03/16/2009 06:38 am ET Updated May 25, 2011

No Free Lunch for Millionaires

Obama wants to stop energy companies from eating our lunch - we shouldn't fight him.

In our backwards political climate, President Obama's sensible carbon cap proposal has gotten him in hot water with everyone from utilities to members of the green movement. While other plans give away pollution permits to energy companies for free --a windfall valued roughly $100 billion per year--President Obama's proposal auctions off the permits and refunds the money to taxpayers.

The plan cleans up our environment, spurs investment that will create millions of jobs, and protects consumers from the rate increases that will come from making this transition to cleaner energy.

The biggest red herring in this debate, pushed by some energy executives, is the idea that auctioning the permits will increase energy prices, but giving away permits for free to energy companies will not. This argument is a stool with two shaky legs.

Shaky leg #1: Utilities say they will pass their savings on to customers. Claiming that giving companies a pile of free permits will decrease electricity prices is like saying that somehow, if we give them all big bars of gold, they will pass them on to consumers for free.

In a competitive market, the price of electricity is determined by the price of inputs; mostly labor and fuel. President Obama's plan would add another input into the production process: carbon permits. Even if they were initially distributed for free, carbon credits would have value on the market, so the price of electricity will reflect the additional cost to the energy company of using the permits rather than selling them. This is true whether we auction them off or give them away.

The real question here is: If they plan to pass along the value of free permits, why are they fighting so hard for them in the first place?

In Europe, governments tried giving away permits to polluters, in the hopes that it would keep down energy prices. The result was windfall profits for companies and rate increases for consumers. This is not an experiment worth repeating.

Shaky leg #2: Utility regulators will protect consumers. About half of the nation gets their energy in regulated marketplaces, where utility regulators help set the price of electricity. Theoretically, local regulators could ensure that utilities passed the value of permits onto consumers by not allowing them to raise energy prices.

However, if history is our guide, we cannot count on regulators to so single-mindedly protect consumers. Electricity companies will fight tooth and nail to keep as much of the windfall as possible, through lobbying, campaign contributions, and public relations blitzes. Their efforts are unlikely to be in vain, and it would be surprising if, even in regulated markets, consumers kept the bulk of the saving. How much customers saved would be entirely contingent on how well their local regulators stood up to industry pressure. This is not a sound basis for national energy policy--it's Congress punting.

In the end, in both regulated and unregulated markets, consumers would lose out from a permit give-away, and energy companies would come out the big winners. That is probably why Peter Orszag, President Obama's budget director, said that giving away permits would be "the largest corporate welfare program that has ever been enacted in the history of the United States."

Revesz is the dean of New York University School of Law; Livermore is the Executive Director of the Institute for Policy Integrity at New York University School of Law; together, they are the authors of Retaking Rationality: How Cost-Benefit Analysis Can Better Protect the Environment and Our Health (Oxford University Press, 2008).