a definite warning of Irene a year ahead, let alone a decade ahead. But if it had been warned years ahead, the economy could have adjusted even more by making plans to locate activity in more protected places. Or perhaps even to invent goods and production processes that are more hurricane resistant.

The opportunities for preparation are one reason why economists expect the damage from global warming to be different, and perhaps less, than from natural disasters that hit by surprise.

Global warming is expected to raise temperatures and sea levels over a period of decades – perhaps centuries. Even if scientists are completely unable to retard or reverse the environmental consequences of global warming, thanks to decades of warning the economy can greatly adjust to minimize the economic costs of those environmental consequences.

That’s the thesis of a recent book, “Climatopolis: How Our Cities Will Thrive in the Hotter Future,” by Matthew Kahn of the University of California, Los Angeles (disclosure: Professor Kahn is a friend and was my classmate at the University of Chicago). Given advance warning, people will protect themselves and innovate in order to make sales in future market when the symptoms of global warming are more threatening.

Time for Green Building Codes?

California is talking about creating a "green" building code. I will put aside the question of whether a green building code is a good idea in the long run. If there is going to be a green building code, is now the time to start (rather than wait until after the recession)? Is California the place to start?

Note that real estate prices have been much lower during this recession than before, especially in California. The low real estate prices (more specifically, the underwater mortgages associated with them) are responsible for a large fraction of our economy's poor performance of late.

Also note that a green building code raises the cost of building new structures (if green building were costless, then there's no need for a government mandate!), and perhaps adding on to existing ones.

Existing structures compete with new structures in the marketplace, so introducing a green building code would raise the value of existing structures by raising the cost of building new ones. It will mean less construction output (and less living in a region with a green building code), which will depress land prices. It will even depress the value of land that has an existing useful structure, although the green code would increase the combined value of that parcel of land and its structure.

There will be less construction output, but possibly more construction input, depending the price elasticity of the demand for living in the region. Thus, a green building code would not necessarily reduce construction employment.

By raising the value of property with existing and useful structures, this could help alleviate one of the major problems in our economy (one offset is that some properties do not have a useful structure, and a green code would put mortgages on them even further under water), especially in California (less so in Nevada or Arizona, were the percentage of mortgaged properties with existing structures may be lower). So now may be the time for a green building code in California.

The Pride of the Self-Sufficient

In the bush country of Alaska, people live miles from the nearest road. They get around by boat, "bush plane," snowmobile, or even dog sled. The bush country residents are proud of their self-sufficiency. The few tourists who go there are impressed.

Why?

I am not talking about admiration of nature. Alaska has millions of acres that seem undisturbed by people, and it is awesome to see it. But, as many people do, one can admire nature without being self-sufficient.

Indeed, like the Grand Canyon or Mt. McKinley, the market is one of the wonders of the world. Although a trip to the top of Mt. McKinley is expensive and sometimes deadly, the market is one of those wonders that pays you to visit it, and helps you live longer.

So why is self-sufficiency a source of pride?

Commenters: what do you think?

How Much Will ‘Cap and Trade’ Cost?

Copyright, The New York Times Company

As part of a public strategy to offset global warming, the president and Congress are considering possible “cap and trade” laws to limit the United States’ carbon dioxide emissions. One question raised in this debate is the amount that such limits would cost United States taxpayers and consumers.

Many scientists argue that carbon dioxide emissions are a significant contributor to global warming, and that humanity would benefit if the government did something to stop, or partly offset, global warming.

One proposal for limiting the United States’ carbon dioxide emissions is to set an emission limit for each business, and allow businesses to trade their emissions “allowances” with each other. The “trades” would involve a business that uses less than its permitted limit and that then sells the remainder to another business that wants to produce over its limit.

If we suppose that limiting the United States’ emissions through a cap-and-trade system would generate an environmental benefit, that still leaves the question of how much taxpayers and consumers would pay.

One component is the cost of reducing United States energy production, and then reallocating energy production toward nuclear power and other means that emit less carbon dioxide per unit of energy produced.

Those “reallocation” costs are hard to know because, among other things, we do not yet know the degree to which restrictions on the building of new nuclear plants will be relaxed to help attain the goal of reducing carbon dioxide emissions. One study puts these costs at about $300 per family per year, although from experience I have seen reallocation costs overestimated because the capacity for our economy to adjust to new circumstances is not adequately appreciated.

On the other hand, one reason why the reallocation costs might be underestimated is that the worldwide pattern of production can adjust so that some carbon-intensive production occurs outside the United States. To the degree that carbon-intensive production leaves the United States, the (financial) costs of cap and trade will be less, although so will be the benefits in terms of reducing global carbon emissions.

A second issue is the distribution of the emission allowances. Will emission allowances be auctioned by the government, as President Obama promised during his campaign? Or will they be given away to existing energy producers?

To a rough approximation, the distribution of the allowances does not affect the total amount of the costs of reducing aggregate emissions, just the allocation of those costs across different sectors (i.e., which industries pay what). To the extent that allowances are auctioned and the revenues go to the United States Treasury, the stockholders and consumers of existing energy companies would pay more and taxpayers would pay less. Some estimates suggest that the amount at stake for the taxpayers is over $3,000 per family.

To the extent that allowances are given away to energy companies, shareholders and consumers pay less and taxpayers pay more.

But the allowances would be valuable. That means existing business would strategically adjust their behavior (and probably already are doing so) to be eligible for a larger emission permit. The costs of jockeying for permits are costs in addition to the cost of reducing and reallocating energy production.

For example, a grandfathering system would give businesses emission allowances in proportion to how much they had emitted in the past. Given the monetary value of emission permits, a grandfathering system gives producers a large incentive to, in anticipation of the grandfather awarding of permits, emit more prior to the creation of the cap-and-trade system.

Reducing carbon is a goal shared by the Obama administration and a number of members of Congress. But, as with the promotion of hybrid vehicles,cleaning banks of their toxic assets, and other government ambitions, it takes more than a lofty goal to create good policy. Cap and trade is yet another example of how the details of regulation matter not only for the costs to taxpayers and consumers, but also for whether the policy actually pushes the economy in the intended direction.