Research AreasEnvironmental and Energy Economics

State-by-State Analysis: High-Cost Case Forecasts of U.S. Cap-and-Trade Legislation

The transformation of our fossil-fuel based economy into a clean-energy economy will be the work of a generation. Three interrelated projects will drive the enterprise: dramatically increasing energy efficiency; equally dramatically lowering the cost of supplying energy from such renewable sources as solar, wind and geothermal power; and establishing limits on emissions of global warming pollution from the use of fossil fuel energy, i.e. oil, coal, and natural gas.

The Obama 2009 economic recovery program makes major headway in the first two areas, of promoting both energy efficiency and renewable energy. The recovery program amounts to roughly $80 billion over two years in public energy investments. It also anticipates encouraging another $150 billion in private investments in clean energy, by offering large-scale tax advantages, matching funds, and loan guarantees for private firms.

The Obama recovery program does not include policies to limit consumption of oil, coal and natural gas. But President Obama has called on Congress to pass a cap-and-trade measure that mandates limits on carbon emissions from burning fossil fuels. This will bring higher prices for using oil, coal and natural gas. How much higher these prices will rise is uncertain. We also cannot know in advance how much any increases in fossil fuel prices will affect the economy’s overall performance.

Several organizations have attempted to forecast the effects of a carbon emissions cap on the overall economy, despite the near impossibility of producing reliable forecasts. Still, it is important to try to understand the potential costs of a carbon cap. We thus assess the economic implications of the forecasts generated by the American Council on Capital Formation and the National Association of Manufacturers (ACCF/NAM). The ACCF/NAM forecasts are significantly more negative than, for example, similar exercises conducted by the Environmental Protection Agency and the Energy Information Administration. We also focus on the worst-case scenario in the ACCF/NAM report, what it terms its “high-cost case.”

According to even this ACCF/NAM high-cost case forecast, a cap-and-trade law will have only a minor impact on the performance of the U.S. economy over time. This becomes clear in comparing their high-cost case with their “baseline” forecasts, in which they assume no cap-and-trade law has been implemented. For example, their forecasts imply that the average resident’s income will grow at an annual rate of 1.7 percent between 2007 and 2030 under their baseline forecast versus 1.6 percent under their high-cost case with cap-and-trade. ACCF/NAM presents its forecasts by focusing only on the minor differences between their baseline and high-cost cases. We restate their forecasts by directly comparing their high-cost case relative to actual economic conditions in 2007.