[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]





                 CAP, AUCTION, AND TRADE: AUCTIONS AND
              REVENUE RECYCLING UNDER CARBON CAP AND TRADE

=======================================================================

                                HEARING

                               before the
                          SELECT COMMITTEE ON
                          ENERGY INDEPENDENCE
                           AND GLOBAL WARMING
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                            JANUARY 23, 2008

                               __________

                           Serial No. 110-23




             Printed for the use of the Select Committee on
                 Energy Independence and Global Warming

                        globalwarming.house.gov








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                SELECT COMMITTEE ON ENERGY INDEPENDENCE
                           AND GLOBAL WARMING

               EDWARD J. MARKEY, Massachusetts, Chairman
EARL BLUMENAUER, Oregon              F. JAMES SENSENBRENNER, Jr., 
JAY INSLEE, Washington                   Wisconsin, Ranking Member
JOHN B. LARSON, Connecticut          JOHN B. SHADEGG, Arizona
HILDA L. SOLIS, California           GREG WALDEN, Oregon
STEPHANIE HERSETH SANDLIN,           CANDICE S. MILLER, Michigan
  South Dakota                       JOHN SULLIVAN, Oklahoma
EMANUEL CLEAVER, Missouri            MARSHA BLACKBURN, Tennessee
JOHN J. HALL, New York
JERRY McNERNEY, California
                                 ------                                

                           Professional Staff

                     David Moulton, Staff Director
                       Aliya Brodsky, Chief Clerk
                 Thomas Weimer, Minority Staff Director












                            C O N T E N T S

                              ----------                              
                                                                   Page
Hon. Edward J. Markey, a Representative in Congress from the 
  Commonwealth of Massachusetts, opening statement...............     1
Hon. F. James Sensenbrenner, Jr. a Representative in Congress 
  from the State of Wisconsin, opening statement.................     3
Hon. Earl Blumenauer, a Representative in Congress from the State 
  of Oregon, opening statement...................................     4
Hon. Marsha W. Blackburn, a Representative in Congress from the 
  State of Tennessee, opening statement..........................     5
Hon. Jay Inslee, a Representative in Congress from the State of 
  Washington, opening statement..................................     6
Hon. Jerry McNerney, a Representative in Congress from the State 
  of California, opening statement...............................     7

                               Witnesses

Dallas Burtraw, Senior Fellow, Resources for the Future..........     8
    Prepared Statement...........................................    11
Peter Zapfel, Coordinator for Carbon Markets and Energy Policy, 
  European Commission--Environment Directorate General...........    33
    Prepared Statement...........................................    35
    Answers to Submitted Questions...............................   100
Hon. Ian Bowles, Secretary of Energy and Environmental Affairs, 
  Commonwealth of Massachusetts..................................    43
    Prepared Statement...........................................    46
    Answers to Submitted Questions...............................   108
    Appendix to Statement........................................   129
John Podesta, President and Chief Executive Officer, Center for 
  American Progress..............................................    49
    Prepared Statement...........................................    50
    Appendix to Statement........................................   131
Robert Greenstein, Executive Director, Center on Budget Policies 
  and Priorities.................................................    65
    Prepared Statement...........................................    67
    Answers to Submitted Questions...............................   117

 
  HEARING ON CAP, AUCTION, AND TRADE: AUCTIONS AND REVENUE RECYCLING 
                       UNDER CARBON CAP AND TRADE

                              ----------                              --
--------


                      WEDNESDAY, JANUARY 23, 2008

                  House of Representatives,
            Select Committee on Energy Independence
                                        and Global Warming,
                                                    Washington, DC.
    The Committee met, pursuant to call, at 9:30 a.m., in Room 
2128 Rayburn House Office Building, Hon. Edward Markey 
[chairman of the Committee] presiding.
    Present: Representatives Markey, Blumenauer, Inslee, 
Larson, Herseth Sandlin, Cleaver, Hall, McNerney, 
Sensenbrenner, Sullivan and Blackburn.
    The Chairman. Good morning. This past December the New 
Direction Congress passed the Energy Independence and Security 
Act, a momentous first step towards combating global warming 
pollution and securing our energy independence. With that down 
payment in place, Congress now must turn to the next great 
challenge: enacting an economy-wide cap-and-trade program that 
will reduce heat-trapping pollution 80 percent by 2050.
    A cap-and-trade system harnesses the power of the market to 
ensure that pollution will be cut by a defined amount at the 
lowest possible cost. Cap-and-trade is an idea that is made in 
the U.S.A. Its advantages have been demonstrated under the 
Clean Air Act's highly successful acid rain program. The 
Europeans have adopted this idea for their emissions trading 
system for carbon dioxide. And, fortunately, we are now in a 
position to benefit from the lessons we have learned in 
implementing that system.
    One of the most important questions that any cap-and-trade 
system must answer is how tradable pollution allowances should 
be distributed. Should they be given away for free to polluters 
or should they be auctioned off? The acid rain program and the 
early phases of the EU emissions trading system rely primarily 
on free allocation. But both economic theory and the EU's 
recent experience have taught us that giving allowances away 
may result in massive windfall profits for polluters and, 
surprisingly, does not lower costs to consumers.
    In most cases, polluters will charge consumers for the 
value of the allowances, even if they receive those allowances 
for free. Auctioning avoids this problem and ensures that 
allowances distribution is transparent and fair based on the 
free market, rather than political deals. Auctioning also has 
the advantage of sending a carbon price signal that is loud and 
clear, not muffled by special interest giveaways. And, finally, 
auctioning can provide tens of billions of dollars of revenue, 
which can be used to greatly reduce the overall cost of the 
program and speed the transition to a low-carbon economy.
    By investing auction revenues in technology research and 
development, efficiency, renewable energy, and rebates and tax 
cuts for low and middle-income households, we can provide a 
much needed stimulus to the economy, one that will get us out 
of the doldrums and unleash a clean, green revolution of 
innovation and prosperity.
    For all of these reasons, economists have long been nearly 
unanimous in advocating auctioning over free allocation. Now, 
policy-makers around the world are moving decisively towards 
robust action. As Mr. Zapfel, our witness from the EU will 
explain, the European Commission just this morning announced 
its proposal to move to 100 percent auctioning of allowances 
for electric utilities by 2013 and to increasing reliance on 
auctions for other industrial sources. At least six of the 
Northeastern states, including my home state of Massachusetts, 
represented this morning by Secretary of Energy and 
Environmental Affairs, Ian Bowles, are planning to use nearly 
100 percent auctions to distribute allowances under the RGGI 
cap-and-trade program.
    As Congress begins debate on cap-and-trade legislation, it 
is imperative that we learn from these experiences. The health 
of our planet's atmosphere is a sacred public trust that 
belongs to all of us, and the right to pollute it should not be 
given away for free, nor should we adopt a program that will 
enrich corporate polluters at consumers' expense.
    I believe that with a well-designed cap-and-trade program 
based on robust auctions and revenue recycling, we can do our 
part to save the planet from global warming in a way that grows 
our economy, creates jobs, is efficient, transparent, and 
socially equitable. Our distinguished panel of witnesses today 
is well-qualified to help us to move forward on this endeavor.
    I would also at this time like to inform the members that 
David Moulton, who serves as the Select Committee's Staff 
Director and Chief Counsel, will be leaving that position on 
February 7th. David is one of Capitol Hill's most experienced 
veterans. And, much to my regret, he has decided to retire from 
the Hill after more than 25 years of serving in the House and 
the Senate.
    David has been at my side on every major issue I have 
worked on since 1985, from energy to the environment to 
telecommunications to consumer protection. Over the last 23 
years, he has worked with me in a series of capacities, 
including Legislative Director, Chief of Staff in my personal 
office, and as Staff Director of the Subcommittee on 
Telecommunications and Finance, before assuming the role of 
Staff Director for this Committee.
    Whether it is energy efficiency or the V-chip, children's 
educational television, or rollercoaster safety, protecting the 
Arctic refuge, or fighting global warming, David has been my 
closest adviser. He has combined a deep commitment to the 
public interest with a mastery of the legislative process.
    Over the last year, David played a pivotal role in setting 
up the Select Committee. And he has helped to grow it into a 
force for change in this Congress and in the world.
    David exemplifies all of the best qualities of the staff 
whose hard work and professionalism make it possible for this 
institution to serve the public. He combines the soul of John 
Audubon with the writing talents of Mark Twain. His skills, 
counsel, and creativity will be greatly missed by me and by all 
of my staff.
    David, I want to thank you for all that you have done for 
me over the years. You are not only one of the top advisers 
that anyone in Congress has ever had, but you are also my very 
dear friend. And I wish the very best to you, your wife, 
Francie, and your two daughters in all of your endeavors in the 
years ahead.
    And I know for myself and all of the staff of the Select 
Committee and the members of the Select Committee, we offer you 
our thanks for your public service. Thank you so much for 
everything you do.
    [Applause.]
    The Chairman. Let me turn to recognize the ranking member 
of the Select Committee, the gentleman from Wisconsin, Mr. 
Sensenbrenner.
    Mr. Sensenbrenner. Thank you very much, Mr. Chairman.
    First of all, let me say that I think I speak for over 
72,000 other people who were in Lambeau Field Sunday night that 
we don't think global warming is such a bad thing. [Laughter.]
    Because if it weren't for global warming, it might have 
been 20 below there, rather than just a little bit below the 
zero margin. And the game was bad.
    Today's hearing will focus on the details of a cap-and-
trade system. Specifically, the hearing will examine how carbon 
credits and allowances are to be distributed in a cap-and-trade 
system. However, I will not be offering much input into this 
nuance question because I will oppose a cap-and-trade 
regulatory regime and oppose it strongly, no matter how credits 
are distributed within the system.
    My reason for opposing this mess is simple. From the 
outside of the Select Committee, I said that I will oppose any 
legislative effort that will hurt jobs and the economy. And I 
am convinced that a cap-and-trade system will do just that.
    One needs look no further than Japan, Italy, and Spain to 
see what quicksand awaits U.S. ratepayers under a cap-and-trade 
system. Together these nations will have to fork over $33 
billion to buy carbon credits according to a November 30th 
Bloomberg news article. This amounts to a tax on electricity in 
those countries since the cost of these credits will probably 
be hidden in the overall electricity bill.
    Make no mistake. These costs are the price tag of the Kyoto 
treaty. President Bush has received much grief for failing to 
sign on to that bloated regulatory regime. But after seeing how 
it is raising electricity costs in Europe and Asia, I am 
pleased that the President followed my advice and kept the 
United States out of that bad deal.
    The question isn't if a cap-and-trade system will raise 
electric costs. The question is how much they will raise costs. 
This is a question that I have been asking over and over today 
and throughout the year as we continue to examine this issue.
    When this Select Committee conducted a field hearing in 
Seattle last November, I engaged with New York City Mayor 
Michael Bloomberg on the differences between a cap-and-trade 
system and a direct tax on carbon. While I disagree with Mayor 
Bloomberg on the need for carbon tax, we both agreed that at 
least a carbon tax is an honest attempt to reduce carbon 
emissions; whereas, a cap-and-trade system simply buries the 
cost deep within your electricity bill.
    Cap-and-trade is a politician's dream, doesn't have to vote 
for the tax and then can run around and criticize the evil 
electricity companies for passing the cost of these credits on 
to consumers. It's a dishonest way of doing it. At least Mayor 
Bloomberg said that if we're going to do this type of a taxing 
system, we ought to do it the honest way.
    If the politicians in Washington believe it is a good idea 
to use taxes in an effort to fight global warming, then they 
should show the ratepayers exactly how much they are spending 
on these so-called global warming solutions. I think most 
people would find that to be the real inconvenient truth.
    Ten years ago, when I was Chair of the Science Committee, 
an employee of the Clinton administration testified that the 
Kyoto treaty and the cap-and-trade system that was envisioned 
in that would raise electric rates by 80 percent.
    I can't face the senior citizens in my district, saying 
that a procedure that I have advocated cost them that much 
money. And what is going to happen to manufacturing when the 
cost of energy here goes up that much but the cost in China 
doesn't go up at all?
    Since 2005, Europe has been under a cap-and-trade system. 
So far the results don't look good. Open Europe, a group that 
studied the system, found that it acted like a wealth transfer 
mechanism, subsidizing polluters in states making little effort 
to control carbon emissions while punishing states that had 
tougher emission allocations.
    Perhaps the cost of this system would be worth it if they 
were actually creating measurable improvements to the 
environment. But as Open Europe notes, this regulatory system 
has actually led to an increase in emissions from Europe.
    The American people deserve a technological approach to 
global warming that improves the environment while protecting 
the economy. They don't deserve a tax hike that masquerades as 
a solution.
    I yield back the balance of my time.
    The Chairman. Great. The gentleman's time has expired. The 
Chair recognizes the gentleman from Oregon, Mr. Blumenauer.
    Mr. Blumenauer. Thank you, Mr. Chairman. I, as always, 
appreciate the eloquence of our ranking member. One of the 
fallacies I hear, though, in his presentation is that we are 
already paying huge costs as a result of global warming. And 
the scientific evidence is that it is going to be far greater.
    The Stern review suggested that by investing as little as 
one percent of our GDP, we could avoid the worst effects. 
Failure to avoid the worst effects could have the GDP worldwide 
dropping 20 percent. I mean, this is a wise investment.
    And the good news is that a year from now, the United 
States will no longer be the single holdout of the 
industrialized countries that don't believe that we're going 
into a carbon-constrained economy. It is still open to how that 
carbon constrained. And it maybe that carbon tax has some 
merit.
    I am intrigued, as you, Mr. Chairman, with the potential of 
the carbon cap-and-trade. It might just be the key to saving 
the planet, but it also might be very helpful to get us out of 
the current economic crisis that we find ourselves in because 
we have systematic weaknesses, economic deficit, environmental 
deficit, infrastructure deficit.
    A cap-and-trade has a potential for creating a great deal 
of value. How that is captured and where it is allocated is of 
great interest to me. I am going to be posing some questions to 
this terrific panel that you have assembled to see if there is 
some way that a portion of this value could be reallocated to 
deal with crumbling infrastructure, in some places in the wrong 
places, invested in the wrong ways, that we might be able to 
take a portion of it to be able to revitalize the 
infrastructure, to reduce the carbon footprint over the long 
run while we stimulate the economy in the foreseeable future 
and avoid economic catastrophe in the future.
    I deeply appreciate this opportunity and look forward to 
pursuing this. But be forewarned. This is something I would 
like some of our witnesses to think about with this.
    The Chairman. Great. The gentleman's time has expired. The 
Chair recognizes the gentlelady from Tennessee, Ms. Blackburn.
    Ms. Blackburn. Thank you, Mr. Chairman. Thank you for the 
hearing. And I want to thank our witnesses for being here 
today. I also want to apologize. We have an O&I Committee 
hearing with Energy and Commerce. So I am going to have to be 
up and down and back and forth today, Mr. Chairman, but I do 
thank our witnesses for being here. And I thank you that we are 
going to look at how a cap-and-trade would be administered and 
the prospects for such a system.
    I will tell you right up front I have some grave concerns 
about this type carbon reduction scheme because of my belief 
that it would drastically affect the nation's energy supply and 
would significantly distort the market. So I join my colleagues 
in letting you know that I do have some questions that I would 
pose to you.
    Now, I know that proponents of the cap-and-trade system 
argue that the system is necessary because humans are causing a 
global climate change through emissions and carbon dioxide. 
And, therefore, we have to institute something that is going to 
drive a change to this human behavior.
    But then we turn around. And in our study and research, I 
have read several things in some of our scientific journals 
from the past decade that show that most, if not all, of our 
recent global warming is caused by the sun and other natural 
causes and cannot be specifically and irrefutably linked to 
human activity.
    And if these schemes were to be implemented, they would 
have little to no effect in changing the current projected rate 
of temperature more than a couple of degrees over 100 years.
    So I think that it is our responsibility. It's this 
Committee's, and it is Congress' responsibility to take 
reasonable actions to protect the environment. But closing coal 
plants and imposing massive energy costs on consumers in 
developing nations is in my opinion not the way we ought to go.
    A cap-and-trade or a carbon tax system will likely lead to 
shuttering many of the power plants that are in existence today 
and would compromise the American job market and could lead to 
a greater dependence on foreign energy sources, rather than 
driving us toward energy independence. And all of this would 
end up having a negligible environmental effect.
    In my opinion, that may be a little bit too steep a price 
to pay. This past summer, several of my colleagues and I 
traveled to Europe and firsthand had some firsthand visits with 
those on the cap-and-trade system. It raised some concerns. We 
look forward to hearing from you today.
    I yield back.
    The Chairman. Great. The gentlelady's time has expired. The 
Chair recognizes the gentleman from Washington, Mr. Inslee.
    Mr. Inslee. I was talking to the President of the National 
Academy of Sciences the other day. And he wasn't worrying about 
the sun wobbling around or sunspots destroying the climactic 
system of the Earth. This is a problem we have got to tackle. I 
am glad we are here because if we don't solve this problem, 
nothing else matters.
    I want to make three comments about cap-and-trade. First, 
those who are critical of the cap-and-trade system, I would 
just simply say, as they say in Texas, show me what you've got. 
Show me what you've got to solve this problem. And those who 
criticize this and approach from a lot of other criticisms 
never come up with another system to solve this problem. It is 
the best system we have available, and we should implement it.
    Second, for those who argue that a cap-and-trade system is 
sort of a camouflage system, trying to avoid responsibility, I 
would suggest the reason it is important is the first word. It 
is a cap. And a carbon tax does not have a cap. A carbon tax 
makes some assumptions about behavior that may or may not be 
true.
    The European experience has been a tax alone does not and 
cannot solve the problem. You have to have a hard, meaningful, 
concrete, impenetrable, legally enforceable cap.
    And this we guarantee our constituents. We are going to 
tell our grandkids we are going to have a solid, enforceable 
limitation on how many megatons of CO2 we are 
putting into the atmosphere.
    Third, the most important debate we will have in the next 
12 months is on an auction because there are some things we can 
learn from Europe. It's true they don't know what football is, 
but there are some things we can learn from them.
    And the number one lesson from Europe is that you have to 
have an auction if you are going to have a meaningfully 
successful cap-and-trade system, both for reasons of equity 
because of the tragedy of the commons that they first 
brainwashed me about in economics back 36 years ago but also 
because it has to work that way from an equity standpoint and 
an enforcement standpoint by putting a price on carbon. That is 
a lesson from Europe. They have learned it. We don't have to go 
through their painful first few years. We can learn from their 
experience.
    I will be working on legislation to have the earliest 
implementation of 100 percent oxygen as soon as humanly and 
politically possible. It is what I believe will be the single 
most important debate we have in Congress this year. And we 
hope that the forces of oxygen prevail for our grandkids' sake. 
It is a lesson from Europe. We have got to learn it.
    Thank you.
    The Chairman. The gentleman's time has expired. The Chair 
recognizes the gentleman from California, Mr. McNerney.
    Mr. McNerney. Thank you, Mr. Chairman.
    I want to thank the panel for coming here today. The cap-
and-trade policies that are ultimately adopted by this 
government are not only extremely important, but it is also an 
extremely interesting process.
    Speaking as a scientist, I look forward to getting into 
some of these details and having some fun mucking around, but, 
in particular, such a program will determine the direction of 
our economy. It will help or hurt our poor, our lower-income 
people. It will guide industry and, if done properly, will make 
America a leader as we move forward into the twenty-first 
century.
    So, with little or no pressure on the panel, I look forward 
to your testimony. And I reserve the balance of my time.
    The Chairman. The gentleman can do that. The Chair 
recognizes the gentlelady from South Dakota, Ms. Herseth 
Sandlin.
    Ms. Herseth Sandlin. Thank you, Mr. Chairman. I will 
reserve my time for questions as well. Thank you.
    The Chairman. The Chair recognizes the gentleman from 
Connecticut, Mr. Larson.
    Mr. Larson. Thank you very much, Mr. Chairman. I, too, look 
forward to the testimony. And I feel somewhat like that old 
George Gobel line. I feel like a pair of brown shoes at a black 
tuxedo event.
    I do favor very strongly a specific tax credit, carbon tax 
credit, because I think that that is the most direct, most 
efficient means of us accomplishing a goal. I am skeptical 
about the cap-and-trade and remain to be convinced and 
certainly am anxious to hear from our panelists today.
    But I am especially concerned about the auction and about 
how the auction takes place, how a cap-and-trade is going to be 
administered, what is going to happen down line to people when 
we know the costs are going to rise.
    I especially am concerned in the Northeast about the 
constituents that I represent. And I feel that they would be 
more advantaged by making sure that we had a payroll tax 
deduction specifically tied to a carbon tax that would both 
benefit them and I think provide both an appropriate cap and a 
path forward for us to solve this very difficult problem.
    I think it also would be helpful to us in dealing with our 
foreign partners, most notably in China and India, because of 
the transparency issues that obviously exist but remain to be 
convinced otherwise.
    The Chairman. The gentleman's time has expired. And all 
time for opening statements from the members has been 
completed. So we will now turn to our panel.
    And we will hear first from Mr. Dallas Burtraw. He is a 
Senior Fellow at Resources for the Future. Mr. Burtraw is an 
economist who is recognized as one of the leading national 
experts on emissions cap-and-trade systems. He has worked in 
this area for the past two decades and has played an important 
role in evaluating the Clean Air Act's acid rain program and 
has worked extensively on the Northeastern states' RGGI program 
and on the EU's emission trading system. We welcome you, Mr. 
Burtraw. Whenever you are ready, please begin.
    Mr. Burtraw. Thank you. Thank you for the opportunity to 
testify today.

                  STATEMENT OF DALLAS BURTRAW

    Mr. Burtraw. Resources for the Future neither lobbies nor 
takes positions on specific legislative or regulatory 
proposals. So I emphasize that the views I present today are my 
own. I mean, I am going to talk specifically about the question 
of how emission allowances are allocated or initially 
distributed in the implementation of a cap-and-trade program by 
addressing several specific questions.
    The first is, what are the efficiency benefits of auctions? 
There are not many viewpoints that you can get most economists 
to agree on, but one of them is that the role of an auction in 
the implementation of an emissions cap-and-trade program 
delivers significant efficiency benefits.
    One perceived virtue of auctions is that they are 
consistent with the principle of simplicity and transparency, 
which is valuable in the formation of a new market.
    A second and equally forceful reason that economists favor 
an auction is that it makes funds available that can be used to 
achieve other goals. Depending on how these revenues are used, 
they can help in an important way to reduce the economic costs 
of climate policy. For the purposes of minimizing the costs and 
promoting economic growth, economists would favor dedicating 
the use of revenues from an auction to reduce preexisting 
taxes.
    A second approach would be to reinvest some portion of 
allowance value to reinforce policy goals. For example, in the 
ten-state Northeast Regional Greenhouse Gas Initiative that 
takes effect in 2009, at least 25 percent of the allowance 
value which would be realized through an auction is to be 
budgeted to consumer benefit, such as investments and energy 
efficiency.
    A third idea is that even a relatively small sliver of 
auction revenues would provide a relatively substantial 
infusion of support for research and development of new 
technologies. I know that others on this panel have other ideas 
that deserve consideration on this revenue question.
    Second, would free allocation of allowances significantly 
reduce economic impacts on consumers? The group that is most 
affected by climate policy will be consumers.
    In the electricity sector under an auction, although we 
find that some electricity generators are going to bear some 
costs under an auction, consumers of electricity bear about 
eight times greater costs. This results because generators are 
able to pass along the cost to consumers through increasing 
prices.
    Free allocation of emission allowances to generators cannot 
be expected to reduce this impact where there are competitive 
markets. The only important exception is in that portion of the 
electricity sector where there are regulated prices. And in 
these regions, consumers would benefit from free allocation to 
firms.
    However, in general, throughout the economy, the ability of 
firms to pass on the cost of allowances does not hinge on how 
they receive the allowances initially. Sometimes one hears 
firms argue to the contrary, saying they would not charge their 
customers for emission allowances they received for free.
    When one hears this, one might think that a different 
conversation needs to be had between those firms and their 
shareholders because it is shareholder value they would be 
giving away.
    The fact that a firm and competitive market will charge its 
customers for the use of an asset that the firm has received 
for free is often a difficult idea for people to grasp at first 
but is wholly consistent with economic theory and is in general 
what has been observed in empirical studies. In general, giving 
allowances away for free to firms will provide little benefit 
to consumers.
    There is one way that consumers could benefit from free 
allocation, however. And that is if citizens were to receive 
allowances' value directly. This approach has been called a 
cap-and-rebate to every person with a Social Security number.
    Number three, to what extent do auctions deprive polluters 
of capital needed to invest in achieving substantial reductions 
in greenhouse gases? In the electricity sector, most new 
investment and generation relies on project-specific financing, 
meaning that each project is evaluated and financed 
independently with capital from outside the firm. As a 
consequence, implementation of an auction will not affect the 
availability of capital for financing new projects in the 
important electricity sector.
    What proportion of allowance value is needed to compensate 
polluting firms? Overall, economic estimates suggest that the 
loss in market value of industries that are going to be heavily 
affected by climate policy is less than 30 percent of the value 
of emission allowances. This estimate masks some differences 
among firms because many firms turn out to be winners, and some 
firms are losers.
    In the electricity sector, which, again, is the center of 
much attention, the industry as a whole would require just six 
percent of allowance value, but this accounts for firms that 
gain value. And to compensate only the losers would require 
about 11 percent of the allowance value.
    Is it feasible to allocate, construction an allocation 
formula, that would efficiently target compensation to those 
firms that are adversely affected?
    The award of free allowances is a blunt instrument for 
achieving compensation for producers. Free allocation tends to 
reward winners as well as losers, thereby eroding efficiency 
and the ability to compensate other affected parties.
    We find the opportunity costs of compensation to producers 
in the electricity sector is five times the cost of 
compensation delivered successfully. The difference accrues to 
firms as windfall profits.
    One way to improve this would be to apportion allowances 
for the states and let the states conduct allocation to achieve 
compensation goals. This cuts in half roughly the cost of 
achieving compensation or more modest compensation targets also 
reduce the cost. Nonetheless, under any strategy, there are 
important considerations regarding the difficulty of achieving 
compensation.
    Finally, to what extent are the economic impacts of 
legislation on polluting firms likely to be spread among 
shareholders who hold diversified portfolios? In this modern 
age, the vast majority of shareholders hold few, if any, stocks 
in individual companies. Most of us hold assets in mutual 
funds. For this reason, the way to deliver compensation to 
owners of equity is to design an efficient policy in order to 
lessen the overall cost of the policy, which is precisely the 
virtue of the use of options.
    Thank you for the opportunity to testify.
    [The statement of Dallas Burtraw follows:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    
    The Chairman. Thank you, sir, very much.
    Our second witness is Mr. Peter Zapfel. Mr. Zapfel is the 
Coordinator for Carbon Markets and Energy Policy for the 
European Commission. Mr. Zapfel has represented the European 
Commission as a delegation member in the U.N. climate 
negotiations and has been actively involved in the commission's 
work on emissions allowance trading, including the EU's 
proposal just released today to transform the EU emissions 
system post-2012.
    I would like to state for the record that the Committee 
appreciates Mr. Zapfel's voluntary participation. The Committee 
recognizes that because of Mr. Zapfel's status as a 
representative of the European Commission, neither Congress nor 
the Committee have legal authority over his presentation today.
    We welcome you, Mr. Zapfel. And whenever you are ready, 
please begin.

                   STATEMENT OF PETER ZAPFEL

    Mr. Zapfel. Mr. Chairman, members of the Committee, it is a 
pleasure to testify today. In particular, as you alluded 
already, before we have earlier this morning when you were 
getting out of your beds, the European Commission has tabled a 
set of legislative proposals to implement our far-reaching 
climate and energy policy goals for the next decade.
    What I would like to do in my five minutes of intervention 
here focusing on auctioning is give you some information of 
what we have proposed this morning, why we have proposed to go 
to auctioning as the main method of allocation, give some 
experience we have with free allocation, and end up with a few 
recommendations.
    Before going into auctioning, I also, however, want to 
point out that the core of our proposal this morning on 
reviewing our carbon-trading scheme is the proposal to bring 
down the emissions cap, the number of allowed emissions, by 21 
percent in 2020 compared to the emissions level in the trading 
scheme in 2005. So we have a very robust emissions cap proposed 
that will drive forward the carbon market and deliver 
environmental benefits and also create a well-functioning 
carbon market.
    The Commission has this morning proposed that as of 2013, 
as of the start of the third trading period, we make auctioning 
the main method of allocating allowances and we go and do a 
transition so that by 2020, in principle auctioning is the only 
method of allocating allowances to the European common market.
    Free allocation would immediately end at the end of the 
second rating period in 2012 from our plans. And for other 
industrial installations in other sectors covered by our 
scheme, free allocation would be phased out over an eight-year 
period so that by the end of the third trading period in 2020, 
we would no longer in principle have free allocation.
    Why have we made these proposals? We see three merits, in 
principle, for auctioning. Auctioning has merits in simplicity. 
Auctioning has merits in transparency. And auctioning is also 
seen as advantageous from our side for the efficiency in the 
clear carbon pricing that it creates.
    What experience do we have in Europe with free allocation 
for the first eight years, the first two phases of our scheme? 
Free allocation is a very complex process to handle. The asset 
value of the allowances of the carbon allowances is 
considerable. And for the formal process, you need a device to 
allocate the allowances free of charge. You need a lot of data, 
which is administratively a very cumbersome process, the first 
point.
    The second point of free allocation tends to be a rather 
in-transparent process while this major asset value is 
allocated into the allowance market.
    Thirdly, because of the periodic nature that we do the 
allocation process and because of the possibility and, 
actually, the rules for free allocation change from period to 
period, this has the potential actually to distort decision-
making by actors in the market and has, in fact, to some extent 
distorted decision-making.
    And, fourthly, as has already been alluded to in 
introductory statements, free allocation creates distributional 
disadvantages for some sectors in a sense that the additional 
benefits in terms of companies increasing their prices far 
outweigh the additional costs and you create something which 
politically is called windfall profits.
    Finally, as I said, some recommendations. I think we reckon 
in the European Union that auctioning as a method of allocating 
emission allowances is a fairly new thing in emission markets.
    There are several environmental markets operated here in 
the United States. Some auctioning has taken place there. Also 
we in Europe at this stage have limited experience with 
auctioning. But in a number of fields on a daily basis--on a 
very regular basis--governments organize the allocation of 
economic assets by auctions. And we can learn a great deal from 
such other government-driven auctions; for example, for 
government bonds, for spectrum licenses. So we are not starting 
something completely new with transitioning to auction as the 
main method of allocating carbon allowances.
    There are two things I want to raise at the end of my 
testimony of what is crucial in our view to make auctioning a 
successful mechanism of allocating allowances. First of all, we 
think we need to take time to design the auction mechanism very 
well. That's why we have proposed today to trust in principle. 
We want to go to auctioning, but we will work out as part of 
the implementation process a detailed regulation. And we want 
to work with a lot with stakeholders, with the experts in 
financial markets to design a well-functioning auctioning 
mechanism because the economic assets involved are 
considerable. So we need more time to work that out in a good 
way.
    And, secondly, we need smart ways of recycling the revenues 
from the auctioning. There are various things to which the 
allowance value, the revenue can be put to. And there is 
further work to be done in working out, as I say, in a smart 
and effective way to allocate, to recycle the revenues.
    Thank you very much.
    [The statement of Peter Zapfel follows:]

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    The Chairman. Thank you, Mr. Zapfel. We very much 
appreciate your being here today.
    Next we have Ian Bowles. He is the Secretary of Energy and 
Environmental Affairs for my home state of Massachusetts. He is 
a recognized national leader in climate and energy policy. 
Secretary Bowles oversees the state's six environmental natural 
resources and energy regulatory agencies. Among other things, 
Secretary Bowles has the lead role in Massachusetts' 
implementation of the Regional Greenhouse Gas Initiative, RGGI.
    Prior to serving as secretary, Mr. Bowles was Associate 
Director of the White House Council on Environmental Quality 
under President Clinton.
    We welcome you. Mr. Secretary, whenever you are ready, 
please begin.

                    STATEMENT OF IAN BOWLES

    Mr. Bowles. Thank you very much Mr. Chairman and members of 
the Committee. Thank you for your focus on this tremendously 
important topic today. I am delighted to be here.
    My comments today reflect the general context in New 
England. We have expensive electricity. We have no indigenous 
coal and natural gas, face transportation costs to bring those 
fuels to our region. We have on average lower greenhouse gas 
emissions than the rest of the nation. And we have across New 
England a deregulated power market.
    In Massachusetts, we have also made--and other New England 
states have as well--considerable investments in energy 
efficiency. And in Massachusetts, we are currently in a rate 
decoupling proceeding where we are trying to eliminate the 
current economic incentive on our distribution utilities to 
maximize power sales at a time when we are trying to cut 
greenhouse gas emissions.
    We already have in place some limited greenhouse gas limits 
on our power plants. And, as the Chairman noted, we are in the 
process of transitioning to the RGGI system the first of next 
year.
    In renewable energy, we are moving forward with three new 
biomass power plants, the Cape Wind project, a sizeable solar 
program, and new incentives for biofuels. And, as the Chairman 
noted, we have combined, first state in the nation to do so, 
our energy and environmental agencies together to focus on 
three key goals: tapping the economic potential of the 
burgeoning clean energy sector--in Massachusetts, we have got a 
quarter of billion dollars of private venture capital 
investment and a great deal of job creation in that area--
second, curbing our greenhouse gas emissions; and, third, 
reducing our energy costs.
    When Governor Patrick brought Massachusetts into the RGGI 
process early last year, one of the central questions we faced 
was whether to auction for allowances or whether to grant them. 
Based on our analysis, we concluded that auctioning was a 
better way to protect the interests of the ratepayer.
    And the core thing to know there is that in a deregulated 
power market, the value, the economic value, the market value, 
of an allowance is going to make its way into the electricity 
bill one way or another, whether that generator decides to 
expend the allowance as they dispatch power to the grid, 
whether they save those allowances for a future generation 
event in the future, or whether they decide to sell those 
allowances. And either way that value is priced in, whether or 
not that allowance is given out or whether it is sold to the 
generator.
    On the contrary, if you sell it to the generator, then 
you've got those revenues to do something with and you can 
protect the ratepayers. And that's what we decided to do with 
our auction proceeds. And our first auctions begin in the 
second quarter of this year as we move into the compliance 
period for RGGI.
    As we did an analysis of what we should spend those monies 
on to best protect the ratepayer and achieve our environmental 
objectives, energy efficiency stood out above all else. We have 
the opportunity to not only save money for the ratepayers but 
also to lock in permanent greenhouse gas emissions reductions.
    In terms of the cost of RGGI, we see in the first couple of 
years less than a one percent increase in potential electricity 
bills. And as energy efficiency investments grab hold and 
accrue over time, within ten years, we see over five percent 
energy savings.
    Now, why is that? It's because we've got a great deal of 
energy efficiency left in our system and, indeed, across the 
nation that is cheaper in many cases than power generation.
    In terms of how much revenue we are going to produce, if 
it's a $1 permit, you will produce about $26 million. If it's a 
$5 permit, it will be $133 million. At the higher end of that 
scale would be effectively doubling our investment in energy 
efficiency in the Commonwealth.
    As you think about a federal system, I would make a couple 
of key points. One is that states, I think, are in the best 
position to deliver energy efficiency services. It's something 
where the federal government is somewhat too removed from the 
individual ratepayers and the end-use consumers. It's something 
that states have done a great deal on. And I think you could 
set up objective standards to say, ``What is the performance 
basis that we would like to see for use of proceeds down at the 
state level for energy efficiency?''
    I would also make that point that as compared to a 
grandfathering scheme, where you are giving out allowances, the 
auctions really level the playing field across all of the 
different sectors, instead of building in potentially unfair 
treatment for early movers.
    As we conduct our auctions this summer, we are going to 
focus on a few things. I will mention them quickly. I am happy 
to get into more detail in the questions.
    We are going to have our auctions open to any qualified 
buyer. As we watch the market develop, we may add rules in the 
future to make sure there isn't any hoarding or anything of 
that nature. We are going to have a sophisticated market 
monitoring system so we know who some of the players are. And 
then as we go forward, we are going to use a three-year 
compliance period to allow some flexibility between years 
because emissions vary depending on things like weather events.
    Finally, I just would mention I have submitted a longer 
ten-page appendix. And I would be delighted to take questions. 
And I thank you for your focus on this. We in the states look 
forward to engaging with the Congress as you move forward.
    Thank you very much, Mr. Chairman.
    [The statement of Ian Bowles follows:]

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    The Chairman. Thank you, Mr. Secretary, very much.
    Our next witness, Mr. John Podesta, is the President and 
CEO of the Center for American Progress. Mr. Podesta served as 
Chief of Staff to President Bill Clinton from October of 1998 
to January of 2001, where he was responsible for directing, 
managing, and overseeing all policy development, daily 
operations, and staff activities of the White House.
    Mr. Podesta has also held a number of other senior 
positions on Capitol Hill and in the White House and is a 
recognized expert on technology policy, amongst other areas. We 
are very fortunate to have him with us here today.
    We welcome you back, John. Whenever you are ready, please 
begin.
    Mr. Podesta. Thank you, Mr. Chairman.

                   STATEMENT OF JOHN PODESTA

    Mr. Podesta. And I started with David Moulton, but they 
kicked me out a lot faster. So it's nice to be back here.
    You have got my full statement.
    [The statement of John Podesta follows:]

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    Mr. Podesta. I would like to make four quick points. First, 
I would like to take this up a notch. Make no mistake. While it 
may be slow-moving, I think we are in a crisis. As our 
understanding of the implications of global warming increase, 
the case for dramatic, immediate action is only made stronger.
    Just last week, we learned that the western Antarctic ice 
sheet is melting faster, at a rate that was anticipated this 
could mean a sea-level rise of two meters, as Dr. Pachari 
noted, in this century, not the inches or feet, as originally 
predicted by the IPCC Fourth Assessment, which will threaten 
population centers, agricultural patterns, and coastal 
ecosystems around the world.
    Perhaps the best we can hope for and certainly the least we 
ought to plan for is a climate that will cause severe economic 
dislocation and national security challenges to the United 
States. Worldwide we are already feeling some of the economic 
consequences of climate change. We will soon feel the national 
security consequences of human migration, food shortages, water 
scarcity, destructive weather events, spread of disease, and 
national resource competition.
    The challenge I think we face as a nation and a world is 
nothing short of conversion of our economy that is sustained by 
high-carbon energy, putting both our national security and the 
health of our planet at risk to one based on low-carbon, 
sustainable sources of energy. The scale of that undertaking is 
immense, but its potential, as the Chairman noted, is also 
enormous.
    My second point is that energy policy is economic policy. 
In order to reverse the economic downturn we are currently 
facing and to capture the opportunities provided by a low-
carbon energy transformation, we must put energy at the center 
of our nation's economic growth. Fundamentally changing how we 
produce and consume energy, investing in low-carbon innovation, 
and transforming our economy to a low-carbon model are key to 
promoting economic growth, mobility, job creation, and 
regaining the technological leadership in the global innovation 
marketplace.
    Mr. Sensenbrenner noted a ten-year-old EIA projection, 
which proves I think in more recent projections to be wrong. I 
would note that ten years ago the United States had 44 percent 
of the solar market. Today we have nine percent, a loss mostly 
to Japan and Germany. I think the jobs of the future clearly 
are on the clean energy side.
    The U.S. Congress obviously realizes the importance of 
energy policy to the Economy. I commend the Congress for 
passing the 2007 energy bill and particularly for your work, 
Mr. Chairman, over the years on the raising the CAFE standard.
    The Center for American Progress recently released a report 
entitled ``Capturing the Energy Opportunity'' that laid out a 
strategy that we believe is pro growth, provides opportunity, 
and takes on global warming, all in a fiscally responsible way. 
At the core of that strategy is a fundamental commitment of the 
federal government to invest in green-collar jobs, research and 
development, and deployment of low-carbon technology, and to 
assist low and middle-income Americans with rising energy 
costs.
    My third point is that a cap-and-trade needs to be at the 
center of that energy policy. CAP advocates an energy strategy 
that employs both a cap-and-trade system and a suite of public 
investment policies funded by the auction revenue of carbon 
permits.
    A cap-and-trade will identify the necessary level of carbon 
reductions to get us to a point where we have a sustainable 
planet and allow the marketplace to price the cost of those 
emissions. In order to avoid a windfall profit for polluting 
industries, we recommend auctioning 100 percent of the carbon 
credits. Our proposal would allocate ten percent of auction 
revenue to businesses operating in energy-intensive sectors to 
compensate shareholders, employees, and communities in those 
sectors. We recommend half of the remaining 90 percent of the 
revenue be allocated to low and moderate-income Americans to 
help offset energy price increases.
    Polluting industries, and not hardworking American 
families, should shoulder the burden of this transformation to 
a new energy in the future. And to ensure that low and 
moderate-income Americans are protected from short-term 
increases in energy costs, we estimate and commit $336 billion 
over 10 years for income support and for middle class tax 
support. The remaining half of the revenue would go to support 
science and technology innovation; drive transition to a low-
carbon economy by funding R&D efficiency, as Ian has 
mentioned; and other initiatives, including infrastructure 
investment, Mr. Blumenauer.
    To meet the overall goal of emissions reduction under this 
cap-and-trade model, we recommend adopting complementary 
policies. For example, we support going further than what the 
Congress has recently passed in implementing a 55-mile-per-
gallon cap-based standard by 2030, improving our distribution 
in fueling infrastructure, investing in transportation 
infrastructure, and another suite on the electricity side, 
including creating a performance standard for all new coal-
fired facilities equivalent to the best available carbon 
capture and store technology.
    So my last point, and I will conclude by saying that we 
cannot continue waiting to jumpstart this energy 
transformation. Adopting a combination of short-term stimulus 
and long-term public investment policies will not only enable 
for the U.S. to once again become a world leader in low-carbon 
energy innovation but will also diversify our energy base, thus 
fostering economic stability, helping to boost economic growth, 
creating new green-collar jobs, and boosting productivity for 
our economy. We think we can create a virtuous cycle and a win-
win situation for the American public.
    Thank you.
    The Chairman. Thank you, Mr. Podesta.
    And our final witness, Mr. Robert Greenstein, the founder 
and Executive Director of the Center on Budget and Policy 
Priorities. Mr. Greenstein has written numerous reports, 
analyses, and articles on budget and poverty-related issues, 
including most recently how best to design planet policies to 
address impacts on low-income households. For his outstanding 
work at the center, Mr Greenstein was awarded a McArthur 
fellowship.
    We welcome you here today. Whenever you are ready, please 
begin.
    Mr. Greenstein. Thank you, Mr. Chairman.

                 STATEMENT OF ROBERT GREENSTEIN

    Mr. Greenstein. My focus is on the effects that climate 
change policies can have on the budgets of American families 
and the federal budget and the implications that has for the 
design of a cap-and-trade system.
    Our analysis indicates that Congress can design climate 
change policy that is environmentally sound and fiscally 
responsible, treats consumers fairly, and avoids increases in 
poverty. But to do so, the policy will have to be well-
designed, and it will need to generate sufficient revenue to 
meet the requirements of sound climate change policy and 
mitigate the impacts on vulnerable populations. That means it 
will be essential to auction most or all of the allowances.
    Our analysis of these issues can be summed up in four key 
numbers. Number one, $750 to $950 per year. That is the average 
increase in energy-related costs for the poorest fifth of the 
population from a quite modest, 15 percent, reduction in 
emissions, the kind of target that is often mentioned for, say, 
2020. As you know, climate change policies work, in part, by 
raising the price of fossil fuel energy products to encourage 
efficiency and the substitution of clean energy sources. That 
will raise costs to consumers for a variety of items, from 
gasoline and electricity to food, mass transit, and other 
products that have energy inputs.
    Households with limited incomes will be affected the most 
because they spend a larger share of their income on energy-
related products than more affluent households do. And they 
also are less able to afford investments that can reduce their 
energy consumption, such as buying a new energy-efficient car 
or going out and buying a new heating system for their home. If 
climate change legislation is passed but nothing is done to 
protect people of limited means, more of them will slip into 
poverty, those who are poor will become poorer, and the trend 
toward widening income inequality will be aggravated. Now let 
me give you a little context.
    This figure of $750 to $950 per year in increased costs for 
the bottom fifth of the population, from a 15 percent reduction 
in emissions, the people in question, the bottom fifth of the 
population, have average income of only a little over $13,000 a 
year. So 750 to 950 would be a big hit on them.
    Figure number 2, $50 billion to $300 billion per year. That 
is the Congressional Budget Office estimate of the resources 
potentially generated by climate change policies. That is CBO's 
estimate of the value of the emissions permits under a cap-and-
trade system. In other words, it is the amount of the proceeds 
the government would receive if the permits were fully 
auctioned off.
    Key figure number 3, approximately 14 percent. That is the 
share of the auction proceeds needed to fully offset the 
increased energy costs that low-income consumers would face. In 
my written testimony, I outline principles for designing a 
mechanism, an approach to fully and efficiently offset the 
increased energy costs on the bottom 20 percent of the U.S. 
population and also provide some relief to hard-pressed working 
families in the next to the bottom 20 percent. That could all 
be done for about 14 percent. That is one-seventh of the value 
of the proceeds from auctioning off the permits in a cap-and-
trade system.
    Now, if Congress wanted to assist middle-income consumers 
as well, that could be accomplished if a somewhat larger share 
of the proceeds were used for that purpose. For example, with 
approximately half of the allowance value, half of the value of 
the permits, Congress could fully compensate the bottom 60 
percent of Americans and provide significant compensation to 
the next 20 percent, leaving out only the most affluent 20 
percent, which is the group that consumes the most energy and 
is most able to afford to make sizeable adjustments in their 
consumption patterns.
    My final, my fourth, key number, less than 15 percent. That 
is the Congressional Budget Office's estimate of the share of 
the allowance value that is needed to fully compensate energy 
companies and other emitters for financial losses due to 
climate change policies.
    CBO has conducted a review of all of the literature in the 
field. There are a number of studies that have been conducted. 
The broad set of findings are that the net impact on the 
emitters could be in terms of potential economic losses would 
be offset for less than 15 percent of the permits. And CBO has 
called the provision of a larger share of the permits free to 
emitters as an approach that would result in, CBO's terms, 
windfall profits for the companies receiving the free 
allowances.
    Now, there is a misconception--Mr. Chairman, you referred 
to it in your opening remarks--a misconception some have that 
energy prices will not rise or not rise as much if the 
allowances are given away. That belief flies in the face of the 
basic laws of supply and demand. A cap on emissions will limit 
the supply of energy from fossil fuels. And when supply is 
restricted, prices rise. Regardless of whether the government 
gives away or sells the allowances, the energy companies will 
be able to sell their products at the higher price. They will 
be able to charge what the market will bear.
    Harvard economist Greg Mankiw, who served as Chair of 
President George W. Bush's Council of Economic Advisers, has 
characterized a cap-and-trade mechanism in which the allowances 
are given away in large numbers for free as a form of, in 
Mankiw's words, corporate welfare. Now----
    The Chairman. If you could please summarize?
    Mr. Greenstein. Let me summarize. The final thing I simply 
wanted to mention was the impact on budgets. Higher energy 
prices will raise the cost of federal, state, and local 
services. The cost of heating schools, hospitals, and the like 
will go up. Cost-of-living adjustments for Social Security and 
veterans' programs will need to be higher to reflect the higher 
energy costs.
    The Pentagon is the nation's single largest consumer of 
energy. And its costs will rise. Those can all be addressed, 
too, those issues, by devoting a share of the permits to 
offsetting the resulting increases in federal, state, and local 
costs, all of which comes back to the same issue.
    All of these things can be taken care of if most or all of 
the permits are auctioned off. If they are not, you get a 
potential for increased poverty, increased deficits in debt 
from the higher government costs, alongside windfall profits 
for emitters.
    Thank you.
    [The statement of Robert Greenstein follows:]

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    The Chairman. Thank you, Mr. Greenstein, very much.
    And now we'll turn to questions from the Select Committee. 
The Chair will recognize himself.
    Mr. Zapfel, thank you again for being here today. It is 
very important to us.
    The EU is making a big change today. They are moving in a 
completely different direction than they did in their original 
phase in dealing with greenhouse gas emissions.
    What happened when the allocation was free for the various 
sectors of the European economy? What was it that you found 
happened?
    Mr. Zapfel. Thank you, Chairman.
    As I pointed out before, when we go into the fourth year of 
free allocation now in our first rating period and, thus, in 
our second rating period, we have predominantly free 
allocation, we learned very early on, even before our trading 
scheme started via the future markets on the side of our 
prices, that the value of the allowances get priced, first and 
foremost, into electricity.
    We continue to do ongoing economic assessment. Our scheme 
is now just going into its fourth year. There is empirical 
evidence we continue to learn. But in principle, we see that, 
as has been said before, even if allowances are given for free, 
some sectors find it fairly easy to include the value of 
allowances into the prices. And this distributional effect is 
something that has resulted in a lot of debate in Europe and is 
actually one of the multi-weighting factors proposals that we 
have made today.
    The Chairman. Okay. So how do you deal with the challenge? 
Many people say that this is an unprecedented step that you are 
taking and that industry is unprepared to deal with the 
consequences of having an auction system. What is your response 
to that?
    Mr. Zapfel. It is not something we do overnight. As you 
know, we are now in the year of 2008. And the proposal is that 
the changes come in the year 2013.
    In principle, overall in the design of the regulatory 
framework for our carbon market, we pay a lot of attention to 
that we give this new market sufficient regulatory stability. 
And one of the key issues there is that we give sufficient 
foresight so we don't do changes overnight.
    We had, for example, a lot of debate whether we should 
already change our rules on very short notice so that the 
second phase would already see regulatory changes. The 
Commission has not entered in such changes because we think for 
the market to develop well, to work efficiently, it needs 
sufficient lead time so that everybody can prepare for the rule 
changes.
    The Chairman. And how are you dealing with industry 
opposition? And which industries are most opposed to moving to 
an auction system?
    Mr. Zapfel. I think, also as you said before, I think we 
are not the only ones across the world who is considering 
starting a legislative debate to move towards auctioning.
    We, of course, follow very carefully the debate in the 
United States. We have seen what is happening in the RGGI 
system or what has been decided in the RGGI system. There are 
other carbon markets designed around the world, in Australia 
and New Zealand. There is a debate here. So I think we are 
moving along an international trend that is developing.
    Of course, I think from the perspective of an individual 
business, if you are subjected to a carbon cap, it is always a 
preference for an industry to ask for free allowance, rather 
than to have to pay for the allowance. I think that is a 
natural opposition that we have in our political process.
    What is important to us is that there is to continue to 
empirically evaluate what are the real effects. What empirical 
evidence do we have? As I said, so far, there is no compelling 
empirical evidence that this is damaging. What we reckon is 
that some sectors, as I said, the borrow sector can move 
quicker. And other sectors need some time to adapt, industrial 
sectors, which we give more time to adapt to those changes.
    The Chairman. Okay. Thank you.
    Mr. Podesta, you are an expert on the budget and 
appropriations process. What recommendations would you make to 
ensure that any revenues that do come from an auction system 
are, in fact, preserved for R&D, are preserved to take care of 
the poorest citizens, who may be affected by this very dramatic 
change in the way in which we regulate energy in our country?
    Mr. Podesta. Mr. Markey, that is a very good question, but 
I think that we have dealt with it before in the Land and Water 
Conservation Fund and other funds that could be segregated 
either through the direct appropriations process or moving in 
the direction that we see, for example, in the Lieberman-Warner 
bill, where the money is deposited directly into certain 
accounts that would be used only for the purposes that would be 
put forward.
    But I think that's in the end of the day I think a critical 
question to ensure that the money goes to both what Mr. 
Greenstein spoke about, which is to cushion the burden. Again, 
in our proposal, we take it up to the middle class so that 
while they may see net increases in their energy pricing, we 
also believe that their energy bills can over the mid term bend 
down, as we have seen in California, because they are using 
less energy as efficiency is driven through the system. But 
ultimately they are going to pay a little bit more.
    And we think that those accounts need to be balanced and 
that the structure of the cap-and-trade system needs to 
essentially fence off that money so that both of those things 
can take place: the right kind of investments and protection of 
working people in this country.
    The Chairman. Thank you, Mr. Podesta. Again, Mr. Zapfel, 
thank you for being here. We feel like we are here on day one 
at 8:00 A.M. of the new era of auctioning. And I personally 
just want to praise the European Union for their courage in 
moving in that direction. I think it is the correct direction.
    The Chair's time has expired. And I recognize the gentleman 
from Wisconsin, Mr. Sensenbrenner.
    Mr. Sensenbrenner. Thank you very much, Mr. Chairman.
    As I think we all know, there is a great deal of concern 
about the direction that our economy is taking. And the fix is 
on for a bipartisan economic stimulus package. And the debate 
is over not whether to stimulate the economy but how best to do 
it. The bottom line is that there will be money pumped into the 
economy to try to prevent a recession from occurring or worse.
    Now, I am a member of Congress. And everybody up here is a 
member of Congress. How does a member of Congress justify 
voting to pump money into the economy in an economic stimulus 
package and then turn around and support a cap-and-trade 
program, which takes money out of the economy and could cost 
both consumers and businesses billions of dollars? Let me start 
with you, Mr. Podesta, since your advice is always very good to 
members of Congress.
    Mr. Podesta. Well, Mr. Sensenbrenner, I don't think you 
need to have that net impact. In fact, I think, as I said, you 
could create the virtuous cycle of taking money out of the 
economy that's going towards polluting the atmosphere, creating 
a worldwide crisis, causing us long-term national security 
problems that will require us to put more money into defense, 
take that money out from the pollution side, put it back in 
through rebates for low-income people, middle class people, and 
investments that will build a long-term economy.
    Mr. Sensenbrenner. Okay. First of all, we don't need to get 
into the science, but CO2 is not a pollutant. 
CO2 is a naturally occurring gas. It's not like 
sulfur dioxide or something like that. Every time we exhale, we 
exhale CO2. And that is not polluting this room.
    Mr. Podesta. I never thought I would say this, but I agree 
with the Supreme Court and disagree with you, Mr. 
Sensenbrenner.
    Mr. Sensenbrenner. Well, the Supreme Court is not right all 
the time either.
    Mr. Podesta. I agree with that.
    Mr. Sensenbrenner. Okay. Yes. The thing is let me continue 
on this. In 2000, the CBO did a study on cap-and-trade system 
and determined that the cap-and-trade system would be 
tremendously regressive.
    Now, I think that both you and Mr. Greenstein seemed to 
indicate that without tinkering around with the cap-and-trade 
system, it would be regressive and without the tinkering 
around, we end up giving carbon breaks for the rich using 
carbon, instead of tax and debate in the vernacular.
    If we go to tinkering around, which people are debating 
about, aren't we turning cap-and-trade into a wealth 
redistribution system? Mr. Greenstein.
    Mr. Greenstein. I would say the answer is no. Under a cap-
and-trade system, you have a decision. You have to make a 
decision. You give the permits away for free. You auction them 
off. You have to make a decision.
    The CBO report indicates if you have a cap-and-trade system 
and you give away the permits for free, you have highly 
regressive effects. If you have a cap-and-trade system and you 
auction off some substantial share to all of the permits, then 
whether it's regressive, progressive, or neither of the above, 
sort of make this just kind of right in the middle, depends on 
what you do with the proceeds from those permits that you 
auction off.
    But the only way in which it is clearly regressive is if 
you either--if you give away a substantial share of the permits 
for free, it is clearly going to be regressive because you 
clearly won't have enough money to offset the regressivity that 
the increases in consumer prices alone would cause.
    As long as you auction off a substantial share of the 
permits, you have the potential to ensure that the system is 
not regressive. You can make it progressive if you want to. You 
can simply avoid the regressivity.
    Mr. Sensenbrenner. But getting back to what Mayor Bloomberg 
told this Committee last November in Seattle, you know, why not 
be honest? If we're going to increase energy costs to do this, 
why doesn't Congress directly levy a tax, which is the honest 
way of doing it? And that way members of Congress have to be 
accountable for their votes one way or the other, rather than 
simply folding the cost of this into energy bills and then 
Congress taking a bow for ``giving money away'' to people that 
we decide need to get the money from the auction. Isn't Mayor 
Bloomberg right in saying, ``Let's be up front and honest,'' 
rather than, you know, going through this tremendously 
bureaucratic system with all kinds of values of who deserves 
the money from the auction and who doesn't?
    Mr. Greenstein. There may be a different set of answers on 
the panel here. Let me quickly note for starters that your 
prior question, ``Is it regressive? Is it not regressive?'' the 
same question applies to a carbon tax. It would all depend on 
what you did with the proceeds for----
    Mr. Sensenbrenner. Yes. I am not for carbon tax either. 
[Laughter.]
    Mr. Greenstein. Now, as you know, the advantage of a cap-
and-trade is you have a firm cap on emissions. And the 
disadvantage is you don't know in advance the impact on the 
price. With the carbon tax, you have certainty on the price but 
uncertainty on the exact level of emissions reduction that you 
get. Many economists, including----
    Mr. Sensenbrenner. Well, my time is up. You know, Europe 
has had cap-and-trade. And the amount of emissions has gone up. 
So my time is up. Thank you. Europe has failed, don't need to 
copy them.
    The Chairman. The gentleman's time has expired. The Chair 
recognizes the gentleman from Oregon, Mr. Blumenauer.
    Mr. Blumenauer. One of the benefits of the head in the sand 
attitude of this administration is that we have a chance to 
look at the experiences in other parts of the world as people 
are struggling with how we are going to have a carbon-
constrained economy.
    Lots of things are not pollutants in the natural order. I 
mean, CO2 in its normal amounts is not salt, but if 
we get too much of a good thing, we have real problems. And I 
appreciate our witnesses saying that these things are not 
mutually exclusive in terms of stimulating the economy by not 
taking it out of the economy.
    Everything I heard from the witnesses is you are thinking 
that this is not somehow something that is going to be shot 
into space that is going to be circling the planet. This value 
is going to be reinvested somewhere. It is going to be a 
windfall in the hands of some. It is going to be targeted 
towards redevelopment.
    Mr. Podesta, I am not certain that I would use the Land and 
Water Conservation Fund as an example that gives me hope. I 
think we can learn from that experience as well. But you are 
suggesting that it is part of a comprehensive strategy.
    As I hinted at in my opening statement, what I am 
interested in is your observations about making it part of a 
comprehensive strategy that focuses on the two principal 
expenditures of American households, both in terms of dollars 
and in terms of carbon, housing and transportation.
    I would be interested in observations, particularly from 
the right wing here on the panel, at least my right wing, in 
terms of how you think we can best harness the value that could 
be created to help households with infrastructure and energy 
conservation and transportation that would reduce their carbon 
footprint, stimulate the economy, and protect their economic 
security.
    Mr. Podesta. Well, let me begin. I think the Congress--and, 
again, I commend you--has already taken a giant step by 
increasing vehicle efficiency on the transportation side. There 
is obviously more investment to do in transportation, in smart 
growth, in some of the initiatives that you have championed in 
more mass transit spending, et cetera. And I think some of the 
proceeds of the auction should go and ought to go to those 
kinds of investments.
    On the housing side, I think you get it that through, 
again, complementary policies through the cap-and-trade, better 
building codes, a smart grid, investment in the electric 
infrastructure so that you could have real-time metering and 
basically begin to do what has happened in California, which 
over the past 30 years has kept its per capita energy 
consumption flat while the United States energy consumption has 
grown by 40 percent while maintaining high levels of growth in 
the economy and high levels of wealth in the state.
    So I think those complementary policies--and Mr. Bowles is 
trying to implement those in Massachusetts--are directly going 
at the issues of efficiency, building codes. That is where the 
low-hanging fruit is. And we need to pay attention to that, in 
addition to creating the right kind of structure over the cap-
and-trade.
    Mr. Blumenauer. Mr. Bowles, you referenced the trade-off in 
terms of the one percent increase, five percent longer-term 
savings in energy. Can you talk about in a little more detail 
how you think you can seize on that and make that sort of 
difference?
    Mr. Bowles. Yes. I mean, just the key point, I think, of 
the question is--and I would agree with everything John just 
said--that we have a tremendously inefficient and creaky 
electricity system in the United States. We need to upgrade 
transmission. We need real-time metering. And we need a hell of 
a lot more end-use efficiency. It is the lowest-hanging fruit.
    So when Congress thinks about what should we be doing to 
use these auction proceeds, I think a lot of the whole panel 
agrees that auctioning makes sense. Once you got the proceeds, 
what do you do? How do you prioritize it? I would use the 
criteria of, how can we save the most for consumers, low-income 
middle class? I mean, how can we lock in the greatest 
environmental benefits?
    I think things like appliance standards, which Congress has 
moved forward on, vitally important. Building codes are at the 
state level. We in Massachusetts are joining the International 
Energy Conservation Code, vitally important. So I think you can 
do a great deal of that.
    On the efficiency side, there is a tremendous amount of 
return. We did an economic analysis. In fact, it was done under 
the Romney administration--I am happy to share it with the 
Committee--that showed the disproportionate returns that would 
come from allocating the auction proceeds to energy efficiency. 
We could see savings above five percent in commercial, 
industrial, and residential parts of the electricity sector. So 
that's the lowest-hanging fruit and I think the biggest 
opportunity for savings.
    The Chairman. The gentleman's time has expired. The 
gentleman from Oklahoma, Mr. Sullivan.
    Mr. Sullivan. Thank you, Mr. Chairman.
    I would like to thank all of the panelists for being here 
today. I guess this question is for anybody who wants to answer 
it or as many of you that want to answer it. What certainty do 
we have that any cap-and-trade program would achieve carbon 
target certainty? And also with all of the trading going on, 
where do you see the tangible reductions taking place? Anybody?
    Mr. Burtraw. On the second part first, our modeling and 
modeling by the EIA suggest that over the first couple of 
decades of a climate policy, although the electricity sector is 
responsible for about 40 percent of the CO2 
emissions in the country, it's expected to account for two-
thirds to three-quarters of the emission reductions that would 
be achieved. That is why there is so much attention given to 
the electricity sector.
    The other part of your question is, how can we be sure that 
a cap would be obtained and not violated? That has been the 
predominant success of capped programs previously. The issue 
when there have been emission increases has been when a cap was 
initially set at a level that was regrettable and not as tight 
as perhaps it could have or should have been.
    Mr. Sullivan. Yes, sir?
    Mr. Zapfel. Yes. When we designed our carbon market in 
Europe, we studied very carefully the experience in the U.S. 
The main thing to achieve the emissions reductions is to have a 
very credible and robust compliance and enforcement system.
    The price of a carbon allowance today in Europe is roughly 
20 to 22 euros per ton of CO2. If you fail to 
surrender the emission allowance, there is a financial penalty 
levied on the company of 100 euros per ton of CO2. 
So that creates a very strong incentive to comply with the cap.
    And the reductions come not from the trading of the 
allowances but come from the carbon price signal that you 
create in the economies. So you make it worthwhile to innovate, 
to push forward on the technological front and bring the 
emissions down.
    Mr. Bowles. I would just add--and thank you for the 
excellent question--that one of the benefits of auctioning is 
you have price discovery and you figure out what it is worth to 
have one of these allowances.
    If you just give them away, you don't have that 
information. So you can adjust your cap at the federal level to 
say, ``Are we hitting our target? And do we need to send a 
louder price signal into the economy?'' I think it's a real 
benefit of the cap and the auction approach that you don't get 
necessarily from a carbon tax approach.
    Mr. Sullivan. Anyone else? How much time do I have left?
    The Chairman. The witnesses can take 2 minutes and 23 
seconds.
    Mr. Sullivan. Okay. I've got----
    The Chairman. You can yield it back or ask a question.
    Mr. Sullivan. I've got one more question. I'll ask anybody.
    The Chairman. Okay. Please?
    Mr. Sullivan. Would you say that the allowances and their 
prices should be set by Congress, the administration, or the 
market? What if the price of allowance skyrocketed to an 
unsustainable level? What would be the backup plan? I guess you 
kind of talked about a little of that.
    Mr. Bowles. Let me just comment quickly on what we have 
done in the Regional Greenhouse Gas system. So there are two 
different triggers based on price that allow access to a larger 
market for offsets. So there is a large market for carbon 
offsets, which are other ways to achieve greenhouse gas 
reduction. So it starts out in a New England market, then goes 
national, and goes international based on price triggers. So as 
price goes up, you have an increasing pool of alternative ways 
to reach compliance.
    I don't know if that answers your question.
    Mr. Sensenbrenner. Would the gentleman from Oklahoma yield?
    Mr. Sullivan. Yes, I will yield.
    Mr. Sensenbrenner. I was just advised that the Times of 
London reported this morning that the United Kingdom under the 
new European system that Mr. Zapfel described would end up 
having to pay an additional 6 billion pounds, or $12 billion, a 
year in order to comply with this.
    You know, I am just wondering what the hit on the British 
economy would be, which is an economy that is much smaller than 
the American economy, with this kind of essentially a 
bureaucratic hit. Maybe Mr. Zapfel can answer that.
    Mr. Zapfel. I cannot confirm the figures that you put 
forward. We have undertaken a substantial evaluation for the EU 
overall. We have come to the conclusion that our far-reaching 
climate and energy targets, so not just the reductions via the 
weighting scheme, overall can be achieved at a fairly 
affordable cost of roughly half a percent of our GDP. All of 
this needs to be compared to the----
    Mr. Sensenbrenner. If the gentleman will yield further, a 
$12 billion hit on the economy of the United Kingdom is not 
insignificant. And this is what the largest and most respected 
newspaper in the United Kingdom analyzed what you have just 
announced today. It ain't free.
    Mr. Zapfel. As I said, I cannot confirm those figures. 
Overall for the European economy overall, the costs are fairly 
insignificant. We also have to look at the cost of non-action, 
as has been outlined in the Stern report, which can be a lot 
more considerable than cost of bringing down our emissions.
    Let me also use the occasion because you said no emissions 
have been reduced. There is some research. Your statement 
refers to the first period, the first trading period, 2005 to 
2007, which was for us in Europe a learning period.
    We didn't have the benefit, as you have in the U.S., with 
air pollutant trading programs, SOx and nitrogen trading 
programs. So we started from scratch in Europe. Our emissions 
cap was not binding in 2005 to 2007. Also, we do not have our 
Kyoto commitments kicking in in 2005 to 2007.
    We brought down the emissions cap for the trading scheme in 
the second phase already about 10 percent compared to the first 
phase, which makes sure that we will see emissions reductions 
in the second phase. And, as I stated in my introductory 
statement before, this emissions cap will come down by another 
11 percent so that we are 21 percent below 2005 emissions by 
the year 2020, which guarantees emissions reduction and the 
environmental integrity of the European common market.
    The Chairman. The gentleman's time has expired. And the 
Chair will recognize the gentleman from Washington State, Mr. 
Inslee.
    Mr. Inslee. Thank you.
    I think Mr. Greenstein mentioned that someone argued that 
this would be corporate welfare if you don't have an auction 
system. I just want to ask about the logic of that.
    Going back to this issue of the tragedy of the commons, my 
understanding is that people who argue that essentially say, 
``Look, there is an asset. The atmosphere only has a limited 
carrying capacity for CO2.'' And if we're going to 
give rights away to people to pollute that, you are giving away 
a scarce asset. It has an economic value.
    And, therefore, it would be a sense of welfare of giving 
away a public asset for free. It would be like giving away gold 
from our national parks or the like. Is that the logic? And 
does an auction solve that problem?
    Mr. Greenstein. Well, an auction does solve that problem, 
but you don't have to go to that logic to reach the corporate 
welfare conclusion. And the term isn't mine, although I would 
agree with it.
    What is interesting is the ``corporate welfare'' term in 
this context actually is Greg Mankiw's term. He is a leading 
conservative Republican economist at Harvard. He was the Chair 
of President George W. Bush's Council of Economic Advisers.
    What Mankiw was saying--you don't even have to go to the 
commons thing to get it. What Mankiw was saying was, ``Look, if 
in a cap-and-trade system you give to energy companies and 
other emitters allowances that exceed in value the increased 
costs they will incur under the new system, then you're giving 
them a form of welfare. It's one thing if you simply offset the 
increased costs that will occur, but if you go beyond that and 
you just give them these permits, which they can sell for 
billions of dollars above and beyond what is needed to offset 
their costs, that is corporate welfare.''
    That is what CBO is essentially saying as well. CBO's term 
is ``windfall profits.'' Mankiw's is ``corporate welfare.'' It 
is simply saying you give them more than they need to offset 
their costs. You are giving away billions of dollars in gain to 
these companies and their shareholders. That is clearly a form 
of windfall.
    Mr. Inslee. I appreciate that.
    Mr. Podesta, I really appreciate you are basically saying 
that environmental policy in this case isn't economic policy, 
it's a view I share. I want to let you know you are not alone.
    I was just looking at a report from McKinsey and Company. 
It just came out in December. They concluded that almost 40 
percent of abatement could be achieved at negative marginal 
costs. In other words, 40 percent of your savings of 
CO2 you would actually reduce your costs. There 
would actually be a profit margin for the U.S. economy, if you 
will. And it talked about the barriers to achieving those 40 
percent improvements or principal capital accumulation to do 
the work, the rehabbing your house, the acquisition of new 
heating and cooling system, more efficient cars, the whole nine 
yards.
    I just wondered if you could give me any more thoughts 
about how we could fence off the revenues from a cap-and-trade 
system to be used for the legitimate purposes of that, both 
R&D, help to consumers to weatherize their homes, help to them 
to obtain new efficient equipment. What is the best way to do 
it? I know you gave us some ideas, but what is the best way in 
the real life to do that?
    Mr. Podesta. Well, as I said--and maybe I could provide 
some more information for the record, Mr. Inslee--I think that 
creating accounts in which the Congress decides where that 
money is going to go, either by allocating permits to it, which 
is the approach taken in the new Lieberman-Warner bill, or by 
auctioning 100 percent of the permits, which is our preferred 
approach, segregating that money and making those important 
investments but ensuring that that money is available, either 
through tax credits, which, again, we hope to see, I think, the 
production tax credits reauthorized in this session of Congress 
on renewable energy or through direct investments that could be 
operated either through the states or directly, is the best way 
that takes, again, a good chunk of that money and apply it to 
the very real challenge.
    The other place that we would spend some money is on 
innovation itself, into boosting the R&D portfolio of the 
United States. We have seen enormous returns of investment in 
the past, particularly at DARPA and the DOD programs, but if 
you think about the information technology revolution driven by 
federal investment at the front end, I think you can imagine at 
least an energy innovation virtuous cycle driven by investment 
at the federal level into these new technologies.
    We see a lot of venture capital pouring into that arena 
right now, but I think if you had the right kind of investment 
portfolio from the federal government, that would really 
quicken the change that we need.
    Mr. Inslee. Thank you.
    The Chairman. The gentleman's time has expired. The Chair 
recognizes the gentleman from California, Mr. McNerney.
    Mr. McNerney. Thank you, Mr. Chairman.
    Mr. Podesta, you laid out in your testimony how the revenue 
from a cap-and-trade scheme based on auction might be equitably 
distributed. I think that is a terrific approach. Can you recap 
your proposal and then comment on how free giveaway of the cap-
and-trade system would distribute revenue?
    Mr. Podesta. Well, I think that, you know, again, we have 
had your European experience described here this morning. I 
think going to the second part of the question, I think if you 
have a free giveaway and no watch and no allocation of revenue, 
what is likely to happen is rates will go up. The generating 
companies will pocket the money. Their shareholders would do 
very well. And the people at the other end will do very badly.
    So we support the kinds of proposals that Mr. Greenspan--
Mr. Greenstein was--he's still a liberal. [Laughter.]
    Mr. Greenstein was talking about taking 45 percent of the 
auction share and rebating that to people, either directly 
through the tax code or, particularly for low-income people, 
where that mechanism doesn't work very well, to do it through 
other kinds of income supports, which Bob, of course, is the 
expert on, and then taking 45 percent, making these public 
investments that I described.
    And then we also recognize that and I think the work that 
CBO has done suggests that 10 to 15 percent of the revenue 
might go to companies and communities particularly hard hit by 
increasing the costs of production of energy.
    I am thinking here particularly in places hard hit that are 
coal-producing and those kinds of arena. The CBO estimates that 
that looks like to be about 10 to 15 percent of the revenue. So 
we would say put that back into those communities, help them 
weather the transition to a new economy.
    Mr. Greenstein. Can I add one quick point on that? There 
have been questions from several members to John on, how do you 
make sure the money actually goes for these purposes? And there 
have been discussions of trust funds and the like. I think we 
need to separate out the discretionary part of the budget, the 
appropriated part, from the other parts, entitlements, taxes, 
and so forth.
    You would need some kind of trust fund mechanism like that 
for the discretionary part. You wouldn't--and I wouldn't 
recommend it--for the consumer relief part. If you're giving 
part of the consumer relief through an expansion in the earned 
income tax credit or a new tax credit, such as Mr. Larson has 
in his bill that's based on the first certain amount of the 
payroll tax that is paid, we don't have anything in the tax 
code where the IRS has to look each year at how much money is 
in a particular trust fund and make the tax credit go up and 
down every year.
    You just do the tax credit. You work with CBO and the Joint 
Tax Committee. You have an estimate of how much revenue is 
going to come in from the auctioning of the proceeds. You 
design the appropriate tax credits that you need. You make sure 
the scores all fit, and you go forward.
    So trust fund thing would be needed for the discretionary 
part. For the tax part and the direct spending part, you need 
some direct spending for the low-income people, as John 
mentioned. You just write that into the cap-and-trade bill, and 
you go forward.
    Mr. McNerney. Thank you.
    Mr. Bowles, in a state like Massachusetts and also in 
California, we're starting to see the effects of RGGI and AB 
32. Do you have any specific recommendations in terms of how to 
make sure that the federal programs complement those, instead 
of what other possibilities there are?
    Mr. Bowles. Thank you for the excellent question. One thing 
I just would try to underscore for this whole discussion is a 
lot of the cost-negative items that Mr. Inslee mentioned from 
the McKinsey report, which I commend to the Committee to read, 
are really implemented by the states, things like building 
codes, energy efficiency, building renewable power plants, 
zoning, smart growth. A lot of the easy stuff we need to do is 
going to be implemented by the states.
    So I really encourage the Committee and the Congress to 
look at giving financial incentives with some of those auction 
proceeds to say if you, state, are doing all those things plus 
rate decoupling, maximizing efficiency, then we're going to 
support you.
    You need to create some incentive because the states are 
the units that regulate the utilities and have such a big role 
where a lot of the easy things are going to be done first.
    Back to your broader question. Look, I think the Congress 
could do us in California and 17 other states a great favor by 
making sure EPA got out of the way on the CAL LEV standards. 
They are vitally important and goes beyond what the CAFE 
increase, which is terrific, does. Obviously we're seeking EPA 
implementation of the Mass v. EPA case on the Clean Air Act.
    And so I think there are a lot of things that the Bush 
administration could do to get out of the way of states like 
Massachusetts and California. But thank you for the question.
    Mr. McNerney. Thank you. I yield.
    The Chairman. The gentleman's time has expired. The Chair 
recognizes the gentlelady from South Dakota, Ms. Herseth 
Sandlin.
    Ms. Herseth Sandlin. Thank you, Mr. Chairman.
    I thank all of our witnesses today for helping illuminate 
further in acknowledging and helping quantify what costs may be 
associated with making this transition but also identifying the 
economic opportunities that exist and ensuring that we don't 
ignore the fact that there are costs to inaction.
    I do want to describe sort of a set of circumstances, 
though, as it relates to the part of the country that I 
represent, the great plains in rural America, and just get your 
thoughts if you could comment on if we do move to a cap-and-
trade and as we discussed the issue of free allocations versus 
auctions and then reinvesting and recycling the revenue, just 
to get your thoughts on whether or not we phase this in and 
give time to adapt, as Mr. Zapfel described, or if we move to 
something more 100 percent auction nearly immediately with what 
we set up because I have some concerns about that in light of 
the circumstances present in, say, South Dakota.
    On the positive side of cap-and-trade for South Dakota, I 
see greater incentives to develop our wind resources, greater 
incentives to develop solar resources throughout our area in 
the Southeast and other regions, reinvestment in our 
hydroelectric facilities, the investment for carbon capture and 
sequestration because we are a very heavily coal-dependent 
region of the country.
    There are also economic opportunities here for agriculture 
as it relates to certain farming and grazing practices as 
carbon storage and transitioning to integrating new 
technologies for cleaner burning coal in our coal-fired 
facilities that service our rural electric cooperatives. But 
that is sort of the difficult side here of cap-and-trade that 
when you have rural electric cooperatives, you have rural 
consumers, you have very poor consumers in certain parts of the 
Great Plains that live on Native American reservations when we 
are still working to develop the transmission that some of you 
talked about, the need to sort of reinvest in the 
infrastructure of our transmission capacity for wind, time to 
measure just precisely--and the Chicago Climate Exchange is 
trying to do this for agriculture. It seems to me that we need 
a little time to adapt.
    And that's why I think that, at least for now, I sort of 
favor more of a phase-in approach, rather than something that 
is nearly a 100 percent option immediately within the system.
    So if you could comment on that and then, Mr. Zapfel, if 
you could also comment on perhaps as you describe, maybe an 
initial misjudgment in the European system being that they were 
free allocations versus an auction, now you're making that 
transition, but I understand that you chose not to help 
measure, quantify and measure, for agriculture to participate 
in the cap-and-trade system in Europe. And if you could comment 
on that?
    Mr. Greenstein. Could I make a comment on the phase-in 
issue? We should note that under all of the bills, there is a 
major phase-in in the sense that the emissions reduction target 
is a small amount of emissions reduction initially. And that 
phases in very gradually over a number of decades. That is the 
major phase-in.
    With regard to the permits, one could do something where 
you give away a large share of the permits for free initially 
and then phase that down. The Lieberman-Warner bill I think 
gives away 40 percent or more of the permits for free 
initially. And on paper it eventually phases it to zero.
    My concern is, the politics being what they are and the 
power of the companies being what they are, I believe that if 
Lieberman-Warner were enacted, we would never get to zero. The 
Congress would come back and change the law well before we got 
to zero and that we could end up getting stuck permanently at 
too high a level.
    That doesn't mean you couldn't do any phasing at all, but I 
think the notion of starting with--I don't know--more than 15 
or 20 percent of the permits being given away, starting with 
any higher percentage and just assuming you're phasing it way 
down I think is dangerous.
    I think it risks the potential that before the phase-down 
occurs, companies get the law changed. And then the various 
purposes for which you thought you had money, such as a number 
of the things you just mentioned, can't get the resources to be 
funded.
    Mr. Burtraw. I would like to just add the phase-in in terms 
of the changes in electricity prices is going to be immediate. 
So the program can be put in place, and you can talk about 
allocation in different ways, but you are going to see an 
immediate change in product prices.
    So there is no phase-in to talk about except in some 
portions of the country in the electricity sector, where there 
are two alternatives in those regions of the country where 
there are regulated prices and a free allocation to firms will 
get passed through to consumers and soften the blow initially. 
But the problem is that treats the country in a very asymmetric 
way because you have roughly half the country under cost-of-
service and half the country with competitive electricity 
markets. I think that's inviting a new civil war.
    So an approach that has emerged recently that has 
surprising support from very disparate companies would be free 
allocation to load serving entities. These are the retail 
electricity companies that deliver electricity services 
directly to customers. And they could be expected to pass 
through to customers the value of the emission allowances.
    This has a politically attractive appeal that it would keep 
electricity prices low and would look like a phase-in as we 
enter the new constrained carbon regime. The problem, as other 
speakers have already mentioned, is this constitutes 
essentially a subsidy to electricity consumption that you don't 
get for natural gas or transportation fuels or to industry and 
commerce. And so to put this in place, to enshrine this, would 
dramatically raise the cost of carbon policy nationally. We 
don't want to get our feet stuck in cement there.
    So if you want to look for a phase-in, allocation to load, 
as is the component of the Lieberman-Warner bill, is a 
reasonable way to start, but I would urge you to think about 
that as a rapid transition to a full auction and recognize 
coming from the Great Plains, you know, this creation of this 
$350 billion a year in intangible property right is analogous--
the last time we saw this in American history was the 
assignment of property rights in the great American West 
because this is going to be on a recurring annual basis. This 
is an enormous new property right.
    And the question is, to whom will it accrue over the rest 
of the century? And that's why the auction is such an important 
question.
    The Chairman. And the gentlelady's time has expired. But 
could you, Mr. Zapfel, deal with this issue of how Europe is 
treating the agriculture sector? I think it is important for us 
to hear that.
    Mr. Zapfel. Yes. It is a pleasure to do so.
    Our common market is not as it is discussed here, an 
economy program. We see the common market as one of the 
essential elements of bringing down our emissions.
    We have reviewed now whether we should include credits from 
agriculture and forestry, but we remain of the opinion that for 
the time being, they should stay outside of our carbon trading 
mechanism for mainly two reasons. First of all, we need high-
quality monitoring/reporting of the emissions, which we do not 
see we can do yet in those sectors. And, secondly, we also 
haven't been able to address the questions of permanence and 
leakage yet. Especially in the forest, if you grow forests but 
in the same time other places you cut down forest, so the 
permanence in the leaking is important.
    As Mr. Sensenbrenner, Congressman Sensenbrenner, has 
pointed out, the environmental integrity of the common markets 
delivering emission reductions is essential, also for the 
public. So, for that reason, we have proposed that agriculture 
and forestry credits stay out of the system up to 2020.
    The Chairman. Great. The gentlelady's time has expired. The 
Chair recognizes the gentleman from Connecticut, Mr. Larson.
    Mr. Larson. Thank you, Mr. Chairman. And thank you for 
putting together this incredible panel. And it is with a 
certain amount of trepidation that I go forward with my 
questioning knowing the vast amount of work that you and my 
good friend and colleague Jay Inslee have done on cap-and-
trade.
    My only regret is that you didn't have Polar bears here 
today so that we could have more of the press here on such a 
weighty issue of discussion of the cap-and-trade system versus 
something that I think still needs to be pursued in terms of 
dialogue and discussion in terms of a carbon tax.
    Now, I say that, and I want to thank Mr. Podesta because I 
thought he started off and framed this in the appropriate--
we're in a crisis. And this crisis has to be solved. And it has 
to be solved now.
    The inconvenient truth is that, as you heard our good 
colleague from Wisconsin say, that, well, the most direct and 
straightforward transparent way to deal with this, of course, 
would be for a carbon tax. But, of course, he wouldn't be for 
that. And neither would a lot of colleagues because of the 
anathema attached to taxes.
    And, of course, we have an aversion to taxes in this 
country. For example, we fund a war or, well, we don't fund the 
war with taxes. We go into debt with a war and tell the 
American people that it is being paid for. So I believe that 
the choices are difficult and they become more clear.
    And I thank Mr. Greenstein also for I think illuminating 
the choices that we face here: one that deals with the 
certainty of emissions, the other with the certainty of price. 
I come down on the side of the certainty of price.
    I am proud to have initiated legislation along with Mr. 
Blumenauer and Mr. Miller that pretty much follows what Vice 
President Gore--and, my God, if we can get Vice President Gore 
and the President of the Chamber of Commerce to agree that this 
is the way that we should go in terms of a carbon tax and that 
it should have to offset the mitigating factors and the 
regressivity of it a direct payroll reduction that corresponds 
in it so that you can get down-the-road relief for people that 
actually need it, then I think we've got something, 
notwithstanding I am interested in this whole auctioning thing.
    I have to say, I have to give this the Augie and Ray's 
test. Now, most of you don't know what Augie and Ray's is. It's 
a little hamburger/hot dog joint in East Hartford, where most 
of the people that I know gather. But they're pretty down to 
Earth, you know, and they read people pretty well, debate the 
Red Sox and the Yankees, yadda yadda yadda.
    But here is the deal. You say auctioning to them, and 
they're looking at me like I am on Mars. And I've got to be 
honest. How would it work? Who administers it? Mr. Greenstein 
and even Mr. Sensenbrenner make some sense when they say, isn't 
there a more direct, specific, easier way for us to administer 
something, albeit it may be a tax? And how is this all going to 
transpire?
    This is not going to be--and I heard Mr. Greenstein talk 
about the Lieberman-Warner bill. Gee, is this a hedge fund 
windfall? How would this be administered? How do the proponents 
of this see this auction actually taking place? Who controls 
it? Who sets up the auction? Who is purchasing? What is going 
on here? Mr. Bowles? Thank you.
    Mr. Bowles. Let me just comment from our experience in New 
England, Connecticut being an important member of the RGGI 
process. The easiest thing to do is what we are doing first, 
which is power generation only. Covered plants in the RGGI 
footprint are 25 megawatts and up.
    They bid into the ISO every day into the bid stack to 
figure out whether they're going to dispatch power or not. So 
they do it every day. They know how to do it. It's not 
complicated. All we have to do to set up the auction process is 
get one of the auction vendors in the RGGI organization----
    Mr. Larson. What is an auction vendor?
    Mr. Bowles. Auction vendors are folks who run the 
NOX program, people who administer any number of 
other----
    Mr. Larson. You can see my problem here.
    Mr. Bowles. Yes, but----
    Mr. Larson. You say, ``auction vendor.'' You say it runs 
the NOX program. I would say, ``The NOX 
program'' at Augie's. They would be saying, ``Are you talking 
about the Sox or the Nox? What are you talking about here?''
    Mr. Bowles. I guess all I am suggesting to you is that----
    Mr. Larson. You are doing a very good job, by the way. I 
didn't mean to interrupt you, but I am trying to make a point 
here about how this will all take place.
    Continue, please, Mr. Bowles. I'm sorry.
    Mr. Bowles. I was just going to say I think the answer to 
your voters is to simply say, ``Power generators do this every 
day. Nothing much changes except that we're going to make them 
pay for this little thing to help protect the environment. And 
we're going to find a way to pass that back into more savings 
for you'' because, like Massachusetts, Connecticut is also just 
passing least cost procurement through legislature. And there 
is going to be a bunch of savings available.
    So I guess I would say in the power sector, it is quite 
simple, and it happens today. I think it is more complicated to 
move into other sectors, particularly to explain. But thank you 
for the question.
    Mr. Larson. Mr. Greenstein.
    Mr. Greenstein. I don't think the big complexity is 
administering the auction. You know, we had auctions of the 
electromagnetic spectrum. The FCC administered that. We could 
establish a new federal agency to run the auctions. I do----
    Mr. Larson. Would that be a more efficient way to do this?
    Mr. Greenstein. I do want to say that, all else being 
equal, I would prefer a carbon tax to a cap-and-trade. Having 
said that, I don't want to let the perfect be the enemy of the 
good. I am not sure you could pass a carbon tax. I think you 
would be more likely able to pass a cap-and-trade than a carbon 
tax.
    And if you have a cap-and-trade with an auction, what that 
auction really does is to make the cap-and-trade more like a 
carbon tax, not fully, just partly. I mean, if you can pass a 
carbon tax, more power to you, but I think part of how we got 
here is the sense that that would be hard to pass.
    Mr. Larson. Thank you.
    The Chairman. The gentleman's time has expired. I think if 
we could pass a carbon tax, it probably would be less power to 
us subsequently, but I think that's a lesson that we have 
learned.
    The Chair recognizes the gentleman from New York, Mr. Hall.
    Mr. Hall. Thank you, Mr. Chairman.
    And thank you to all of the witnesses. I think part of what 
needs to happen is as you are educating us, we need to go out 
to our constituents and to the country and help to educate them 
so that they will understand that the corner store or, you 
know, the deli that I go to in my district when people talk 
about a carbon tax versus a cap-and-trade, to help them 
understand what that is. It's not, as you say, given the 
NOX and the SOX and, you know, the 
successful change in chlorofluorocarbons that was wrought by a 
similar kind of governmental process. This is proven ground.
    I also come from a place myself, moral place and a 
philosophical place, that says that there is, there should be, 
and there exists an implicit environmental bill of rights and 
that every one of us, every child born on this planet, has a 
right to breathe clean air and to have clean water to drink and 
unsoiled soil for their food to be grown in.
    And so I object to the idea that, oh, we're interfering 
with business. Somehow we got way ahead of ourselves and 
polluted the planet and the ecosystem to the point where we're 
not only dealing with or trying to deal with climate change, 
but we're also suffering from asthma epidemics and emphysema 
epidemics in our inner cities, especially among our children. 
And last summer across the entire State of New York, there were 
a number of days when we had dangerous air quality alerts in 
rural parts of the state, where you wouldn't expect that. And 
it's because of the pollution moving from other power plants in 
the Midwest or wherever across state lines.
    And so by trying to deal with greenhouse gas emissions, we 
will also be dealing with our dependency on foreign sources of 
oil, a balance of trade deficit, creating new jobs in new 
industries and new technologies here, making ourselves more 
independent, keeping our sovereignty, not having to fight wars 
in unstable parts of the world, et cetera, et cetera. So there 
are so many. It's a win-win-win thing we're talking about. Cap-
and-trade is only one small aspect of it.
    So having made that little bit of a speech, I want to ask 
Secretary Bowles. In particular, I am interested in the idea 
that efficiency seems to be endorsed unanimously as one of the 
most effective and immediate steps we can take to cut 
greenhouse gases and our power bills.
    But under the current system, it is counterintuitive for 
utilities to pitch in since they make their money by selling 
power. In your testimony, you reference efforts to decouple 
sales from revenue. Could you elaborate on those efforts and 
what types of investments we could make with auction revenues 
or allowance incentives that we could use to bridge the gap?
    Mr. Bowles. Thank you for the excellent question. And thank 
you for your statement, very well-said, at the beginning. I 
would agree.
    New York State just did a rate decoupling, as I am sure you 
know. The public utility commissions of the states regulate 
utilities. They have got a history of rate-making that is, by 
and large, tied to volumetric sales of power, whether or not 
those utilities own the power generation or not.
    So in the half of the country, as Dallas mentioned, that 
has a deregulated power system, New York and Massachusetts and 
all of New England, our utilities don't own the power 
generators. They own just the wires. So they bring it to your 
house. And the power generators own power generation.
    So we have inherited a system in the past where it made 
sense to measure rate recovery for the utilities based on the 
volumetric sales. It seems like a simple thing. Instead, the 
criteria should be on performance and reliability, outages, 
things like that, least cost service, so making sure that the 
utilities are bringing good power and reliable power to your 
doorstep but not incenting them or discouraging them on the 
volume of power that they sell.
    And that is really the crux of rate decoupling, is severing 
that link, that manifest economic incentive that says to the 
utilities, ``Maximize power sales in order to maximize revenue 
for your shareholders.'' Instead, we need the utilities to be 
indifferent or, in fact, incented on a performance basis to be 
partners in energy conservation.
    I think the utilities--New York has got a terrific model 
with NYSERDA. In different states, the utilities, such as 
Massachusetts, actually run the efficiency programs. And that 
is a good thing because they are very close to their partners, 
but they need the type of oversight to make sure their spending 
is done well.
    So I think a federal incentive in terms of conditioning 
some of the auction proceeds back to states who have done 
decoupling and have done least cost procurement, things of that 
nature, really makes a ton of sense for getting that low-
hanging fruit.
    Thank you for the question.
    Mr. Podesta. Very briefly, the same applies to the natural 
gas market as well.
    Mr. Hall. Thank you.
    The next question I have is, how directly do you think we 
should try to--I guess I am done.
    The Chairman. Ask one more question.
    Mr. Hall. Okay. I will ask my last question. What would you 
think of, Mr. Podesta, for starters, for instance, a proposal 
to target auction revenue by using the sales of credits for 
power plants to do something like helping car companies to put 
electric vehicles into mass production or to build alternative 
fuel infrastructure?
    Mr. Podesta. Well, I think that, again, that is exactly the 
kind of incentives that you want to encourage. That not only 
helps, to go back to your opening statement, on the overall 
CO2 problem and the global warming problem, but I 
think if we could move the transportation fleet more onto the 
electric grid through plug-in hybrids and other types of new 
generational vehicles, you have also dealt with the oil 
security problem, which is another pressing problem the United 
States faces, both from a balance of trade perspective but, 
most importantly, I think, from the sources of oil and where 
that money is actually flowing to in the United States.
    So I think that is important. And I think that some of 
those proceeds and we would recommend that some of those 
proceeds go to the U.S. auto companies in the form of tax 
rebates to re-tool to get onto this new generation of vehicles 
that, either through plug-in hybrids or, as General Motors is 
moving towards, a slightly different platform, the Chevy Volt.
    Mr. Hall. Thank you very much. I yield back. Thank you.
    The Chairman. The gentleman's time has expired. The Chair 
recognizes the gentleman from Missouri, Mr. Cleaver. And I 
think there is going to be a roll call coming up in just a very 
little bit, up on the House floor. But if each member for a 
second round would like to have two minutes to ask if they have 
one compelling question, we can recognize them for a second 
round. On the first round, to complete the first round, we will 
recognize the gentleman from Missouri, Mr. Cleaver.
    Mr. Cleaver. Thank you, Mr. Chairman. I apologize I was 
late. I've had another committee hearing.
    And I only have two questions. And I guess I should preface 
it by saying I support either cap-and-trade or carbon tax, 
either way. But I am going to take a little negative slant 
here. And I hope this hasn't already surfaced.
    When I was mayor of Kansas City, we had a municipal 
ordinance that would allow us to fine slum landlords $2,000 
each time their property was cited as violating the city code. 
And we discovered after about five years that there were some 
landlords who actually built the fines into the cost of doing 
business because, you know, you are only going to get caught 
every month or every other month. And so they just built it in.
    What happens if there are power plants or entities 
participating in the program from just placing the cost of 
polluting into what they spend to do business? And it's not a 
matter of stopping. It's just a matter of I'm going to pay the 
cost.
    Mr. Bowles. I guess I just would say that I think that 
really summarizes the argument for auctioning, instead of 
allowances, because the power generators will charge their 
customers for the economic value of that permit because they 
can sell it to someone else or they can expend it when they run 
or they can save it for the future.
    So I would say that concern is best addressed through 
having an auction, whether it is a clear transparent 
understanding of what the value is. And then you also have the 
revenue that you can go back to help out low-income energy 
consumers to get control of their own energy bill through, 
things like energy efficiency.
    But others may have answers as well.
    Mr. Greenstein. I would add that the whole purpose of the 
cap-and-trade system is really to raise prices in a sense for 
fossil fuel energy and create the incentive for private actors 
in the market, companies and consumers, to switch to cleaner, 
more efficient forms of fuel.
    In fact, I think--so to the degree that a company keeps 
prices higher putting all of this in, then whether it's wind 
and solar or all sorts of other forms of alternative energy 
that may not be that economically attractive now, they become 
very economically attractive because they become cheaper.
    One other quick point on that is when you are thinking 
about how to use the proceeds. Certain things that can't happen 
now without government subsidies in the energy sector no longer 
need government subsidies under a cap-and-trade because the 
price point has changed.
    And, in fact, listening to the discussion this morning, Mr. 
Chairman, I started to become a little concerned that I would 
offer a caution. When you design the legislation, make sure you 
don't squander some of the proceeds on efficiency incentives 
that the government isn't needed anymore, that the market 
itself will drive as a result of the changes in prices that the 
cap-and-trade will come about.
    I'm not saying you don't need any energy efficiency 
subsidies, but I think you may need less than you think you 
would need if the cap-and-trade works the way it is supposed 
to.
    Mr. Cleaver. Thank you. Actually, you answered my second 
question, Mr. Greenstein. Thank you.
    The Chairman. And Mr. Burtraw, do you want to respond to 
Mr. Cleaver?
    Mr. Burtraw. Yes, sir. I just wanted to point out that for 
fossil fuel consumption, the electricity sector, there are in 
place continuous emission monitors that record on a 15-minute 
basis the emissions from the power plant. So this is 
electronically reported. And also major fuel users report to 
the EIA their fuel use. It's fairly transparent to calculate 
the carbon content of fuels that are being used.
    So that is one fortunate aspect of this problem that with a 
lesson we have learned from that sulfur dioxide trading 
program. With certain penalties in place, you can expect to 
achieve virtually 100 percent compliance under this program.
    The Chairman. The gentleman's time has expired. Now we will 
go to a lightning round here, give members if they want two 
minutes to ask any follow-up questions they would like to make. 
The Chair recognizes the gentleman from Washington State.
    Mr. Inslee. Thank you.
    We went to Europe last summer and looked at the cap-and-
trade experience. And it was described to me as a great 
scandal, the situation where there was an allocation without 
auction. And then there are windfall profits in the billions of 
dollars taken by utilities in Europe.
    And consumers in Europe were outraged by this when they 
found out they had been gamed by this system that this asset 
had been given to the utilities and then they turned around and 
put it in the rate base and charged the consumers the implicit 
value of not selling the asset. And they said not selling the 
asset was a cost to the utility which then they turned around 
and sent right to the consumers.
    So what I was hearing from Europe is that give-away system 
turned out to be a scandalous affair and I presume is one of 
the things that is driving the move now towards more of an 
auction.
    I just wonder, Mr. Zapfel, if you could comment on that. 
Was I reading that situation correctly? And then I want to ask 
Mr. Burtraw to what extent could that be replicated in the 
United States?
    Mr. Zapfel. Thank you, Congressman.
    I would not go as far as considering it as a scandal, but I 
think what we have learned in practice is that the same thing 
happens that, for example, Mr. Burtraw would show, even if you 
give away the allowances for free in some sectors, it is very 
easy to pass them on in the prices.
    So this conceptual effect has very much proven it would be 
so also in practice. And this is, as I have stated already in 
my introductory statement, one of the main multi-weighting 
factors that we move over to auctioning now.
    So I would not see this as--we had initially this 
perception in Europe that our mechanism was failing because 
this was happening, but now as we go ahead on this, more and 
more people look into this and research this. This is 
demonstrating that the carbon market is, in effect, 
functioning, that the price signal is created, and the price 
signal works itself through the economy. And the efficiency 
advantages of the common market can be realized in practice.
    What we talk about with allocating allowances is a 
distributional effect. And where in society do you want to put 
the distributional effect? Do you want to give it to the 
taxpayer in the first place or do you want to give it to the 
shareholders of the power company?
    Mr. Burtraw. Sir, to a first order, we would estimate that 
the change in product prices will not depend on how that 
allocation occurs. So if you are giving away this valuable 
asset to firms, that is a transfer that is a form of 
compensation. There is a second form of compensation they 
receive, which is the changes in revenues, the changes in 
product prices. And this opens the possibility for potentially 
dramatic overcompensation or what people have called windfall 
profits.
    So the same thing I would expect to occur in the U.S., as 
was observed in the EU if there was free allocation of emission 
allowances to generators or to emitters throughout the economy 
generally.
    Mr. Inslee. Thank you.
    The Chairman. The gentleman's time has expired. Mr. 
Podesta, you would like to respond.
    Mr. Podesta. Actually, I would just like to disagree with 
my friend Mr. Greenstein for a second. I think the chances of 
the Congress overinvesting in public goods is small. And I 
think that the amount of money that we're talking about to 
incentivize states to decouple rates to do home weatherization, 
to add the kind of efficiency boost in the early days of this I 
think would be money well-spent and, again, creates a virtuous 
cycle of efficiency, productivity in the economy, and job 
creation.
    And so I wouldn't worry just about the price. I think sort 
of applying some of that revenue against that efficiency 
portfolio would be a very good thing for you to do as you 
design this cap-and-trade.
    The Chairman. Mr. Greenstein, 20-second rebuttal?
    Mr. Greenstein. I am all for weatherization. I think when 
you write this bill, you will be besieged by various industries 
and interests, promoting all sorts of subsidies and tax credits 
that are billed as green and pro efficiency. And a substantial 
share of them will not be necessary. The market signal will do 
it. And if you give into them, you won't have enough money for 
other key things, like consumer needs.
    The Chairman. The gentleman's time has expired. The 
gentleman from California, Mr. McNerney.
    Mr. McNerney. Thank you.
    The Chairman. Two minutes.
    Mr. McNerney. One of the auctioning schemes I am aware of 
starts with the first year of the auction giving out permits 
equal to the amount of carbon produced in the prior year and 
then reducing that level by a percent or two per year until 
over a 30-year period you have reached your long-term goals.
    Now, that would allow businesses to plan ahead for 
auctioning price increases and so on. Is there another scheme 
that makes more sense than that or is that basically what you 
are advocating, whoever would care? Mr. Greenstein.
    Mr. Greenstein. I am sorry. Clearly everyone is talking 
about phasing in the tightening the cap over time. I think that 
is the key. No one is talking about going to, say, a 50 percent 
emissions reduction in 10 or 15 years. The key I think is to 
have that emissions cap gradually tighten over an extended 
period of time, have people know where that cap is going over 
an extended period of time. And that is the key thing I think 
for the planning of the future.
    Mr. Podesta. The old McCain-Lieberman bill stair-stepped 
down. It had more dramatic reductions at a stair-step level. 
But I think that a phased reduction is a more sensible way. It 
is easier to plan. And it permits you to hit your target and 
again get the pollution savings that are necessary.
    But I think the most important issue at the end of the day 
is what you are trying to get to. And I would say Europe has 
adopted the target of hitting a two degrees Centigrade rise in 
temperature above pre-industrial level by 2050. That is I think 
an appropriate target. And sort of creating the curve to get 
you to that point in 2050 with early action between now and 
2020 and 2025 is really critical.
    Mr. Bowles. Could I just comment on that, Mr. Chairman, 
just to say I draw a distinction between a phase-in of a cap 
versus a phase-in of auction versus allowance. I think a 
weakness to my mind of some of the Senate bills is the phasing 
in of auctioning. I mean, an auction process is manifestly 
superior in terms of returning benefits to the ratepayer and 
consumer. I think phasing in the cap, of course, makes sense.
    Mr. Greenstein. I fully agree with that.
    The Chairman. The gentleman's time has expired. The Chair 
recognizes the gentlelady from South Dakota.
    Ms. Herseth Sandlin. Okay. Let me pursue that a little bit 
further because I know you think and, to a degree, I agree with 
you the auction is the way to level the playing field. But 
there are certain regions of the country that start out at a 
disadvantage. And I am very concerned.
    Mr. Podesta, if you could respond to this? Because, as you 
laid out how you see the percentages of how you allocate the 
revenue, I don't see sufficient revenue there to dramatically 
improve our transmission capacities.
    So when I am in South Dakota and we are dealing with the 
Western area power administration of the West and the Midwest 
independent system operator to the East and we have got all 
this wind that we can't get out that would benefit the 
electricity providers and other businesses in South Dakota, I 
mean, I would be more willing to identify it as a weakness in 
terms of the phase-in of the auction if there were some 
combination of the investment in the infrastructure with a cap-
and-trade. And so if you could comment on that?
    Mr. Podesta. Well, I think, again, there are two different 
issues involved with that. We apply ten percent to try to 
soften the blow, if you will, on communities that are 
particularly affected. You know, you could argue it's 15 
percent, but it's probably not much more than that.
    There is a second question, which is, does giving away the 
auction permits actually result in the investment or does 
auctioning the permits and then having the money available to 
make those investments, which is the better system?
    I think the people on the panel all think that a more 
transparent system is auction the permits and then use the 
proceeds of the permits to upgrade the grid, make the R&D 
investments, et cetera.
    Ms. Herseth Sandlin. And I don't think I disagree with you 
on that. My concern is the 100 percent auction at the outset. I 
mean, I am looking at it as building in some time. And maybe 
the weakness of the Senate bills is they build in too much 
time, they start too low.
    Mr. Podesta. Right.
    Ms. Herseth Sandlin. But you can understand my concern 
about----
    Mr. Podesta. I think that if you are going to move in that 
direction, though, you also may want to condition what those 
permits are being granted for with respect to the reinvestment, 
for example, in the grid upgrade so that they are not just 
being passed back as a sort of benny, as was the European 
experience that Mr. Inslee has described in a larger sense to 
the shareholders of those companies.
    Ms. Herseth Sandlin. Okay.
    The Chairman. The gentlelady's time has expired. The 
gentleman from Missouri, Mr. Cleaver.
    Mr. Cleaver. Thank you, Mr. Chairman.
    For the last two years, I guess the people who are in the 
Northeast area of our country have been very, very pleased 
because there has been a ten percent reduction in greenhouse 
gas emissions but not because of any intentionality on the part 
of power plants. The weather has been mild. And as a result of 
the weather being mild and there is a ten percent decrease in 
emissions, isn't that dangerous when we are talking about 
trying to create incentives for people to reduce their 
emissions?
    I mean, what if the cap is above? It may be too high above 
the emissions. Doesn't that just have a negative impact?
    Mr. Bowles. I would just comment----
    Mr. Cleaver. And how do we handle it?
    Mr. Bowles [continuing]. To say that that is an argument 
for multi-year compliance periods because you do have weather 
events and you have got increases and decreases in energy use 
during that.
    So I would say the Regional Greenhouse Gas Initiative is a 
three-year compliance period. We also in our trading scheme 
have unlimited banking going forward. So if you buy a permit, 
you can use it in the out years. And so I think that is best 
dealt with through market rules.
    But I agree you will have fluctuation based on weather 
events.
    Mr. Cleaver. Mr. Burtraw.
    Mr. Burtraw. Yes. I would like to add I really echo your 
concern. I think as we look across the performance of emissions 
trading systems previously, although there is a lot of concern 
about price spikes and cost containment, empirically the most 
important phenomena has been price collapses or prices have 
turned out to be much less than we thought because, well, it 
turns out economic incentives work and a lot of innovation 
comes to the market.
    So one of the ways to protect against that is a reserve 
price in an auction, which makes--and that is a standard 
feature of good modern auction design. You are going to find it 
on eBay the next time you try to go auction something there. 
And so it puts in a floor on the value of emission allowances 
within an auction and thereby provides sustainable expectations 
for innovators and new investors going forward.
    Mr. Cleaver. Do all of you agree with that? [No response.] 
Then I guess I must agree as well [Laughter.]
    Mr. Podesta. Particularly if eBay does it.
    The Chairman. All right. The gentleman's time has expired. 
I am going to ask a final question here, and I am then going to 
ask each one of you in reverse order of the original statements 
to each give us your one-minute summary of what you want the 
Select Committee on Global Warming to know as we are going 
through this year and trying to make recommendations on how to 
construct a program to deal with this issue. We are also 
waiting for Mr. Blumenauer to return. And hopefully he can make 
it here before the end of that process.
    Mr. Burtraw, let me ask you this question. When we did the 
acid rain bill back in 1990, all of the allowances were given 
away. And everyone says that worked great. What is different 
with this problem, the CO2 problem? Why is that 
lesson from 1990 not applicable to this issue of dealing with 
greenhouse gases because that is a very commonly asked 
question? And all of you on this panel seem to disagree with 
that approach of giving away the allowances. And the acid rain 
process did work. So what is the difference?
    Mr. Burtraw. There are two things that are different. 
Number one, that was only targeting the electricity sector. And 
in 1990, 100 percent of the electricity sector was under cost 
of service regulation. So if the regulators were awake and 
doing their job, they were going to make sure that companies 
could not charge consumers for something they had received for 
free.
    So consumers were well-protected under traditional cost of 
service regulation. Today we have had half the country in the 
electricity sector move away from that for their very own good 
reasons.
    The second is that, again, that was only in the electricity 
sector. And today we're looking at a program that is going to 
affect the entire economy. So with that type of free allocation 
in the electricity sector, it made sense in that it suppressed 
electricity, any change in electricity, prices any more than 
needed to happen there, but when we go economy-wide, that type 
of an approach for those regions of the country in the 
electricity sector that are still regulated will constitute a 
subsidy to electricity consumption. And that is going to cause 
a disequilibrium in marginal costs across the economy and raise 
the costs of carbon policy significantly.
    Our modeling, for example, suggests that it could push up 
national allowance prices by 15 percent. That means all of the 
other sectors of the economy are going to have to work that 
much harder.
    The Chairman. Great. Thank you.
    I received a letter from the Southern Alliance for Clean 
Energy regarding the subject of today's hearing. And I would 
like to ask unanimous consent that it be included in the 
record.
    Without objection, so ordered.
    Let me turn now to our concluding one-minute statements. 
And we will begin with you, Mr. Greenstein.
    Mr. Greenstein. I think the case has been well-made at this 
hearing for auctioning the permits and also for the need, both 
substantively and politically, for consumer relief. So I won't 
use up much of my one minute on that.
    However, there is one issue I mentioned in my testimony we 
never came back to. And it's kind of I think maybe not on the 
radar screen. So let me spend 30 seconds on that.
    We really do need to pay attention to the fact that the 
price point, the increase in prices, which will create 
incentives for various efficiencies, will also raise the price 
of everything from heating school buildings, education at the 
state and local level, to a variety of federal programs from 
the Pentagon's cost to veterans' cost of living increases.
    And you need to make sure that there is some room within 
the allowances to deal with those costs that the public sector 
is going to incur. You don't want an impact of cap-and-trade to 
be cuts in local education budgets or cuts in veterans' 
programs. I know it is not as politically attractive as this 
incentive and that incentive, but I think it is a key part of 
what needs to be taken into account or we end up having cuts in 
basic services, increases in other taxes, or big increases in 
deficits down the road as a result of the impact of higher 
energy prices on the important things that local, state, and 
the federal governments do.
    The Chairman. Thank you, Mr. Greenstein.
    Mr. Podesta.
    Mr. Podesta. Again very briefly, the cost of doing nothing 
is a lot more than the cost of doing something. And I think if 
we get this right and I think cap-and-trade is at the heart of 
a new energy policy, it can really power the economy forward.
    It is not as sexy as sort of complex, undecipherable 
financial instruments, but maybe if we put the minds of the 
people who currently are on Wall Street trying to do that 
towards innovation in this sector, it will create jobs, it will 
create efficiency, it will create productivity, and it will be 
a great boon to places like South Dakota as well as the rest of 
the country.
    The Chairman. Thank you, Mr. Podesta.
    Mr. Bowles.
    Mr. Bowles. Mr. Chairman, I would ask your permission to 
include a longer appendix as part of my testimony I've prepared 
for the Committee.
    The Chairman. Without objection, it will be included.
    [The appendix offered by Mr. Bowles follows on page 129.]
    Mr. Bowles. I would echo John's point about the clean 
energy economic opportunity. The United States, the great 
inventor of technology that is exported to the world in so many 
areas, has been lagging behind. Governor Patrick has made this 
a central part of his economic development strategy. And I 
think we need to start looking at it in the opportunity context 
more.
    Second, I just would tell the Committee we have also built 
in greenhouse gases to our state environmental review process. 
And we have seen new proposals for green buildings. We saw the 
Harvard Allston campus agree to the first legally enforceable 
cap on greenhouse gas emissions from a real estate development 
project. That is another area that we can get into that I think 
is important.
    And, third, I would just say send clear signals and level 
the playing field. Don't penalize early action states as you 
move forward. And measures like auctions really set an even 
playing field. And I encourage you to move forward as quickly 
as you can.
    Thank you, Mr. Chairman.
    The Chairman. Thank you, Mr. Bowles.
    Mr. Zapfel, again a special thanks to you for being here 
today.
    Mr. Zapfel. Thank you, Mr. Chairman.
    I would want to go back to the broader context in my 
closing statement of beyond the auctioning. I think we have 
seen, both in the United States and in Europe, we see, that 
environmental markets can deliver sulfur and nitrogen oxide 
markets here. The common market starts to deliver in Europe.
    So there has been I think some of the debate you were 
having here now should you go for a cap-and-trade system. We 
had the same debate in Europe. But now three or four years 
after introducing our system, it has become a feature of daily 
business in Europe. And we got used to it. We got used to 
having a common price of some $30 a ton of CO2. And 
nobody has ever revised down our macroeconomic cost 
projections. So the economy can continue to steam ahead with a 
common price.
    EU is ahead in the common market while you are ahead in the 
effluent pollutant markets. We have learned a lot from you on 
the effluent pollutant experience. We stand ready to continue 
to transfer this dialogue, transfer this experience to where we 
are ahead on the common market.
    We are not ahead everywhere. On auctioning I think we are a 
bit of a latecomer. And we can collaborate even more. So I 
think together, the U.S. and Europe, we can make headway in 
building a global common market and solving the big challenge 
we have ahead of us, bringing the emissions, greenhouse gas 
emissions, down significantly over the decades to come.
    Thank you for this opportunity to testify.
    The Chairman. Thank you, Mr. Zapfel.
    And you are the cleanup, Mr. Burtraw.
    Mr. Burtraw. Yes. Thank you.
    Well, first of all, I would just like to leave the 
impression that auction design is actually fairly simple. 
Emission allowance is a very simple commodity compared to the 
spectrum auction or the daily electricity auctions. And this is 
not the time to go into it in great detail, but, really, it is 
dramatically simple.
    So do not be intimidated by the notion that designing and 
putting in place an auction for emission allowance is going to 
be a difficult thing to accomplish. It is probably one of the 
more simple auctions that could be designed. And it is not at 
all uncommon for the government to now charge for things that 
previously it gave away for free to put such a mechanism as 
that in place.
    And, secondly, I would just like to leave the question in 
your mind with you of where does this value come from in the 
first place. It really comes from citizens in the U.S. in terms 
of their value isn't being taken out of the economy or sent 
away and burned but, rather, it's changing the way that 
property rights are assigned throughout the economy.
    An approach that I think is a candidate approach with all 
others, I mean, an economist prefers an auction because of the 
opportunity to use auction revenue to promote economic growth 
and other program goals, but also another approach that could 
be a candidate would be to use an FDR type of an approach and 
see that these emission allowances belong to citizens and they 
could be directly allocated to citizens. That would be the most 
way to achieve the most progressive income distribution as a 
consequence.
    The Chairman. Thank you, Mr. Burtraw, very much. And I 
agree with you on that spectrum auction point in 1993 working 
with the Clinton administration. We moved over 200 megahertz of 
spectrum. We created a third, fourth, fifth, and sixth cell 
phone license in every community. And it revolutionized the 
wireless marketplace moving from analog to digital.
    Up until then we had given away the spectrum, but by 
changing the model, we actually created a more entrepreneurial 
environment and derived more revenues for the federal 
government. I don't think it is as complex. I do agree with you 
on that as well.
    Before closing, I would like to thank the outstanding 
panel. I think we are unanimous in that that this was a first 
class panel and an excellent way to kick off this important 
debate this year. I think we have learned that robust auctions 
and well-targeted revenue recycling must be a core element of a 
cap-and-trade system. This is the only way to ensure that we 
can meet the goal of saving the planet while keeping the 
playing field level, ensuring consumers are protecting, and 
spurring innovation and economic growth as we move to a low-
carbon economy. I think it is also clear that we need to look 
closely at mechanisms for oversight of auctions and the carbon 
market to ensure simplicity, transparency, and fairness.
    With that, this hearing on carbon auctions is adjourned. 
Going once, going twice, sold.
    [Whereupon, at 11:58 a.m., the foregoing matter was 
concluded.]

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