Is Cap And Trade A Financial And Environmental Solution For Illinois?

Apr 7, 2014

Prof. Don Fullerton
Credit University of Illinois

An Illinois professor says state government could improve it's financial predicament and lower greenhouse gas emissions at the same time.  

Don Fullerton is proposing what's known as a "cap and trade" program where a limit is placed on emissions. 

Going above the level would cost money for operations like coal fired power plants.  But even he admits it's unlikely to happen anytime soon. 

Read Fullerton's proposal in the article below:

Taxing Waste, not Work: Cap-and-Trade as a Revenue Source

By Don Fullerton

The suggestion to implement cap-and-trade in Illinois has almost nothing to do with global warming. Given huge emissions from the rest of the world, cutting emissions in Illinois will have no perceptible effect on global emissions and climate change.  For Illinois, it’s about the money.

Illinois faces huge budget deficits, while cap-and-trade can earn much needed revenue for the state. The Institute of Government and Public Affairs at the University of Illinois estimates that the state’s annual budget deficit will rise within ten years to about $14 billion per year. Cap-and-trade could be a partial remedy. If Illinois sells permits for carbon dioxide emissions at about $10 per ton—similar to a program already in place in California—the state could raise $2 billion per year.

Illinois would set a limit—or a “cap”—on carbon dioxide emissions statewide. It would then auction permits to large producers of coal and petroleum products. These permits allow them to sell products that emit a certain amount of carbon dioxide each year. The number of permits would be limited in order to enforce the cap, and the firms could sell—or “trade”—the permits to each other.

How would consumers be affected? First, gasoline prices would likely increase by about ten cents per gallon (about 3 percent). Coal is used to generate just under half of the electricity used in Illinois, and cap-and-trade would increase the cost of that production by about a penny per kilowatt hour (about 10 percent). Moreover, critics complain, a cap-and-trade plan could put some people out of work. These disadvantages are real.

Yet any alternative way of raising $2 billion per year would also place burdens on Illinois taxpayers. Any income or sales tax would similarly raise production costs and reduce economic activity. In contrast, cap-and-trade would raise those funds while placing more of its burdens on those who live outside the state: the owners of coal-fired power plants and their stockholders.

A coal-fired power plant is a long-lived investment with a huge sunk cost (about $3 billion to build a plant with a thousand megawatt capacity). These plants are owned by large national corporations that can afford to build them.  A ten percent increase in the cost of coal will not prompt these companies to shut down and throw away their $3 billion investment. Instead, they will likely continue to operate, to employ workers, and to buy coal from mines that also continue to operate. 

Meanwhile, the price of electricity in Illinois is determined in competitive markets that include natural gas plants with much smaller carbon content and renewables with no carbon content (like wind power). This competition will not allow coal-fired power plants to pass the costs of cap-and-trade on to their customers. Thus, the main effect of making electricity more expensive to produce will be to reduce the profits to the owners of coal-fired plants (and reduce the value of their corporate stock).

Must Illinois legislators heed lobbyists from those national corporations rather than the interests of consumers and taxpayers in Illinois?

Consumers in Illinois might pay a bit more for gasoline and electricity.  But Illinois residents’ burden from cap-and-trade is likely much less than our burden from collecting the same revenue using an income tax or sales tax. While it would have a negligible impact on global carbon dioxide emissions, cap-and-trade would likely reduce other local pollutants that cause urban smog and local health problems. And it might give technology in Illinois a jump on other states, getting ready for a possible worldwide agreement that requires cap-and-trade at the national level—one that might actually impact worldwide carbon emissions and climate change.

Don Fullerton is a professor of economics at the University of Illinois at Urbana-Champaign and with the Institute of Government and Public Affairs. This commentary is part of the Illinois Budget Policy Toolbox series. The toolbox is a virtual resource center that assesses policy options that the state’s leaders can consider as they work to put Illinois on sound fiscal footing.