How cap and dividend works

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Cap and dividend starts with a descending economy-wide cap on carbon suppliers rather than carbon emitters. The way the cap works is extremely important.

There are two possible places to cap carbon: (1) where CO2 leaves the economy and enters the atmosphere, and (2) where carbon enters the economy in the form of a fossil fuel. Economists call the former a downstream cap and the latter an upstream cap.

In choosing where to put the cap, it’s important to recognize how carbon differs from other pollutants. Most pollutants are impurities that can be regulated or removed where they are emitted. Carbon, however, gushes not just from a few pipes, but from hundreds of millions. Capping carbon emitters is therefore extremely difficult. To the extent it can be done, it will be an administrative nightmare for businesses, consumers and government. And it will never catch all of the carbon that flows into the atmosphere.

By contrast, capping carbon as it enters the economy is relatively simple. The cap can be administered by requiring the first sellers of oil, coal and natural gas to buy permits equal to the carbon content of their fuels. Once a year the companies would ‘true up’ and pay a stiff penalty if they don’t own enough permits. No other businesses would need permits, and no smokestacks would need to be monitored.

Dividends. When fuel companies buy permits, they’ll pass that cost along to their customers. This is as it should be: the cost of emitting CO2 needs to be paid by energy users. By adding this currently ignored cost, we’ll shift private investment away from fossil fuels and toward efficiency and clean energy.

Higher fuel prices have a downside, however: they take lots of money out of everyone’s pockets. The trillion dollar question is, where does that money go? In traditional cap and trade, the extra money we pay goes to companies who receive free permits. Under cap and dividend, by contrast, it flows into a not-for-profit trust. There it’s divided into equal shares and wired to every American’s bank account or debit card. This happens monthly and automatically. As the price of carbon rises, so do the dividends everyone receives. And no large bureaucracy is needed.