The trouble with leakage: Trying to micro-manage market innovation in climate legislation

Written by dkoplow Posted: 11/6/2009 10:6 AM EST

Starting a conversation about leakage immediately makes people uncomfortable.  Their gaze shifts to floor, and it is clear they are hoping the speaker will have the good sense to avoid the rather uncomfortable topic addressed by the smiling actors in a Depends undergarments commercial. 

Rest assured: your averted eyes have been noticed.  But leakage in the world of environmentally-harmful subsidies and climate change is hardly a happier exchange.  At least with Depends there is a recognition, albeit an awkward one, that the problem is an unhappy fact of the human condition. 

Not so the with the second category.  Policy makers continue to be surprised (shocked, absolutely shocked) when affected parties game the politicians' carefully worded statutes to the great detriment of the environment and the public purse.

Such willful blindess is unjustified given that examples of policy leakage are everywhere.  International lenders want to direct funds to clean energy, yet it turns out that 400 million British pounds that the UK has given to the World Bank is financing coal plants instead.  Or that the billions of dollars in the US cash for clunkers program bought almost no increased efficiency in the auto fleet, instead often swapping one inefficient vehicle for a newer inefficient vehicle - though perhaps in a cooler color.   Or that the landfills that are going to be able to sell carbon offsets for methane capture may actually be leaking a big share of the methane they produce into the atmosphere entirely free of cap and trade constraints.  Or -- and here's a surprise -- when you are paying people for what they aren't doing (but could), they exagerate what they would have done in the absence of the payment in order to get more money. 

Policies may leak because they are built that way to provide goodies to targeted constituents in a less public (and politically less-costly) way.  They may leak because they are too complex or naively structured.  Even well-intentioned policies may contain just enough vagueness in their wording for enterprising lawyers and trade associations to rip them open in the back-alleys of the policy world (such as tax courts, rulemakings, or conference committees), in the process extending subsidy support to entirely new classes of activities. 

An arcane private letter ruling by the US Internal Revenue Service, for example, defined a portion of an ethanol production facility as a solid waste plant, opening the door to tax-exempt bonds in the hundreds of millions of dollars for nearly every plant that followed.  The logic of the ruling -- that mid-process byproducts of complex production facilities had negative market value, and therefore met solid waste definitions -- was rather silly and would seem to apply to nearly all complex industrial processes.

A creative reinterpretation of paper industry recovery boiler operations to include a bit of diesel fuel will cost the US federal government an estimated $8 billion per year, despite the fact that the industry has been recovering energy from its "black liquor" waste products for decades.  There have been other similar schemes:  "splash-and-dash" for biodiesel, and "spray-and-pray" for coal.  Too often, it is the lowly taxpayer left doing the real praying.

In many cases, it is impossible to tell whether the loopholes that ultimately cost us so dearly were mere accidents of drafting, or whether the vagueness was intentional, inserted by forward-thinking lobbyists and their like-minded Congressional allies.  In some cases, the loopholes get closed once enough sunlight shines on the cost.  In some closure happens very slowly, or not at all.  The US Mining Law of 1872 has been giving away publicly-owned hard rock minerals for a very long time, with reform continually held at bay.

These headlines are more likely the exceptions than the rule.  In fact, in the absence of any systematic reporting on subsidy disbursements or receipts, it would be would be foolish to assume that the programs that have been flagged by our media or public policy groups comprise any mroe than a small fraction of the schemes, redirection, and inefficiency that is actually present.  The definition of "solid waste" (paragraph 297) on which tax credits can be earned in the US, for example, includes nearly every possible residential, commercial, and industrial waste stream other domestic wastewater and radioactive wastes.  We live in a bizzarro world with ever larger subsidies to burn and landfill wastes, undermining the inherent economic benefits of recycling in terms of recapturing invested energy and materials processing.  We are entering a world with increasingly complex policies being applied globally, and where the risks of damage from these types of problems are ever larger.

Why does all this matter?  Because the crafters of today's climate plans are acting as though their new bills, filled with hundreds of pages of handouts, will somehow avoid the frequent and expensive failings of the past.  They are focusing on cutting deals and not on building a policy structure that will provide real transparency and accountability. 

For Senators John Kerry and Lindsey Graham, the handouts are not a bug in the program, they are the feature attraction.  They noted in a recent New York Times op-ed that

killing a Senate bill is not success; indeed, given the threat of agency regulation, those who have been content to make the legislative process grind to a halt would later come running to Congress in a panic to secure the kinds of incentives and investments we can pass today.  Industry needs the certainty that comes with Congressional action.

The "agency" in question is the US Environmental Protection Agency that they say will botch things up by imposing regulations that

are likely to be tougher and and they certaintly will not include the job protections and investment incentives we are proposing.

It is not clear why the US EPA will screw things up any worse than politically driven allocations of hundreds of billions of dollars in carbon credits, and terms and compliance schedules that may do little to address the core purpose of the bill in constraining greenhouse gas emissions.  Yes, we need to constrain emissions.  But is this really the best the country can do?  Might a carbon tax, levied on base fuels, be subject to much less gaming and inefficiency?  What about a full auction of credits, rather than political allocations?  Or much smaller allocations and a shift from offset sales to emission regulation from land-use based sources of GHGs such as landfills and agriculture?  Or much more rapid expiration of allocated credits so firms need to go to market quickly for at least a portion of their allocation? 

Can Kerry and Graham at least be honest about the level of leakage they are creating in their effort rather than pretending they have the "blueprint for a clean-energy future that will revitalize our economy, protect current jobs and create new ones, safeguard our national security and reduce pollution"?