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Hearing of the Senate Committee on Finance - Auctioning Under Cap and Trade: Design, Participation and Distribution of Revenues

CHAIRED BY: SENATOR MAX BAUCUS (D-MT)

WITNESSES: ALAN B. KRUEGER, ASSISTANT SECRETARY FOR ECONOMIC POLICY, DEPARTMENT OF THE TREASURY; DOUGLAS ELMENDORF, DIRECTOR, CONGRESSIONAL BUDGET OFFICE; JOS DELBEKE, DEPUTY DIRECTOR-GENERAL OF THE EUROPEAN COMMISSION DIRECTORATE-GENERAL FOR THE ENVIRONMENT; ANNE SMITH, VICE PRESIDENT, PRACTICE LEADER OF CLIMATE AND SUSTAINABILITY, CRA INTERNATIONAL

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SEN. BAUCUS: Voltaire wrote, "Men argue, nature acts."

While people argued over global warming, nature acted. Now, at long last, people appear nearly ready to act in response. Last year, the Senate had a good discussion of legislation to respond to climate change. As part of that effort, the committee heard from witnesses about the tax and trade aspects of the cap and trade program. But, ultimately, the Senate did not act on legislation last year.

This year, we will once again take up climate change legislation. President Obama has given high priority to addressing it. It is time for us as a nation to show leadership and responsibility. It is our moral imperative to address climate change. It is time for us to act. Action would not be without cost, but the cost of inaction would be far greater.

Many have analyzed the effects that a cap and trade program would have on our economy and our ability to compete in the world. Each study has generated its own set of questions and uncertainties, but we need to move ahead with the best information that we have.

Today we have asked our witnesses to share their analysis of the effects of the cap and trade program on the economy and we've also asked for their thoughts on the best way to design this system to provide certainty where we can. We need certainty in terms of establishing and containing costs and we need certainty in terms of meeting our greenhouse gas reduction goals.

We will ask, how can we reduce the effect of potential increased energy costs on our economy? How can we reduce the effect on energy consumers? How should an auction be structured? How should allowances be allocated? Should they be auctioned, given away for free or some combination? What is the proper balance between free allowances and auction revenues? Are free allowances an effective tool to assist industries facing especially high costs? Are they effective to assist industries who are trade sensitive? If we provide free allowances, who should receive them and based on what criteria?

These are all questions that I hope our witnesses can help us answer. And so while people argued, nature acted. Now Congress can act in response. Let us find out what we can so that we may act wisely.

Senator Grassley.

SEN. CHUCK GRASSLEY (R-IA): Well, I think everybody knows that the Senate Finance Committee, when it comes to the suggested cap and trade tax, that we have a very essential role to play in this. When it comes to the environmental benefits of such an issue as global warming, of course, most of that's going to be handled by the Environment and Public Works Committee. However, we're talking about a program that will raise hundreds of billions of dollars every year for the federal treasury. With revenue of that magnitude, obviously we're having this hearing -- obviously why we're having this hearing.

What's more, the cost will be paid by every American in the form of higher prices for energy services and any product that takes energy to produce or transfer to market. President Obama has acknowledged that under a cap and trade system, electric rates would necessarily skyrocket. And so I should say quote-unquote, "electricity rates would necessarily skyrocket."

When OMB Director Orszag was before this committee last year in his previous capacity, he made it clear that, and I want to quote, "Under a cap and trade program, firms would not ultimately bear most of the cost of the allowances but instead would pass them along to their customers in the form of higher prices." In other words, it's going to be a consumer tax, not a corporation tax. Those latter are my emphasis.

Those energy price increases will also have a significant and negative impact on economic growth and job creation. If that sounds suspiciously like a federal energy tax to those of you here, you're right -- it is. The Senate Finance Committee has jurisdiction over all federal taxes and has extensive experience in considering the tax incidence of certain policies. That experience will be invaluable on this subject because of the very important aspect in designing a cap and trade tax which will ultimately bear the cost of the program and in what proportion. In short, who are the winners and the losers?

One troubling aspect of cap and trade is that speculators from Wall Street, Chicago and San Francisco are foaming at the mouth to get their hands on trading profits from cap and trade allowances. Hedge funds, private equity funds and other companies have been lobbying Congress to pass cap and trade legislation. And when I say a troubling aspect to that, that's not this senator saying it just on my own suspect, but this is what I'm beginning to hear more from the grassroots of my state. It probably comes because right now, Wall Street does not have a very good reputation at the grassroots of America.

And then people are looking at Enron, which isn't much of a company today but 10 years ago was quite a company. They were early supporters of this. And AIG was, as well. And we all know the reputations of those companies, and, when you're talking about their support for things like this, that raises more questions in the minds of people who are already fed up with bailouts and things of that nature.

We have Democratic Representative John Dingell quoted this way: "I attended a meeting of an organization interested in climate change legislation, and guess who was there? It was a bunch of good-hearted Wall Streeters getting ready to cut a fat hog," end of quote.

Well, I want to make sure that the American taxpayers is (sic) not the fat hog that gets cut.

Today's hearing will help us to better understand the economic consequences of cap and trade and the various trade-offs that Congress will need to carefully consider it. Our distinguished panels will help us do that.

Thank you all very much.

SEN. BAUCUS: Thank you, Senator, very, very much.

Our first witness is Alan Krueger, the new assistant secretary of the Treasury for economic policy.

Congratulations, Dr. Krueger on your confirmation. Any day now, he gets sworn in. (Laughs.) We look forward to that very, very much. And I know that Secretary Geithner especially looks forward to having you on board. We all do. And thank you very much for appearing before us on such short notice.

The second witness is Doug Elmendorf, who performs yeoman duty and does everything around here. He crunches numbers on every subject under the sun and under a lot of pressure from lots of different sides to get their numbers first.

And we thank you very much, Dr. Elmendorf, but, from our perspective, we sure like your work on health care reform, especially. (Laughs.)

And Dr. Delbeke, thank you very, very much for appearing before us today. We appreciate your being before us, especially in your capacity as deputy director-general of the European Commission Directorate for the Environment.

And as is the normal course of business when foreign government officials testify before this committee to note for the record that the United States Congress has no authority over Dr. Delbeke. And that begs the question, over whom do we have any authority anyway? (Laughter.) He is appearing today as a diplomatic courtesy.

And, also, Dr. Anne Smith, vice president of -- she is the practice leader of climate and sustainability for CRA International.

Thank you very much, Dr. Smith.

And so Dr. Krueger, why don't you begin?

MR. KRUEGER: Sure. Good morning, Chairman Baucus, Ranking Member Grassley and other members of the committee. I'm delighted to be before the committee again so soon. (Laughter.)

I took your advice very seriously, Senator Baucus, that it was time to get to work and that's why I'm here today to talk to you about cap and trade auctions.

In my remarks, I'll describe the important role that auctions can play in an efficient greenhouse gas cap and trade program. I will also talk about the Department of the Treasury's experience running auctions and how auctions have been used in some existing greenhouse gas cap and trade programs in the U.S. and abroad.

As you know, one of the president's top priorities is to develop a comprehensive energy and climate change plan to invest in clean energy, address the global climate crisis and create new jobs. In turn, we believe that a greenhouse gas cap and trade program should play a central role in our effort to achieve these goals at the lowest possible cost. We are very appreciative of the work being done in the Congress to this end and look forward to working together to craft successful legislation.

One important element of an efficient and fair cap and trade system is allowance auctions. When designed and managed effectively, auctions distribute greenhouse gas emissions allowances efficiently by assuring that they are allocated to those who value them the most, thereby helping to minimize the cost of achieving our economywide emission targets. At the same time, the use of auctions can avoid the creation of undeserved windfall profits and can provide revenue that can be used to help families in the transition to a clean energy economy.

Treasury has had significant experience in running high-value auctions. To finance the public debt, the Treasury Department uses auctions to sell a large volume of debt securities. The regular, predictable and transparent nature of these auctions furthers Treasury's objectives of financing the federal government at the lowest possible borrowing cost.

Each year, the Treasury Department's Bureau of Public Debt conducts more than 250 public auctions and issues over $5 trillion in gross debt. In fiscal year 2008, for example, we conducted 279 auctions, in each case releasing the auction result data within our self-imposed time constraint of two and a half minutes after the auctions close. Given the large volume of financing provided through Treasury's auctions, ensuring a smooth and efficient auction process has been a critical component of our success. We place a premium on running the most reliable Treasury auctions possible in the most transparent manner and the department delivers on this responsibility each and every week. Treasury's long track record of successfully running high-value auctions demonstrates the key technical expertise necessary to manage auction details in a manner that builds public trust and confidence.

Now I'd like to briefly describe a few prominent examples of the use of auctions in existing greenhouse gas cap and trade programs. In 2005, the European Union established its emissions trading scheme, commonly known as EU ETS, which I'm sure that Dr. Delbeke will discuss. This is the world's largest emissions cap and trade program. The EU ETS caps carbon dioxide emissions from the electric power sector and several other major industrial sectors in Europe, which collectively account for about half of Europe's CO2 emissions. The use of auctions in the EU ETS has been limited to date but is growing.

To offer one example of the use of auctions, since November 2008 the United Kingdom has held two single-round, sealed-bid, uniform- price auctions which yielded a combined $144 million in revenue. Britain's treasury conducts these auctions and auction revenue is deposited into the United Kingdom's consolidated fund for general spending purposes. There will be a substantial increase in the use of auctions in the EU ETS program in the future.

Another example of auctions in the greenhouse gas area is the Regional Greenhouse Gas Initiative, known as RGGI. This is the first mandatory greenhouse gas cap and trade program in the United States and it covers electric power plants in 10 participating states in the Mid-Atlantic and Northeast regions. Auctions play a key role in allowance allocations in RGGI. Auction shares are set by each state and currently average 85 percent across all of the participating states. The majority of states auction 100 percent of the allowances.

I think it's useful to highlight some of the principles that were established to guide the development of the RGGI auctions. First is fairness and transparency; second, efficiency; third, price discovery; fourth, revenue; fifth, minimize collusion; sixth, minimize price volatility; seven, to make sure there's adequate liquidity; and eight, to conduction the auctions at the lowest administrative and transactions costs.

To conclude, I would emphasize that the Treasury Department recognizes that designing auctions for a cap and trade program will require careful consideration of many auction features and program goals and substantial expertise. Treasury's long experience in developing and conducting auctions can offer important insights in the design and operation of high-stakes greenhouse gas allowance auctions. I look forward to working with the Congress to enact and implement a successful cap and trade program to reduce greenhouse gas emissions.

SEN. BAUCUS: Thank you very much. That was very informative.

Dr. Elmendorf.

MR. ELMENDORF: Thank you, Chairman Baucus, Senator Grassley, members of the committee. I appreciate the invitation to testify today.

Global climate change poses one of the nation's most significant long-term challenges.

Human activities are producing increasing quantities of greenhouse gases and a strong consensus has developed in the expert community that, if allowed to continue unabated, the accumulation of these gases in the atmosphere will have extensive, highly uncertain, but potentially serious and costly impacts on the world. Moreover, the risk of abrupt and even catastrophic changes in climate cannot be ruled out.

These expected and possible harms can justify policy actions to reduce the extent of climate change. However, the cost of doing so may be significant because it would entail large reductions in global emissions, and thus probably in U.S. emissions, over the coming decades. To accomplish this would mean transforming the U.S. economy from one that runs heavily on carbon dioxide-emitting fossil fuels to one that relies on nuclear and renewable fuels, as well as achieving improvements in energy efficiency or the large-scale capture and storage of carbon dioxide emissions.

One option for reducing emissions in a cost-effective manner is to establish a carefully designed cap and trade program. The government would set gradually tightening limits on emissions, issue allowances consistent with those limits and let firms trade the allowances among themselves. Such a program would lead to higher prices for energy and energy-intensive goods, which would, in turn, provide incentives for households and businesses to use less energy and to develop energy sources that emit less carbon dioxide. Higher relative prices for energy would also shift income among households at different points in the income distribution, across industries and across regions of the country. Policymakers could counteract those income shifts by using the revenue from selling emission allowances to compensate certain households and businesses or by giving allowances away.

Let me make three points about the distribution of revenue or allowances in a cap and trade program.

First, consumers would ultimately bear most of the costs of emission reductions. Indeed, the price increases that would arise would be essential to the success of a cap and trade program because they would be the chief mechanism through which businesses and households would be encouraged to make investments and change behavior to reduce emissions.

Second, higher prices for energy-intensive goods and services would have a variety of consequences for different industries, regions of the country and income groups. For industries, those producing energy or energy-intensive goods and services could experience a decrease in sales with adverse consequences for shareholders and employees. These effects would be larger for producers with foreign competitors who do not face similarly stringent programs for reducing emissions. For different regions of the country, the impact would depend on the extent to which households' income is derived from carbon-intensive fuels and the extent to which their consumption is linked to carbon-intensive activities. For income groups, energy- intensive goods and services such as electricity, home heating and transportation consume a larger fraction of the income of low-income households, so those households would bear a relatively larger direct burden from policies that would reduce emissions.

Point three, policymakers have a wide range of options for distributing the value of the allowances, but choosing among these options entails trade-offs. For example, if allowances were auctioned, some of the revenue could be used to fund climate-related research and development. This approach might reduce the cost of transitioning the economy but would not provide immediate help to affected households and businesses. Instead, auction revenue could be used to reduce existing taxes on capital or labor. This could lessen the overall economic costs of restricting emissions but again would do little to offset the burden that higher prices would impose on certain households and businesses.

A different approach is to use the revenue to give rebates to low-income households, perhaps through the tax system. This would lessen the burden on these households. Alternatively, allowances could be given away for free to certain industries. Giving away allowances is generally equivalent to auctioning the allowances and giving the proceeds to the same firms. Giving allowances to energy- intensive manufacturers would not, by itself, hold down the price of their output, which would rise to reflect the private market value of those allowances. The result could be windfall profits for those firms, which would tend to benefit higher-income households who own most stocks.

However, if the distribution of free allowances was tied to future production or employment, then prices in those industries would not rise as much as otherwise and employment would not fall as much. At the same time, because these firms would not reduce emissions as much as they would have without these free allowances, other sectors of the economy would have to reduce emissions by a larger amount in order to meet the same overall cap.

In sum, emission allowances in a cap and trade system would be a valuable commodity. Your decisions about how to distribute that value would matter tremendously for the overall economic effects of such a system.

Thank you very much.

SEN. BAUCUS: Thank you, Dr. Elmendorf.

Next, Dr. Delbeke.

MR. DELBEKE: Thank you, Mr. Chairman. And thank you very much for --

SEN. BAUCUS: You might want to turn your microphone on, Doctor, maybe pull it closer, or both. Thank you.

MR. DELBEKE: Thank you, Mr. Chairman. And thank you very much for your kind invitation.

Today a comprehensive set of regulations exists in the EU to bring down greenhouse gas emissions. They cover cars, fuels, buildings, appliances. But the central piece of that whole set of regulations is the EU ETS, the cap and trade system that exists already since 2005. It covers the power and manufacturing industry that is almost half of the greenhouse gas emissions of the EU. It does not cover transport, as we have a system of multifuel taxation in place.

This comprehensive policy starts to pay off. Under the Kyoto Protocol, we have to do an 8 percent reduction by 2012. In 2007, we were at minus 4.3 for the EU-15, so (abstraction ?) made from the latest enlargement. In that year, emissions went down by 1.6 percent and analysts attribute that for more than half to the functioning of the EU ETS. The reason is that the carbon price is the driver for increased investments in low carbon technology. That means energy- efficient technology, fuel switching, not least renewable energy.

It is useful to recall that we started in 2005 with the three- year learning-by-doing phase. That was necessary, it turned out, because the cap that the EU member states had allocated was too generous and the system was over-allocated. But since then, the cap setting became more centralized by the European Commission and the overall cap was lowered from 2.3 billion a year in the first period to about 2 billion in the current Kyoto period, and in December the EU decided to lower this further to 1.7 billion annually by 2020, in view of the clear and predictable long-term signal to industry. In December, as well, on allocation, important decisions were made and two principal matters are at hand. Allocations can be given for free to regulated entities or they can be sold at auctions.

The EU ETS now uses a mixture of both. In the period until 2012, in fact, only 4 percent of the allowances on average are being auctioned. But as from 2013, at least half of the allowances will be auctioned.

Why do we do so? We learned that power companies in the deregulated European market increased power prices even though allowances were handed out for free. This was giving rise to a lively political debate on windfall profits, so the EU decided to stop giving free allowances to the power sector. Through full auctioning, money will instead go to the public authorities which can use them for climate action and other purposes. There is only one temporary derogation possibility for the newer member states for plants built before 2008. For the manufacturing industry, in principle the same applies, but to a lesser extent, as the manufacturing industry is much more than (power a price taker ?) on international markets.

We therefore today analyze industry to determine to what extent they have an ability to pass on the costs from ETS. We used cost impact, cost as such and trade openness in this assessment.

As a transitional measure, all manufacturing industry will get some free allowances, contrary to what is going to be full auctioning in the power sector. But the exposed sectors, exposed to international trade, will get a higher share.

The free allowances will be distributed based on technology-based benchmarks; thus, a certain amount of free allowances per ton of products, say per ton of flat glass. This benchmark per product will be determined in advance of the training period and it will be multiplied with historic production figures. As a conclusion, the facilities will therefore know already by 2011 how many allowances they will get for free until the year 2020.

There are many reasons for deciding the amount of free allowances in advance, and they are at length outlined in the written submission. Revisions of the amount of free allowances will be made only if a facility closes down or significantly changes its capacity. The reason is that the EU wants to create a maximum of regulatory stability and wants to limit allocation decisions as much as possible over time. The allocation rules will be reviewed after the international agreement in Copenhagen, and if the competitive situation for European companies is being corrected due to climate action by other nations, then less free allowances will be given away.

As a conclusion, the ETS as a cap and trade system functions reasonably well today but will be strengthened as of 2013 with a much tighter cap and much more auctioning. The key is the price signal. It acts as an incentive for low-carbon technology and energy-efficient equipment and fuel switching, not least in renewable energy.

Thank you very much.

SEN. BAUCUS: Thank you, Dr. Delbeke, very much.

Dr. Smith.

MS. SMITH: Mr. Chairman and members of the committee, thank you for inviting me. I'm Anne Smith. I lead the Climate and Sustainability Group at CRA International. My testimony today is my own and does not represent CRA or any of its clients.

Today we've heard a lot about alternatives for distributing revenues from a carbon cap. These decisions are very important in determining the winners and losers under a carbon policy. But many people think that this carbon revenue will be large enough to eliminate the cost of the carbon cap, and this cannot be so. Any policy that cuts carbon emissions will have a net cost on society.

Now, most people understand that a tax creates net costs to an economy, even while it raises large revenues, potentially large revenues, for the government. In tax circles, that net cost is called the dead weight loss. There's no way that the government can recycle the tax revenues to make that dead weight loss of the policy go away. The same is true of a cap and trade policy, because the allowance price works just as if it were a carbon tax rate.

For cap and trade to work, auction prices have to rise high enough to make using conventional fuels cost more than the more expensive lower-carbon energy sources. The allowance price works just like a tax, by creating an unavoidable net cost. This is the cost of reducing emissions down to the cap and this cost happens no matter whether the government or the private sector is given the rights to the revenues that come from this tax.

There is a corollary to the fact that a carbon limit will have a net cost. Carbon limits cannot increase total employment across the economy. Yes, a shift to more expensive forms of lower-carbon energy will create jobs. These are the so-called green jobs. But the use of the more expensive energy will also reduce demand for workers across the whole economy even more so. And it's important to recognize then that the net cost of a carbon cap could be large, so cost minimization should be just as important as cost burden sharing in designing the policy.

While an auction increases flexibility in how the cost burden can be shared, it doesn't address another concern with cap and trade, which is uncertainty in its costs. Prices in all cap and trade programs are notoriously uncertain. The EU's ETS has seen prices cycle up and down by a factor of four twice in the past few years. In the EU, carbon price uncertainty has inhibited companies from investing in low-carbon technologies, as was desired.

There are other unnecessary costs of allowance price uncertainty, including credit rating risks, costs of risk management by business and their costs of preparing auction bidding strategies. And there's the inevitable wasted investments when price expectations on which decisions were made turned out to have been wrong.

The government also should prefer predictable allowances prices because they make auction revenues predictable. For instance, what use is there for variability in the government's revenues if those revenues will be funding programs that have long-term funding needs? Even if auction revenues would just be rebated back to citizens, would the citizens appreciate variability in the size of their rebate checks?

This price certainty is a completely avoidable feature of a market-based approach to carbon policy. It can be done through price ceilings and floors, or, even simpler, by using carbon fees or taxes. So why is there resistance to these price certainty measures? Some are self-interested. Price certainty could kill the prospects for traders and hedge funds, et cetera, to sell a lucrative array of new financial products. But their lost demand for these services actually means a reduction in the cost of the policy to the economy at large. Others fear price ceilings could take away the certainty that we'll make adequate reductions in emissions.

However, there's no scientific imperative to insist on very precise cap levels in specific time periods and it's that insistence on the very precise reductions that creates the volatility in the prices. The meaningful emissions goal is to reduce all emissions to nearly zero over the long run, over many decades, and this will require sustained investment in utterly new directions in our economy. And that sustained investment will more likely come if the carbon price is predictable and durable and credible for decades to come.

In the end, a cap works just like a carbon tax except that with a cap, you don't know what the tax rate will be. Having better knowledge of what the carbon price will be will help minimize the net cost of the policy, but it will still leave us with carbon revenues that can be used to distribute that policy's cost fairly.

Thank you for this time. There are more details in my written comments, which I request be put in the record.

SEN. BAUCUS: Thank you very much, Dr. Smith.

Dr. Krueger, if we could just flesh out a little more Treasury's experience in dealing with various auction markets and the degree to which the variants in different markets does or does not make a difference in how well Treasury would be qualified to deal with auctions under a cap and trade system. Just flesh out what Treasury does and you did in your opening statement.

MR. KRUEGER: Sure.

SEN. BAUCUS: But a little more details and give us the confidence that we like to have. I think we already have that confidence, if you could underline it and what a great job Treasury would do.

MR. KRUEGER: Sure. I think the Treasury Department and the Bureau of Public Debt does a remarkable job with their auctions. The auctions are transparent. There's a schedule announced well in advance, when each auction will be held, when it opens, when it closes. As I mentioned, the results are announced within two and a half minutes after the end of each auction.

There's a working group that provides surveillance to make sure that the auctions are not manipulated. It meets every two weeks. It monitors price movements, volumes and so on. And I think that Treasury auctions are well regarded throughout the world.

SEN. BAUCUS: Senator Grassley asked, and I don't mean to steal his thunder, but he implied something that I hear from some folks, too, that, gee, if we have an auction with allowances, those folks on Wall Street, they'll figure out a way to make a buck, you know, they'll manipulate it. And the specter of Enron sometimes comes up a little bit.

And you said you have a surveillance team. Could you outline just what manipulation may or may not have occurred under some of the auction markets that Treasury conducts currently, as well as what manipulation may or may not occur if cap and trade allowances were auctioned and that auction were managed by the Treasury?

MR. KRUEGER: The working group that Treasury participates in also includes representatives from the Federal Reserve Board, from the Federal Reserve Bank of New York, the SEC and the CFTC. And, as I mentioned, they meet weekly; they monitor activities. The Treasury, as you know, does not have enforcement power. If it's warranted in the case, the relevant enforcement agencies then follow up.

I think it's important to recognize that the design of an auction can have an influence on its susceptibility to manipulation, and there are a great many design features of auctions -- who participates, how long, are they sealed bids or open bids, what's released after the auction, before the auction and so on -- a great many design features that need to be carefully thought out. But there are ways of designing an auction to try to minimize manipulation and to minimize price volatility.

SEN. BAUCUS: What's the difference between a cap and trade allowance auction market versus, you know, a SOx and NOx auction? You know, EPA conducts, as I understand it, the auction of SOx and NOx, and, of course, this is much, much greater as auctions of allowances in the cap and trade than auctions of nitrous oxides and sulfur dioxides, et cetera.

Could you give us a flavor of just the huge magnitude of difference between a SOx and NOx auction of the Clean Air Act versus an auction of carbon allowances under a cap and trade system? What I'm really trying to establish is the competency of Treasury in conducting such a large auction.

MR. KRUEGER: Yes. Well, they would be several orders of magnitude different in terms of the revenue they would collect. Of course, it would depend on how many of the allowances under cap and trade were auctioned. The administration budget proposed that there would be around $80 billion of revenue from cap and trade per year, which is -- I don't have the exact figures on the SOx auctions in front of me, but several orders, you know, of magnitude different.

I think one way of thinking about the design of the auction is it should be related to the goals, ultimately the goals of the program. The RGGI auctions are actually done quite similarly to the way that Treasuries are auctioned in that they're uniform price, sealed-bid auctions. I think that a good deal of thought would need to go into how best to design auctions under a cap and trade system to meet the ultimate goals of the program.

SEN. BAUCUS: Do you think Treasury's qualified to properly design the market -- the auction?

MR. KRUEGER: I think Treasury has a tremendous amount of expertise and experience in conducting auctions and I think the Treasury Department would be very willing to work with whatever agency or institution ultimately is responsible for conducting the cap and trade auctions and lend their expertise. And I think there is considerable expertise.

I'd also add that auction theory within economics is a branch of economics which is quite well developed, and in preparing for this hearing, I read a paper by John McMillan about some things that went wrong and some things that went right in the spectrum auctions, drawing on international evidence as well as the U.S. And it is an area of economics in which there's considerable expertise outside of the government as well which can be drawn on.

SEN. BAUCUS: Who wrote that paper?

MR. KRUEGER: It was written by John McMillan, who I should also -- in full disclosure, I was the editor of the journal in which it was published, one of the American Economic Association's journals. And, unfortunately, John passed away a couple of years ago.

SEN. BAUCUS: I'm sorry.

Thank you very much.

Senator Grassley.

SEN. GRASSLEY: Dr. Elmendorf and Dr. Smith, between a carbon tax and a cap and trade, which provides more certainty for consumers and businesses, question number one? Question number two, which is more efficient from an economic standpoint? And three and last, what role would speculators play in either a carbon tax system or a cap and trade system?

MR. ELMENDORF: Senator, many analysts favor a carbon tax over a cap and trade system because it provides greater flexibility in the timing of the emissions reductions. But that comparison I just stated is to a sort of basic cap and -- a pure cap and trade system, if you will, and much of the work that's gone on in the expert community and the discussions in Congress had been about essentially hybrid systems in which basic cap and trade -- to which basic cap and trade is added a price ceiling or price floor or other mechanisms for trying to reduce the volatility of prices. And that muddies that comparison. But I think the crucial issue from an expert's point of view is trying to give firms and households flexibility in the timing of emissions reductions; either cap and trade or a carbon tax has the advantage over command and control systems at giving flexibility in who is reducing emissions and in what contexts.

But the additional flexibility and timing, either through a tax or through some of these more flexible versions of cap and trade, are viewed by experts as being very important at minimizing the economic burden of reducing emissions and also at minimizing the uncertainty facing households and firms.

SEN. GRASSLEY: Dr. Smith?

MS. SMITH: Yeah, carbon tax is going to be more efficient than -- and more certain than a carbon cap. Now, as Dr. Elmendorf said, there are some more hybrid schemes that are being suggested but have yet to make their way into the policy proposals that are in front of the Congress to put price floors, price ceilings on top of a cap and trade.

And in doing that, you do get a lot closer to the efficiency of a tax; however, you also get a lot closer to a tax that's just more cumbersome because you have to do auctions and the like and it's just a much more complicated scheme in order to simply set a well- established carbon price. So once you go that route, it really probably makes a lot more sense to just acknowledge it's a tax.

Additionally, if you're auctioning permits -- if you're auctioning all the permits, the benefits of cap and trade that are associated with the allocation of permits go away and the auction looks a lot like a tax, except again, you don't know the tax rate. Thank you.

SEN. GRASSLEY: When it comes to speculators, I think we in Congress have to keep in mind -- particularly as it deals with energy -- the outrage that came last summer with $4 gas and speculators driving it up to $147 a barrel, and in turn, the impact that that made on the price of grains, as an example, and the increased price of the food, as an example. And then, you know, we all want alternative energy, the negative impact it made on alternative energy, particularly biofuels. Some of us are going to be very careful about enhancing the role of speculators in this whole process of solving global warming.

Dr. Smith, just a yes or no on this. Did I read you right that you firmly believe that with this system we're talking about, we're going to increase unemployment in the United States?

MS. SMITH: Yes.

SEN. GRASSLEY: I want to ask you and Dr. Elmendorf another question. We had debate in the Senate on the budget.

Fifty-four senators voted for an amendment stating that, "Any climate change legislation should be done without increasing electricity or gasoline prices or increasing the overall burden on consumers through the use of revenue and policies provided in such legislation," end of quote of the amendment.

I'd like to ask you two, given what you've heard today about the deadweight loss inherent in any cap and trade system, is it possible to design a system using the revenue it generates to ensure no net increase in the overall burden to consumers?

Dr. Smith?

MS. SMITH: No.

SEN. GRASSLEY: Dr. Elmendorf?

MR. ELMENDORF: No, sir.

SEN. GRASSLEY: So then, 54 senators had a wrong assumption based on that amendment.

One last point --

SEN. BAUCUS: That won't be the first time.

SEN. GRASSLEY: No, I'm sure it won't. (Laughter.) And I've made some mistakes too in misunderstanding.

Let me make a point for Dr. Delbeke -- I believe. This comes from Washington Post, April 7, 2007 and it's a long article on European cap and trade. I want to -- it's three paragraphs, short.

"In other ways, the approach has been a bureaucratic mores, with a host of unexpected and costly side effects and a much smaller effect on carbon emissions than planned. And many companies complain that it's unfair.

"Consider the plight of Kollo Holding Factory in the Netherlands, which makes silicone carbide, a material used as an industrial abrasive and lining for high-temperature furnaces and kilns. Its managers like to think of their plant as ecologically (sic) standout. They use waste gases to generate energy and have installed the latest pollution control.

"But Europe's program has driven electricity prices so high that the facility routinely shuts down for part of a day to save money on power. Although demand for its product is strong, it has laid off 40 of its 130 employees and trimmed production. Two customers have turned to cheaper imports from China, which is not covered by Europe's costly regulation."

Is that right or wrong?

MR. DELBEKE: Thank you, Senator. While I'm not familiar with the specifics of the case -- but as I indicated, sir, we had a trial regime between 2005 and 2008, so the system has moved on and the system has been improved in order to avoid any distortions between companies. And I think we have been successful on that. These types of articles are no longer read -- or the arguments are no longer made by our companies.

I think it's very important to indicate that there are economic activities that are going to be favored through a cap and trade and economic activities that are going to be discouraged, because it is those activities with a low carbon technology overall that is going to be at the winning side of the equation. So we see a lot of substitution of economic activities following the cap and trade, but as I indicated, we have independent advice and analysis indicating that the cap that we were setting for ourselves in Europe has been respected successfully, that the emissions go down and that, correspondingly, economic activity has not been hampered --

SEN. BAUCUS: Thank you, Dr. Delbeke, very much.

Senator Kerry.

SEN. JOHN KERRY (D-MA): Thank you very much.

Senator Grassley, I hope you heard that final comment. Economic activity has not been hampered.

And I might add that the RGGI that we have in New England has been entered into voluntarily -- voluntarily. Half the American economy has entered into a voluntary mandatory reduction. And in our mandatory voluntary reduction, we are doing better than many parts of the country economically. And in fact, it has not resulted in a loss of jobs.

But let me just point out one other thing, if I can. I know many people in the country are determined to try to make cap and trade into a, quote, "tax." I've seen the consultant reports and the suggestions. But it is, in fact, not a tax. It creates an asset. And the asset is tradable. Are there some costs attendant because the unit cost of electricity might go up or production of power? Yes.

But what many of the studies don't take into account, including, I believe, Dr. Smith's, is what energy efficiencies come along with that so that the net cost to the consumer goes down. And the Union of Concerned Scientists has just come out with a report showing that in every sector of the country, over a 25-, 30-year period, the consumers' out-of-pocket expenses because of energy efficiencies, better gas mileage, less expenditure, et cetera -- their cost, net, out-of-pocket will be less, even though the unit of gas or electricity, kilowatt hour, may be up.

Now, let me point out something else. On a tax -- carbon tax -- the purpose of this exercise is to reduce emissions. And we want to reduce emissions because science is telling us that if we don't, there are catastrophic consequences. Almost every economic model I've seen thus far, certainly from the industries, never takes into account the cost of the tax to the consumer of the catastrophic damages, never takes into account the energy efficiencies and savings or the new jobs. The modeling is about as deficient or purposefully deficient as any modeling I've ever seen.

And the fact is that if you put a carbon tax in place, that's all well and good. You put a price on carbon, but you have absolutely no guarantee you're going to reduce emissions. You have to wait for the marketplace to perhaps respond to the cost of the carbon tax. But many people will, as they always do, just subsume it into the cost of doing business. So they'll take the tax, they'll write it into the cost of their product and they'll do nothing to reduce emissions.

So if you're going to really meet the challenge of this exercise, which is to reduce emissions, you've got to find a way to create a mechanism in the marketplace that people are thinking emissions reductions, rather than just, you know, writing off the cost of doing business -- oh, we've got to pay this tax. We'll pay this tax. We'll write it into our product. But nobody reduces emissions and you continue to go down a catastrophic path.

Now, I'll just say very quickly, Dr. Elmendorf, is it not a fact that CBO has concluded that -- you know, we hear people trying to say it's going to increase people's taxes. I understand CBO's analysis says that there are ways to design climate change policies so the typical household does not experience a loss of purchasing power in their budget. Is that correct?

MR. ELMENDORF: I think it depends what we mean by typical here. The consensus of economic analysis is that the diversion of resources from making stuff under the baseline set of policies toward reducing carbon emissions under a cap and trade policy, that diversion of resources reduces, by a modest amount, the measured output of the economy, relative to what would otherwise be the case.

I say modest amount --

SEN. KERRY: Well, let me say -- if you have a complementary policy that increases the efficiency of our buildings, increases the efficiency of energy systems, increases the mileage people get for gasoline so they're spending more, you can -- a net cost, in fact, not -- you can reduce or eliminate an impact. You could have a net savings.

MR. ELMENDORF: Sir, my point was about the net cost. Think of a refrigerator; if one spends the time designing and uses the metal to build the parts that make it less -- produce less emissions, then one does not use those pieces and that time to build a bigger refrigerator or a better crisper or what have you. But the effects on net for the country as a whole seem to be modest.

The bigger issue, I think, in economic terms, is the distribution across people and businesses and regions in the country. And one of the key points of my remarks and many people's analysis is that you affect that distribution crucially in what you do with the value of this asset that you describe, Senator.

SEN. KERRY: Well, let me just point out that the global consulting firm, McKinsey & Company, has been hired by no single industry and no party with an interest in this argument, has shown in a study they spent millions on that you can get the first 30 percent of emissions reductions, which takes you to the next 10 or 15 years -- the first 30 percent of emissions reductions pay for themselves.

Is that a fact Dr. Delbeke?

MR. DELBEKE: Indeed, that's what we observe in Europe, indeed.

SEN. KERRY: Thank you.

SEN. BAUCUS: Thank you, Senator.

Senator Cantwell.

SEN. MARIA CANTWELL (D-WA): Thank you, Mr. Chairman. And I thank the panelists for their testimony.

I'm very interested, concerned obviously about the distribution implications of a cap and trade system. And I think that I'm much more interested in something that tries to make the public whole and keep our costs down over the long term. I'm certainly concerned about the trading implications as it relates to Wall Street.

But I am struck that your predecessor, Mr. Elmendorf, was here a year ago, Peter Orszag, and he testified before the committee, quote, "If you don't auction carbon permits, it would represent the largest corporate welfare program that ever has been enacted in the history of the United States."

And so I guess I'm asking you, Mr. Elmendorf, about your CBO studies and analysis of all auctioning of carbon emission permits and returning the revenue to households in the form of payments as the best way to protect households and obviously from higher prices resulting from capping carbon. And if you could, expand on that analysis and what that means, particularly for the low income.

MR. ELMENDORF: CBO has stated consistently that giving away allowances is effectively the same thing as selling them and giving the proceeds from the auctions away. The amounts of money involved can be very large. It depends, of course, on the precise nature of the cap and other parts of the legislation.

In CBO's estimate of the Lieberman-Warner bill last year, we estimated that the total revenue that would be gained from auctioning the permits over 10 years was in the neighborhood of $1.2 trillion. So that is a collection of $1.2 trillion that will show up in higher prices. But then, the distribution of that $1.2 trillion makes all the difference in the world for the impact that certain households and industries and regions would face.

SEN. CANTWELL: And so, instead of giving the companies -- as Mr. Delbeke was saying, in Europe it's happened and the prices go up -- give them to consumers instead to protect them?

MR. ELMENDORF: I think a crucial thing -- point about giving them to companies that I tried to make in my remarks is that just giving them to affected companies amounts to a windfall receipt by them. If, on the other hand, one gives them to companies in a way that is linked to their decisions to continue production or continue employment, then one has provided incentive to them to continue production and continue employment, then it is not simply a giveaway, it has other economic effects. But how one gives them away, what restrictions are on that gift, again, makes all the difference in the world for the economic effects.

SEN. CANTWELL: I'd like to -- I know my colleague Senator Grassley brought this up, and having lived through the Enron thing and now the credit default swap situation, I tell you, the trading scheme thing worries me. I see that last November Credit Suisse announced that they were securitizing carbon deals in which they bundled together carbon credits for 25 offset projects, split these into three tranches representing different risk levels and then sold them to different investors. To me, that sounds a lot like what we just did with the mortgage-backed securities that were at the heart of our meltdown.

So, Mr. Delbeke, I wonder if -- I know the prices have fluctuated sharply from $2 euros to $30 euros over the course of the first phase of the program. What lessons can we learn about the trading experience? I know you said do more on the auctioning side, but I'm also concerned about the offset markets and how to do a better job there, obviously, when you're incenting historic polluters as opposed to those who have already been historically helping in the situation.

MR. DELBEKE: Well, perhaps a few comments to start with. On the use of the intermediaries and the role that they have been playing in the European market, I think that a very important element that was made is that the liquidity of the market is very important and the intermediaries have given that in the European market, because, after all, the European market is a limited market, given the scale of the problem. So the wider the market, the more liquidity, and the intermediaries play that role to a very positive extent.

On the use of the revenues from auctioning, indeed, we have seen in every economic analysis that you can really boost economic activity if you spend -- use the revenues in one or the other way. You can have a positive or a negative effect. So revenue (use ?) is a critical element.

On the price development, I would like to say that of course, prices fluctuate. But I would -- since we have started our system in 2008, under the Kyoto provisions, prices have been fluctuating roughly between 8 euros and 25, 27 euros. That's the maximum we got. They have been rather stable in about 15, 25 (euros).

Now, I would consider that as a normal fluctuation, given the economic recession that we are having, because in fact, through the economic recession, it is cheaper to reach the target. So in that sense, it is pro-cyclical. It helps the companies to make carbon in a time of recession somewhat cheaper. And that has been an important element that we observed today.

Another element is that incentives for innovation have been the key driver and we see in our analysis that the target on the renewable energy that we have set ourselves in Europe for more than half is going to be realized through the cap and trade scheme as we have set it up. So --

SEN. BAUCUS: Thank you. Thank you very much.

Senator Enzi.

SEN. CANTWELL: Thank you, Mr. Chairman.

SEN. BAUCUS: Thank you. Thank you very much, Senator.

SEN. MIKE ENZI (R-WY): Thank you, Mr. Chairman.

When I came in here, I thought I understood what we were doing and now I'm very confused. I thought our purpose was to reduce carbon, but it appears it's to raise money. And I know that there's already a market in trees, orchards. Chicago has an exchange that does some carbon credits.

Now, one of the things that always worries me about that -- I was at The Hague when we were doing some of the global warming Kyoto Protocol and the United States wasn't allowed any credit for trees, I guess because trees have always been absorbing it, so we aren't making any change in the atmosphere by continuing to do trees.

But out our way, the REA has been -- has had a voluntary green program. And a lot of people have been paying, in addition to their bill, so that the REA could buy new trees and plant them. Now, I think that makes some sense. That would be some additional carbon absorption.

But from listening this morning, we're going to have the government print some allowances.

They're not going to provide anything other than a cost of doing business, which to me means a tax. And then we're going to auction them and the businesses, I guess, would buy them in proportion to their emissions. And then the companies would pass that cost onto their customers, who hopefully then would use less. But that sounds like a carbon tax. And the money from the allowances would then be distributed back to the people so that they don't revolt over their increased prices.

Now it's starting to sound like a Ponzi scheme to me. Tax the companies, raise the price, give the money back to the people. Then, the people give the money -- at any rate, I'm also confused on this allowances that are given to industries and that sounds to me like the federal government then picking and choosing the winners and the losers or a brand new form of earmarks.

I've been visited by a lot of small companies and I'm curious as to how the small companies are affected by this. I heard some comments that the system adjusts around after awhile. I'm not sure small companies exist after awhile. And they're the ones that are particularly concerned about the way this is going to hit them and how they're going to be able to participate in an auction.

So you can see that I'm very confused on this and I need a lot of answers and I can't get them in five minutes, but I'll try a little bit here.

Dr. Delbeke, you mentioned that only 4 percent of your credits are auctioned. The rest are given away. How much revenue does that produce and what's the revenue used for?

MR. DELBEKE: This 4 percent is being auctioned today by the member states. And I have no precise figures with me what that represents, but the auctions that are going to happen as of 2013, which is more than half of the allowances in the ETS, will correspond as we see it -- value, depending on the price, between 20 and 30 billion euros a year.

SEN. ENZI: And half of that is going to go to cleaning up things and the other half goes to what?

MR. DELBEKE: Well, at least half would be used to -- technology, to international offsets, domestic offsets. It's up to the member states to decide over this. The other half would go to the general revenues of the state, I assume. But it's not an issue over which the European Commission has direct power. The revenues accrue to the treasuries of the member states.

SEN. ENZI: Thank you.

Dr. Smith, could you go into the deadweight loss a little bit more? Is that small administrative charges or --

MS. SMITH: The deadweight loss is the cost that occurs when you put a tax or a carbon price on the economy. It's just the cost of reducing the emissions. The revenues from the auction, if there is an auction, are never going to be enough to offset that cost. It's a separate piece of the puzzle. And so yes, there's a large revenue stream. There's a lot of recycling of revenues that can be done and spent in different ways.

But you talked about this Ponzi scheme. I wouldn't call it a Ponzi scheme, but you tax the companies, you then have them raise the prices and then you pass the revenues back to the companies. You'd never have enough revenues -- I'm sorry, you pass the revenues back to the citizens. You never have enough revenues to offset the cost from the tax or the carbon cap.

SEN. ENZI: Thank you.

My time's expired.

SEN. BAUCUS: Thank you Senator, very, very much.

Senator Nelson.

SEN. BILL NELSON (D-FL): It was mentioned by Senator Grassley, Mr. Secretary of the Treasury -- assistant secretary of the Treasury, that we saw speculators get into the unregulated marketplace and run up the price of oil. And then when people had to start selling their positions, they started selling their positions and the price of oil came down. Now, as we look to an auction system here, how do we keep speculators out of the marketplace?

MR. KRUEGER: Thank you. The design of the auction can be done in such a way to try to minimize manipulation. So there are features that can be used that increase flexibility, for example, in the availability of allowances over time. And that's one way of reducing the opportunity for speculators, if there were speculators who can infiltrate the market, from influencing the price.

So there are some design features. And I think a good deal of thought needs to go into how cap and trade auctions can best be designed. But there are some design features that can help minimize the role of speculators. And then there are other issues, like surveillance, to try to prevent collusion and market manipulation.

SEN. NELSON: Give me an example of a design feature.

MR. KRUEGER: One issue has to do with whether the allowances can last for more than one year. So you can have a temporary shortfall, where you have more opportunity to exploit limited supply. But if there's banking and borrowing over some period of time, that's one way of potentially limiting the role of speculators who could cause a spike in prices.

SEN. NELSON: Dr. Elmendorf, we had such a success with acid rain, and understandably, this is a much greater magnitude, as you said. But how can we sell this for the objections of people link Senator Enzi, that this is a scheme that's designed to increase revenue more than it is to try to reduce carbon?

How can we sell it on the basis of what we learned with the success of the acid rain?

MR. ELMENDORF: So selling is not my line of work, really. (Laughter.)

SEN. NELSON: Well, it is ours.

MR. ELMENDORF: I think the basic economic point here is that the private markets work very effectively at allocating resources, because people bear the costs of the things that they do. People run a steel plant that uses too much raw materials, they pay more for that, and they don't do as well in the marketplace.

A standard lesson of Economics 101 is that markets is that markets do not do well if people and firms don't bear the costs of their economic activities.

Climate change is a classic example of that. The carbon emissions, attributable to my personal activities, I don't bear the cost of. But collectively, we in this country and we in this world are bearing -- an increasing cost of higher carbon emissions. And what putting a price on carbon does is to get the households and businesses to take those indirect effects into account in their own decisions and to economize on their release of carbon emissions in the same way they economize in their use of steel and their use of fuels and everything else.

The round trip of the money that Senator Enzi noted does indeed sound circular. Buy I think the crucial aspect of that is that even if the money goes directly back to the household, that household still faces a higher relative price of activities that involve a lot of carbon emissions.

So we've changed the relative price of certain activities, of certain goods in the society and thus lowered the price of others. And it's that change in relative price that then tends to reduce the demand for the things with the relatively higher price and redirect it toward activities and products with a relatively lower price. That's exactly the shift that's needed to end up with less carbon emissions.

And so, it's changing the relative price that creates the incentive. But the money that's collected can go back in its entirety, if you choose, to give households back the income that they've lost through the payment of that tax to the government.

SEN. NELSON: Was that the experience that we had with sulfur dioxide and its cap and trade?

MR. ELMENDORF: The scale is sufficiently different that I don't want to draw too clear an example of that. But I think it is -- what that experience does demonstrate is that having a system in which the right to emit things can be traded is a way of -- is a -- with a certain limit is a way of reducing those emissions in a very efficient manner. I think that experience shows that.

SEN. NELSON: And it worked?

MR. ELMENDORF: Yes. It did.

SEN. BAUCUS: Thank you, Senator.

Senator Conrad.

SEN. KENT CONRAD (D-ND): First of all, I want to thank -- thank you, Mr. Chairman, for holding this hearing and bringing this panel before us, because I, for one, feel that I've learned a lot this morning, just in an hour and a quarter.

And I want to thank each of the witnesses.

The purpose of this exercise, as I understand it, is to reduce carbon emissions. So I'd ask each of the witnesses, what is the most efficient way to reduce carbon emissions -- as between cap and trade and a carbon tax?

Start with you, Dr. Krueger.

MR. KRUEGER: Well, as was mentioned before, a cap and trade system has certainty on the reduction in greenhouse gas emissions. So if the main focus is to reduce greenhouse gases, I think the certainty of the cap suggests that -- or is the reason why I would say that cap and trade is a more certain way of reducing emissions.

SEN. CONRAD: Okay.

Dr. Elmendorf?

MR. ELMENDORF: For a given amount of emissions reduction in a year, most analysts would say that a carbon tax is more efficient, because it reduces the volatility of the price of emissions. But it has the feature that Alan Krueger noted, that in a given moment in time one is less certain of the amount of reduction that one would achieve, and that's a trade-off that has to be made.

As I suggested earlier, development of more complicated cap and trade approaches are building in some of the flexibility in the kind of emissions reductions that comes naturally with the carbon tax, and that's bringing those two closer together in their effects.

SEN. CONRAD: But I want to be very clear in what I'm hearing. I'm hearing you say that the most efficient way to reduce carbon emissions is with a carbon tax -- not with respect to an annual target. But going forward, an economic analysis would tell you that the most efficient way is a carbon tax?

MR. ELMENDORF: That would be the conclusion of most analysts. Yes, Senator.

SEN. CONRAD: Dr. Delbeke.

MR. DELBEKE: Well, I would emphasize two elements.

The cap is being reached, so a cap and trade gives certainty on that.

The second is that the flexibility within the system allows that the one for whom it is cheaper to reduce emissions can do more and gain money form that. He gets paid by those for whom it is more difficult to reach the emissions reductions.

So the inherent flexibility into the system is something that is incredibly important, while a tax poses the tax on any economic operator in the same manner, irrespective of what his capabilities are for reducing the emissions.

And that comes close to the heart of technology for one operator may be much more cheaper than for another.

We observed in Europe, for example, that the power companies have much more capability for reducing emissions compared to, for example, steel mills or aluminum smelters. And one can pay for the other to do the job.

SEN. CONRAD: Dr. Smith.

MS. SMITH: A tax actually gives you just as much flexibility as the cap and trade. The idea that one can pay for the other only works if there's a 100 percent allocation of permits to the businesses in the first place, which doesn't happen with an auction.

There's no question a tax is the most efficient way to get the emissions down. It gives you some uncertainty about the emissions at any point in time, but since the goal is a very long-run target of zero emissions across the globe, we need a durable policy, and price certainty of a tax gives you that.

SEN. CONRAD: All right. Let me go to my final question, and that is, in economic terms -- because we've got to be concerned about bringing down emissions. We've also got to be concerned about economic effects. So which of these approaches is best from an economic standpoint -- economic growth, jobs and the rest?

Dr. Krueger.

MR. KRUEGER: One thing I would point out, which is not directly answering your question, but it's certainly related is, I think, the way we measure deadweight loss needs to change. And we need to take into account the effect of emissions on well-being, on society. And the traditional measures of deadweight loss, which Dr. Elmendorf and Dr. Smith discussed, kind of ignore the purpose of the program, which is to reduce greenhouse gas emissions. Now I'm sure that they're aware of this.

So I think a broader measure of well-being and of output kind of adjusted for pollution would take that into account. So it's not clear to me that the deadweight loss goes quite in the direction that was stated.

I guess I would just emphasize, on your question, that you have a tremendous amount of flexibility with a cap and trade system. And compared -- certainly compared to the regulation and command -- regulatory control system -- you have a tremendous amount more flexibility. And that would lead toward a much more efficient system.

SEN. CONRAD: Well, my time is expired, but perhaps we'll have another round.

SEN. BAUCUS: Thank you, Senator.

Senator Bunning.

SEN. JIM BUNNING (R-KY): Thank you, Mr. Chairman.

Dr. Krueger, whether we look at allowance auctions or free allocation under a cap and trade system, this will mean nothing unless we reach an international agreement on cap and trade.

I have concerns about mandating a system that would not only punish American consumers and producers but would restrict domestic economic growth.

Advocates of cap and trade argue that by implementing such a system America can take a global leadership position on climate change. They argue that developing nations like China, India, Russia will follow, not lead on climate change and that mandatory agreements with these nations would not be necessary, because they will voluntarily adopt emissions standards in the future.

Do you agree with that?

MR. KRUEGER: Well, I agree that it's critical to bring the rest of the world's emissions down. I think -- and this is one area where there's a practical difference between a tax and a cap and trade, which hasn't been mentioned. I think it's easier to integrate a cap and trade system in the U.S. with the rest of the world than it would be in a tax.

SEN. BUNNING: No. Answer my question.

Do you agree, unless we have an international agreement with India, China and other emitters of more pollutants than the United States -- even 20 years from now, if we cap and trade or we put a carbon tax on and we don't get any cooperation out of China opening 94 gas -- or coal-fired generating plants with no restrictions, India the fastest growing country in the world, Russia who -- just thumbs their nose at us when we talk about this -- are we going to lower emissions in the world if we don't get that agreement?

MR. KRUEGER: I agree with you that it's very important to have such an agreement. If we lower our own emissions, I do believe that will lower world emissions. That, however, doesn't mean that it's not essential that we have agreements with the rest of the world. And I think it's very important that the special envoy for climate negotiations, Mr. Stern, is pursuing that -- those types of agreements.

SEN. BUNNING: Do you believe that there will be any transfer of economic job loss to other countries who do not cap and trade?

MR. KRUEGER: In some industries, I would believe there's a risk of losing --

SEN. BUNNING: Steelmakers, you know, and those types of people who use a lot of electricity and a lot of power -- aluminum makers and those kind of --

MR. KRUEGER: I think it would be very important to look across industries, look at trade-sensitive, high-energy-using industries and to address them if it's deemed necessary.

SEN. BUNNING: I heard the number $1.2 trillion mentioned, and I don't know whether it was Senator Kerry or somebody at the table.

I saw a study done by MIT that mentioned $1.8 trillion as the cost, or the tax, or whatever you want to call it, of doing a cap and trade system. The $600 billion that was mentioned in the budget was not in the same vocal report that MIT made.

Is that false, or is that anywhere to be -- close to being true?

MR. ELMENDORF: Senator, the amount of money involved depends tremendously on the details of the system. It depends on how much the cap reduces emissions relative to the baseline and how quickly it does that. It depends on the extent to which activities outside of the traditional cap sectors can -- overseas or in this country -- can be used as offsets to the emissions reductions that are required.

So the number that I gave was CBO's estimate of the revenue --

SEN. BUNNING: CBO?

MR. KRUEGER: -- under a particular -- of the particular Lieberman --

SEN. BUNNING: One bill?

MR. KRUEGER: -- legislation from last year.

SEN. BUNNING: Okay.

MR. KRUEGER: We've not scored the Waxman-Markey bill for this year, because it is not a fully formed bill, and we can't do our estimates until we know that.

SEN. BUNNING: I understand that.

MR. KRUEGER: So it depends what the legislation is.

SEN. BUNNING: Okay. We --

SEN. BAUCUS: Actually, your time is expired.

SEN. BUNNING: Thank you.

SEN. BAUCUS: Thank you very much.

Senator Stabenow.

Thank you, Senator.

SEN. DEBBIE STABENOW (D-MI): Thank you, Mr. Chairman.

And thank you to all of you.

I think it's clear that we are talking about rewriting the rules of the economy to a low-carbon economy. And I think there are very important reasons to do that and costs that don't show up in the modeling so far as -- and I'm interested in any studies that have been done regarding increased storms that we have -- hurricanes, the kinds of damage that's been done to families' homes and businesses and changes that will come and agricultural production that relate to these issues. I think there are multiple costs that we need to address as we look at this.

But clearly there are costs as well. And I certainly come from a manufacturing state where we are very concerned about those costs. I also believe -- Dr. Elmendorf, you were talking about sort of the trade-offs on making stuff. I believe that we can make new stuff and clean energy and working very hard around issues of building wind turbines, making the 8,000 parts in my state and as well as across the country and solar energy and all of the other new things that create jobs in the industries that I share the concern about with Senator Bunning.

I'd like to ask questions as it relates to distributing cost, which is really I think very much at the heart of how we do this in a right way. So instead of losing jobs we gain jobs, which is in my mind the critical question.

When we look at the allocations versus auction and the concern -- which I think is legitimate -- about windfall profits going to individual companies -- if we look at an auction and we -- in my state -- and assume a $22 price for carbon, rates I'm told would increase about 20 percent. Wouldn't it be better to address the rate increase directly by providing that the allocations to consumers through the utility commissions or the local distribution companies?

I know that's one of the options I've seen for rate increase mitigation and rebates, so that it's seen directly on the utility bill. You can bypass instead of having that go to the utility. And I know that our utilities would support that as well. Go directly to the state or local -- what in Michigan is a public service commission -- to address whether it be individual home price increases, manufacturers, other businesses. Could you speak to that approach?

Dr. Elmendorf and Dr. Krueger and --

MR. ELMENDORF: I think the key point to keep in mind is that the prices of some things that are fossil-fuel intensive have to rise to induce the shift in behavior. So we can prevent -- you can prevent, through your policies -- increases in particular prices, and a particular design of the use of the allowances might do that for electricity. But that then shifts the burden of the overall emissions reduction -- the difference between where we would be without policy and where you're trying to be. It shifts the burden of that overall reduction out of the electricity sector and into other sectors.

So it doesn't make the concern go away, it puts it somewhere else. The prices of other things will have to rise by more in order to get the emissions reductions outside of the electricity sector if we decide -- if you decide not to take the reductions in the electricity sector.

SEN. STABENOW: Well, I'm not suggesting, first of all, that there not be a cap - and obviously the cap is the ultimate pressure -- the cap and the cap coming down -- and the number of the allocations. But it's a question of whether it goes directly -- that allocation, does it go directly to the utility to determine how to spend that, in terms of lowering rates, or to the regulatory -- the state regulatory agency that can determine, is it the manufacturers rates that are going up? Is it the individual homeowner? You know, what's happening? And they, at least in our state, determine, you know, what shall happen in terms of the rate structure and the rate increases.

MR. ELMENDORF: Again, I would just caution that if the effect of that is to keep household rates lower, then business rates will rise by more, and that cost will be passed on to households in the prices of the products they buy from those businesses. So --

SEN. STABENOW: I understand that. I understand that. For us, they regulate, though, both, I mean, so -- there's no assumption that it has to be a higher rate increase for manufacturers under that. You're saying that is one outcome.

MR. ELMENDORF: I'm just saying that the price -- the price increase will have to occur somewhere in order to induce the change in behavior. And you can move around where it happens, but you can't get away from it all together.

SEN. STABENOW: Sure, sure.

Dr. Krueger.

SEN. BAUCUS: Thank you very much.

Senator Snowe, you're next.

SEN. OLYMPIA SNOWE (R-ME): Thank you, Mr. Chairman.

Thank all you for being here today. There's very valuable testimony as we move forward on this significant initiative.

Dr. Delbeke, welcome. It's important to learn from the European experience as we proceed in crafting legislation regarding cap and trade.

Could you tell me how you would regard a greenhouse gas registry in that now the European Union has established one? That's something that another senator, Senator Klobuchar, and I, you know, are working on -- in fact, got the money to implement it and the EPA is moving forward on that. But the registry as we, you know, have determined would be instrumental.

And you know, obviously having an overall assessment of the level of emissions not only by -- collectively the industries but by each sector in terms of determining how, you know, the allocations are made with respect to allowances or the value, obviously, of the price of carbon. And I know in the European experience the price of carbon collapsed initially.

Would a greenhouse gas registry -- would that have been useful in this process, from the outset?

MR. DELBEKE: Thank you very much for this question.

Absolutely, I would say. This is a essential piece of the infrastructure for having a cap and trade running. And the risk we took in 2005 is that we had to rely on estimates without having historical emissions measured, verified by third parties, et cetera. We didn't have that.

But we were basing our system on estimates. And we had to overcome that. So after the second year we got our database right. So it's an essential piece and that's why we are very confident that the price collapse we had in the first period will never happen again, because we have the -- now the database that we needed to base our reviewed cap and our declined cap between now and 2020 in place.

SEN. SNOWE: So you think it has stabilized, you know, the price of carbon in that sense, at least now that you have a handle in the overall pricing because of the historical basis?

MR. DELBEKE: Absolutely. And even the companies were overestimating their emissions of carbon. So by the moment they had to measure and there was a third party verifying we saw that they had pleasant surprises, that their carbon emissions went down quicker simply because they were looking at it. And before that moment they were just not having that tool available and that element for comparison with others in the sector and across sectors.

SEN. SNOWE: Dr. Krueger, what's your view on that?

MR. KRUEGER: I think it's extremely important to have information -- accurate information. And one of the issues is how is that information released, how transparent? Is the information -- and that's one way of trying to reduce volatility.

SEN. SNOWE: Now, Dr. Delbeke, one of the issues that we're going to be making a decision on as well is to what extent -- how much of the revenues should be allocated for energy efficiency investments? And you know, some parts of the country already have had that experience. Certainly in my part of the country, in the Northeast we had the RGGI -- known as the RGGI system. And about 70 percent of the revenues are reinvested into energy-efficient alternatives and technologies. So it's worked very well, and innovation has developed as a result.

Now, am I to underrated the European Union has had a net investment of its revenues into energy alternatives up to 70 percent now? Is that going forward? And what was the history in the past between member states and in the overall European Union?

MR. DELBEKE: Well, just to clarify an important element of the European institutional setting: That is that revenues and they way they are going to be used belong to the member states and not to the central European decision-making system. So it depends very much what the member states want to do with it.

But we see that those who have been going forward to -- with a willingness to become technology leaders have done so.

If you look at, for example, Germany and what they have done in the field of renewables and cars and carbon capture and storage, it was with the revenues from auctioning, partly, that all these efforts were financed, and they want --

SEN. SNOWE: Yeah, so none of the revenues went to the overall European Union? All went back to the member states --

MR. DELBEKE: Indeed.

SEN. SNOWE: -- in that respect. So there isn't probably an average. Each state makes its own -- each country makes its own determination?

MR. DELBEKE: Indeed, madam.

SEN. SNOWE: Dr. Krueger, this is going to be, obviously, a central issue, because I know the president has suggested 80 percent go to the make work tax credit -- to obviously alleviate the hardship on Americans who are experiencing, you know, increased costs -- and that's certainly understandable -- and 20 percent for energy innovation.

And I -- you know, in the Northeast, obviously there's been about 70 percent investments. Is there going to be any allowance for, you know, flexibility for, you know, those areas of the country that are in a cap and trade system and have shown innovation -- to have some flexibility in continuing that innovation?

MR. KRUEGER: I think you raise a very important issue for a national cap and trade system.

The administration, I think, would be willing to work with -- would welcome an opportunity to work with you in Congress on how we integrate a program like RGGI into a national system. The president has said also that -- or the budget proposal says that it's very important that businesses, communities and citizens see some of the benefit from the money coming back from-- that's collected in this program.

SEN. SNOWE: Appreciate it. Thank you.

SEN. JEFF BINGAMAN (D-NM): Senator Carper.

SEN. THOMAS CARPER (D-DE): Thanks very much.

To our witnesses, welcome.

Dr. Krueger, I think you're new on the job. I think you were confirmed yesterday, and I just want to congratulate you and welcome you and say that we look forward to working with you.

I would ask Senator Roberts to join us in this conversation for just a moment, if I could.

Senator Roberts?

If I could, I'd just --

SEN. PAT ROBERTS (R-KS): Yes. I'm here. Were you going to ask my questions like you normally do?

SEN. CARPER: Yeah, I'd like to, if you'd let me.

I just want to come back to some points that you --

SEN. ROBERTS: We have a luncheon date, as I recall --

SEN. CARPER: We do. We're going to talk about this at lunch, too.

SEN. ROBERTS: Right, okay.

SEN. CARPER: But I just want to come back to a couple of points raised by you and Senator Enzi, who I think are among a more thoughtful and usually entertaining colleagues.

SEN. ROBERTS: Well, I haven't said anything yet. Senator Enzi has been thoughtful and entertaining. And I'll --

SEN. CARPER: You'll have your turn, and I'm sure you will be.

SEN. ROBERTS: Okay.

SEN. CARPER: My colleagues have heard me say before, one of the things that intrigues me as a person who works in public policy and has for a long time is how do we harness market forces to try to drive good public policy outcomes?

And one of the reasons I've been interested in cap and trade is because I think it enables us to harness market forces to drive public policy outcomes, and that is to reduce emissions and to use a market- based system to do that.

Senator Enzi raised the issue of trees and forests and trying to preserve those and -- promote the planting of more. I couldn't agree more. And that's why I've supported for a number of years, as I'm sure he does, the notion of using offsets to -- whether it be trees or forests, including no-till farming, providing methane containment units, whether it's cattle feed lots or pig feedlots or whatever. Those are the kinds of things that I think make sense. I suspect he does as well.

And I would just say as well, I think we have the opportunity -- Delaware is the first state to ratify the Constitution. Our state motto is it's good to be first. I'd go on to say that there's some things you don't want to be first in and maybe one of those is to have a cap and trade system on climate -- on CO2. As it turns out, somebody else has gone first. We will learn from their mistakes, and we have a lot to learn from their mistakes.

And finally I'd say we've also -- we had -- this point's been made by some. But we've had the opportunity to experiment with cap and trade in this country. We've had a chance to do that with sulfur dioxide, and actually it turned out pretty well.

If we'd used a tax on sulfur dioxide, we'd have probably come in with a tax of between ($)800 and $1,200 per ton. With the market approach that we used with the acid rain legislation we ended up with a price, set by the marketplace in a cap and trade system for sulfur dioxide of about $200.

So I would just say, I would urge my colleagues, especially two of them that I address my comments to, whom I respect a lot, to not lose sight of those arguments.

The other thing I would ask my colleagues not to lose sight of is, we focused a whole lot on emissions from our utility plants -- I focused a lot on that in the last seven years. We've not talked much at all about transportation. About a third of the CO2 emissions that we're seeing in this country come from the transportation sector.

In 1975, if you recall we created the CAFE legislation. It raised fuel efficiency standards from about 15 gallons -- 15 miles per gallon to about 25. So you think, wow, we're going to have -- see a big reduction in CO2 emissions from transportation. Wrong. We saw a huge increase instead of a big reduction. And the reason why is because people simply drove more. And we planned our neighborhoods in ways that -- for work and schools -- far from where we live. And we just drove a lot more in the years that followed.

If we're going to make real progress in reducing CO2 emissions, we can't forget transportation.

And today we fund our transportation system through a gas tax, and by that we pay for our roads and transit by burning more gasoline. The more you burn the more you fund your road and -- it's like our incentives are actually kind of perverse there. We drive less, our transportation budgets dry up.

I think we can do better. And Senator Arlen Specter and I have introduced legislation, it's called CLEAN TEA. And CLEAN TEA uses 10 percent of any auctions -- any auction proceeds that would come from a climate change bill to fund more energy-efficient transportation systems such as -- whether it be passenger rail, freight rail, transit, to help people get out of their cars, trucks and vans and to use something that's more energy-efficient.

Under CLEAN TEA, 10 percent of our auction proceeds would be provided to state and localities based on how much they reduce emissions -- how much they reduce emission, not increase emissions.

And question for Mr. -- Dr. Elmendorf: I noticed in your testimony that you did not include funding. Alternative transportation is a way to reduce costs to the consumer. I just want to know, is there a reason why?

And since we're giving more alternatives to driving, will this not save consumers money under what we've proposed?

MR. ELMENDORF: So Senator, we didn't list every option conceivable in the testimony. And the omission of something should not be viewed as a negative judgment about it.

I think in general, the virtues of a carbon tax or a cap and trade system are that the market, as you say, then gets to decide what the most efficient place is to reduce emissions. The more that the government tries to decide separately that the best place to reduce emissions is in transportation, or the worst place is in electricity or something else -- those sorts of judgments will tend to raise the relative -- the cost of the reductions as a whole.

Now, the important exception to that is that we know there are certain sorts of research and development activities and certain sorts of transportation projects and so on that the private sector won't do by itself. And there is, of course, an appropriate public role for the government in funding basic research and development and providing public transportation and other services.

SEN. BAUCUS: Thank you.

Senator Bingaman.

SEN. BINGAMAN: Thank you all very much.

Dr. Delbeke, thank you for your leadership on this important issue and the courtesies you extended to me and my staff when we visited with you at the EU a month or so ago.

Let me just ask Dr. Elmendorf first, and maybe Dr. Krueger, if I'm understanding this correctly.

Seems as though a lot of the discussion is assuming that our choices are three: either leave things the way they are, impose a cap and trade system, or impose a carbon tax.

I don't think those are the three choices we've got because of what the EPA is on track to do.

As I understand what the EPA is now committed to, the Supreme Court told them they had to take action to determine whether or not greenhouse gases, in fact, endangered public health. They entered into -- or issued an endangerment finding. And therefore, they're on track to regulate greenhouse gases under the Clean Air Act unless Congress says, don't do that, we want to do it some other way.

So one way or another, the cost of reducing greenhouse gas emissions is going to be experienced and imposed upon our economy, the way I'm thinking about it. Is that an accurate way to think about it, Dr. Elmendorf?

MR. ELMENDORF: I think there's very widespread agreement that it's much more efficient, much more efficient to reduce carbon emissions through putting a price on carbon through a tax or a cap and trade than it would be to regulate carbon emissions on a plant-by- plant, building-by-building basis. I think you would have difficulty finding anybody who would disagree with that proposition.

Exactly where the EPA is headed at this point I think is less clear. Of course, they're at a very early point in their response. There was a particular concern that under the provisions of the Clean Air Act they would feel they would be forced to regulate many very small emitters. They assert that they don't have to under the act, and I'm not a lawyer with expertise in that area. But even if they don't have to cover all these very small emitters, I think there's still no doubt that it would be more expensive for the country as a whole to reduce emissions through that sort of direct command and control than through one of these market-based mechanisms.

SEN. BINGAMAN: And absent a change in the law -- an amendment to the Clean Air Act or something to that effect -- they are on track to limit greenhouse gas emissions unless we tell them otherwise. Am I accurate in that?

Dr. Krueger?

MR. KRUEGER: This is my first morning on the job, so I probably shouldn't comment on that --

SEN. BAUCUS: You're doing a good job. (Laughter.)

MR. KRUEGER: Thank you.

I should say I haven't even had a chance to sign up for health insurance yet. (Laughter.)

SEN. BAUCUS: Yeah. We're trying to help there, too. (Laughter.)

SEN. BINGAMAN: Let me --

MR. KRUEGER: But I was just going to add that the president very much believes in trying to use market-based solutions to address.

SEN. BINGAMAN: Well, let me just ask, as a matter of economics -- Senator Enzi was complaining about the so-called Ponzi scheme where we have this round trip of the money, where basically we have a cap and trade system. We auction allowances. We then try to return the money to the people who are having to pay for higher electricity bills.

In a direct regulation of greenhouse gas emissions, which I believe the EPA would accomplish, assuming they go ahead, there is no round trip. There is no return of any money to the folks who are bearing the cost of that increased regulation, as I see it.

Is that an accurate way to think about it, Dr. Elmendorf?

MR. ELMENDORF: Yes. That's right.

SEN. BINGAMAN: So basically what we got a choice of here is do we allow this to be done by direct regulation, which it's now on track to be done by? Or do we substitute for that a cap and trade system or a direct tax of some kind where we would at least have the opportunity to return some of that money to mitigate the economic impact on people who may suffer from increased costs in the process.

Is that the right way to think about it?

MR. ELMENDORF: I think you're right, Senator, that the opportunity to use the proceeds from allowances -- or form a tax, if you went that direction -- to mitigate the effects that will be concentrated in particular households and industries and regions is a very important opportunity and a very important decision that you face in constructing this legislation.

SEN. BINGAMAN: My time is up.

Thank you.

SEN. BAUCUS: Thank you very much.

Senator Roberts, you're next.

SEN. ROBERTS: Well, thank you very much, Mr. Chairman.

And thank you for holding this hearing.

I appreciate the admonition and the counsel by my friend from Delaware who has -- who's not present, I see. I was not aware of the CLEAN TEA bill, and we're exploring that.

I'm not going to say what I thought CLEAN TEA was, but we can get into that at some other time.

We have more cattle than people out in Kansas by two to one. And usually they're in a better mood. (Laughter.) And 50 percent of the energy --

SEN. BAUCUS: Than who?

SEN. ROBERTS: Than most of us. (Laughter.)

Fifty percent of the energy consumed by Kansas is generated by coal-fired plants. Actually, I think that's 73 percent, but I won't quibble over that.

We have over 150,000 head of cattle there in Dodge City, which I did stop to think, when you all were talking about measuring CO2, how you would do that with a herd of 150,000. We'd like to invite you out if you've got some ideas. You know, taking it one cow at a time might take you a little long, but it'd be an interesting way to see if you could measure that.

Wichita is a major manufacturing city. It's the "air capital of the world." I've got an awful lot of rural communities very similar to others on this committee -- more, especially in Montana, others in the high plains, Wyoming. They dot the landscape and the prairie. They also have energy-intensive industries that keep the local economy above water and their community banks investing and the American dream a reality. And they feed America in a troubled and hungry world.

So it's a pretty good investment. But cap and trade or cap and tax or whatever we want to say -- a simple energy consumption tax -- our folks take a pretty dim view of that, despite the excellent testimony of the panel.

I met with the chairman and president and vice president of a small, independent oil and gas refining company. I don't need to get into who it is. There are 30 of them, by the way, that make up the small refiners across the country -- 13 percent of our U.S. refining capacity. They just told me that a cap and trade, or a cap and tax system, is what I call it -- the one being considered in the House by Congressman Waxman and others -- if passed would simply cause them to shut their doors on day one. That was their judgment. And I pressed them on the issue, and they were very clear.

I just don't think this is the way we want to treat our domestic small businesses, with the hope that somehow some of that money would come back in the way that Senator Enzi tried to explain it in regards to his testimony.

We feed 145 people -- one farmer feeds 145 people all throughout the high plains and in an agriculture. And they're, you know, they're going to begin their spring planting here real quick if they haven't already started.

During last year's global warming debate I was not at the Hague, but I was at Manhattan, Kansas, and I asked the Kansas State Research and Extension folks to run an economic analysis of what cap and trade -- or the bill at that time, and then I know it's changing -- or cap and tax-- means. That's not MIT, but those are the folks that I really pay attention to in regards to agriculture program policy. And the response I got from them was very much like the small refiner. It was a little frightening. The cost of production for one acre of irrigated corn increased over $100; an acre of wheat, roughly $25, and acre of sorghum, $30.

Parlay this into the increased energy cost for transportation and refrigeration and storage and you can start to imagine how much more disposable income will be used just to purchase our food and fiber. This I think is the reason why Collin Peterson, who is the chairman, the esteemed chairman of the sometimes powerful House Agricultural Committee, indicated in the press just the other day cap and trade is dead as far as he's concerned.

Now, you add the additional tax increase for your electric bill, your vehicle fuel, and you aren't much left with much in your pocketbook. In fact, about the only winner out of this scenario is the federal government and the good intentions of all the folks who work in the federal government and that ties back to the questions that Senator Enzi asked, and I won't repeat that.

But the point that needs to be made is that every cap and trade proposal I have seen is a core way to tax energy consumption to get CO2 down, as was pointed out in previous testimony. But it's also a way to bring more revenue to the federal government.

And once again, my time is running out, and you've been pretty tough on that, Mr. Chairman, but I went to the Antarctic very early and looked at the ice cores when we were even debating if we had a problem with global warming. And I saw the ice corridors, and I became convinced, and I came back, and I was trying to tell everybody in agriculture -- I was somebody then; I was a chairman -- that we really ought to pay attention to this. And don't say there isn't a problem, say, there's a challenge and we can be part of it with carbon sequestration. So I know there's a problem.

But we asked the person who was in charge of that whole operation, if we had passed the Kyoto treaty how much CO2 would we take out of the air in 100 years? And he said, .015, which stunned me. And I said, why? And he said, because without a support of some kind of international cooperation you'll feel good about yourself, and you may take some CO2 out of the air, but you're really not going to make much of a difference.

SEN. BAUCUS: Okay. Senator --

SEN. ROBERTS: I was going to ask Mr. Smith a question, but I'll do it for the record.

SEN. BAUCUS: Yeah, there's a little light on over there at the clock, which means that --

SEN. ROBERTS: I understand that.

SEN. BAUCUS: -- the vote just started.

SEN. ROBERTS: I understand.

SEN. BAUCUS: Senator Hatch, you're next.

SEN. ORRIN G. HATCH (R-UT): Well, thank you, Mr. Chairman.

And I thank all of you for being here.

Ms. Smith -- Dr. Smith, thank you so much for joining us today.

I appreciate learning more about the distinction between auction allowances and free allocations with regard to price volatility. However, I would like to focus on testimony debunking a myth that a carbon tax -- a carbon cap or tax would create jobs. Now, you state that even though a shift towards lower-emitting forms of energy would create new jobs, these jobs would be created by forcing out current energy jobs with more expensive forms of energy. Because it will cost more for companies to produce the same amount of output with these new technologies, overall worker productivity would fall and aggregate payments to workers would also fall. Now, do you believe that implementing a cap and trade program or a carbon tax would result in a -- in net job losses?

MS. SMITH: Yes, that statement argues that there's a net decrease in wages paid to workers, in total. There are only two ways to interpret that. There are either fewer jobs or the jobs that we have are a lot less well-paying.

SEN. HATCH: Okay. Now, some climatologists believe that implementing a cap and trade or a program that would reduce carbon emissions by 83 percent in the year 2050 would reduce temperatures by only .09 of one degree Fahrenheit. Are we sacrificing millions of jobs in order to reduce climate change by .09 of one degree?

MS. SMITH: If we look at the U.S. action in isolation, yes. And there's nothing else that we're considering when we estimate the costs of the U.S. policy.

The costs of inaction are not the benefits of action in the U.S. policy.

SEN. HATCH: Dr. Delbeke, thank you for coming. We appreciate you participating here today.

Now, some European economists examined Spain's green jobs initiative. And as you know, President Obama is using Spain and other European countries as a model for creating more U.S. green jobs.

Now, these economists have revealed some alarming statistics about the transition to greener jobs. Here are some of them: The U.S. can expect 2.2 jobs to be destroyed for every renewable job financed by the government. Nine out of 10 green jobs created by Spain over the past 10 years are no longer in existence today. Since 2000, Spain has spent $753,778 to create each, quote, "green job." Consumer energy costs in Spain would have to be increased 31 percent to repay the debt generated by the green job subsidies.

Now, can you comment on any of these claims that are -- on these particular claims? And do you believe the same would apply to the United States under a cap and trade program?

MR. DELBEKE: Senator, I'm not familiar with the precise figures as you quote them, but two comments: I think that the renewable energy technology is developing very fast. And I would not be surprised that, indeed, those who were in business 20 years ago have changed their business or have gone out of business.

The other thing, I think, that needs to be underlined that we seen in Europe that the jobs created in the renewables sector have been and are today the most growing. And we show also on the stock exchange that the valuation for these companies are incredibly high, including in Spain and elsewhere.

So in that sense we think there is a transition, that there is being undergone in Europe. But it is towards those low-carbon, clean technologies that pay off in terms of jobs and output.

SEN. HATCH: Okay, thank you.

Dr. Elmendorf, my constituents in Utah are deeply concerned about an increase in energy prices as a consequence of cap and trade legislation. The Congressional Budget Office estimates the Lieberman- Warner bill from last year would raise $902 billion over 10 years.

Now, this year's version would be far higher. According to the president's budget proposal, part of these revenues would be redistributed to, quote, "compensate the public," unquote.

Now, according to the National Rural Electric Cooperative Association, if a $50 cost per metric ton of carbon dioxide is imposed under a cap and trade system, residential electric bills would increase by 70 percent in Utah. Now, that is a very high rate compared to most other states.

Now, am I correct that the people of Utah and these other carbon- intensive states such as West Virginia, North Dakota and Arkansas would have to bear a far greater burden of higher electric bills as a result of the president's climate change agenda?

MR. ELMENDORF: Senator, CBO has not done an analysis on a state- by-state or regional basis. And I recognize that it would be very useful for you if we had. So I can't speak to Utah, specifically.

But it is true, and I said in my remarks that the effects of raising the price of energy and energy-intensive goods would be distributed very unevenly across the country. And that puts on your -- squarely in front of you and your colleagues the question of whether you want to use the revenue that would be collected through such a cap and trade system -- or a carbon tax -- to offset those effects and to what extent you want to do that for people who live in certain areas of the country or work in certain industries or have certain levels of income.

SEN. HATCH: Thank you, Mr. Chairman.

SEN. BAUCUS: Thank you, Senator.

Thank you, all.

Senator Cantwell had a question.

SEN. CANTWELL: Could I -- if I could just as a quick question before --

SEN. BAUCUS: Sure.

SEN. CANTWELL: -- do we have time --

SEN. BAUCUS: We've got a couple, three minutes.

SEN. CANTWELL: -- about upstream caps?

Would an upstream cap on fossil fuel cover more than 80 percent of the greenhouse gas emissions, Dr. Smith?

MS. SMITH: It would be close to that.

SEN. CANTWELL: So, I mean, that's an agreement -- everybody's agreed on that? Is that correct?

Is that correct, Dr. Elmendorf?

MR. ELMENDORF: I think that's roughly correct, yes. I'm not -- don't have a precise numbers.

SEN. CANTWELL: Okay. And then the upstream cap obviously would avoid the problems of partial fuel, fossil fuel emission coverage and verification and all of that. That's usually what the cap and trade -- is that right, Dr. Smith?

MS. SMITH: Definitely.

SEN. CANTWELL: Okay.

And then, Mr. Elmendorf, you -- there is research for the future map that basically shows that carbon intensity, if you did an upstream cap, doesn't really vary that much by region, is that right? So, I mean, if you implemented something -- you don't see this variation in cost by region across the country?

MR. ELMENDORF: It's a topic of ongoing research about the -- how the regional effects interact with effects at different levels of the income distribution. So there is a recent study that suggests that low-income people in particular parts of the country might have particular effects. It really depends, as I suggested earlier, on both the fossil fuel intensity of their production in certain areas -- what industries people mostly work in -- but also on the fossil fuel intensity of their consumption. People who drive further because they live in rural areas, people whose local utilities generate electricity mostly using coal and would find it more or less difficult to get power from other sources -- those consumption issues matter as well.

So it is complicated to keep track of this on a regional basis. And the Resources for the Future people are doing terrific analysis that we often draw on. I think it's a little bit of an unsettled question as to how to look at this, again, not just by region but also by region and income group together.

SEN. CANTWELL: Thank you.

Thank you, Mr. Chairman.

SEN. BAUCUS: Thank you, Senator.

And I thank you all. This has been very important, very helpful, informational testimony. I think we've all learned a lot here on an extremely important subject.

And thank you, Dr. Delbeke, for joining us as well.

This is certainly going to require collaborative, cooperative effort and your presence here helps in that regard.

So thank you all very, very much.

And the hearing's adjourned.

MR. ELMENDORF: Thank you, Mr. Chairman.

SEN. BAUCUS: (Sounds gavel.) Thank you.

END.


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