3.   Impacts on the Economy

Allocation of Allowance Revenue

The bill discusses two sources of allowances.  First, the EPA Administrator will issue allowances based on emissions estimates computed from the preceding 3 years.  Second, the Secretary of the Treasury will offer an unlimited number of allowances for sale at the safety-valve price.

Allowances issued by EPA will be distributed to the affected industries and various government agencies as follows:

Printer Friendly Version Allowance Allocation Percentage Allocation Advanced research projects through the Department of Energy 25 Investment/assistance to developing countries through the Department of State 10 Industries affected: 5    - fossil fuel-fired electric generating      industry 5    - petroleum and natural gas      industry 5    - coal industry 5    - energy-intensive industries 5 Transition assistance to displaced workers and to local governments 15 percent in first year, reduced by 1.5 percent per year Low-income home energy assistance 5 U.S. Treasury 25 percent, plus the portion from reduction in transition assistance

The projected revenue from sales of allowances is a function of the market price of the allowances, the number of allowances issued by EPA, and the number of additional allowances sold by the Treasury if the safety valve price is triggered.  Two streams of projected revenues are generated for the two sources of allowances.  In the H.R.5049A case, projected revenue for the EPA allowances increases from $0.6 billion¹² in 2009 to $59.3 billion in 2017. In 2018, the projected allowance price reaches the safety valve price level, whereby all allowances, including the additional allowances provided by the Treasury, will be sold at the safety valve price.  In 2030, projected revenue for the EPA allowances is $103.6 billion, and that for the additional safety valve allowances is $17.8 billion, totaling $121.4 billion.  This represents 0.26 percent of the projected nominal GDP in that year.

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The allocation of allowances or allowance revenues has effects on several categories of the national accounts in the macroeconomic module of NEMS.  In the H.R.5049A case, the 25 percent of revenue distributed by the Department of Energy for advanced research, ranging from $0.2 billion in 2009 to $25.9 billion in 2030, is interpreted as an increase in government consumption expenditures.  Ten percent of the revenue for developing countries ($0.1 billion in 2009 to $10.4 in 2030) is considered transfer payments out of the United States.  Ten percent of the allowances are given to the oil, natural gas, and coal industries which are responsible for submitting allowances for energy-related CO2 emissions, and 10 percent are given to the electric power sector and energy-intensive industries.  Transition assistance is treated as transfer payments from the government to individuals, increases from $0.1 billion in 2009 to $2.7 billion in 2017 and gradually falls to zero in 2020.  Five percent ($0.1 billion in 2009 to $5.2 in 2030) goes to the Low-Income Home Energy Assistance Program (LIHEAP), another type of government transfer payments to individuals.  The remainder, plus the revenues from sales of safety-valve allowances by the Treasury, is retained as government revenue (see Figure 3.1).

In the H.R.5049B case, the safety-valve price increases by 2 percentage points above the previous year’s change in the CPI, compared with 1 percentage point in the H.R.5049A case.  Before the allowance price reaches the safety valve, the revenues are the same in both cases.  When the allowance price is bound by the safety-valve price, the higher price level in the H.R.5049B case generates higher revenue.  In 2030, projected revenue reaches $145.9 billion.

With a lower marginal abatement curve for other GHGs in the H.R.5049C case, demand for the allowances bids up the allowance price, generating more revenue in the first few years of implementation.  The allowance price is projected to reach the safety-valve price by 2016, 2 years ahead of the H.R.5049A case.  From then onwards, total revenue is constrained by the safety-valve price.  In 2030, projected revenue is estimated to be $124.7 billion.

Higher Prices in the Economy

As a direct consequence of the emission allowance costs, aggregate energy prices in the U.S. economy are expected to rise. One way to measure this effect is to look at the percentage change in the level of prices in the economy (Figure 3.3).  Focusing on the H.R.5049A case, the wholesale price index (WPI) for Fuel & Power rises steadily beginning in 2009 through 2017, reaching approximately 6 percent above the reference case in 2020, but then begins to level off for the remainder of the forecast period as the safety valve limits the rise in permit prices.  At the consumer level, the CPI for Energy (CPI-E) reflects the broad effects on the aggregate price for energy goods and services.  The CPI-E rises to approximately 4 percent above the reference case by 2020, but begins to level off as the safety valve comes into play.  Ultimately consumer sees higher prices directly through final price for energy goods and services paid directly, plus the indirect price increases that come about as intermediate goods and services prices rise as well.  The impact on consumer prices is measured by the All-Urban CPI, which rises to 0.6 percent above the reference case in 2020 and remains approximately at this percent difference through 2030.  The fourth chart in Figure 3.3 shows the change in the inflation rate as opposed to the percent change in the level of the CPI.  The inflation rate is the year-to-year percent change in the level of the CPI.  Through 2017, with energy prices on the rise, the inflation rate is higher than in the reference case.  However, by around 2017, the impact on the CPI begins to level off, and the year-to-year (inflation rate) change in the CPI returns to baseline levels.  Post 2017, the economy has a higher price level, but it no longer is experiencing higher inflation, and it is actually slightly below the reference case level of inflation after 2025. 

As might be expected, the H.R.5049B case follows the same trajectory as H.R.5049A through 2017, however the higher limit for the safety-valve price results in the permit price rising further.  The H.R.5049C case reflects the faster rise in the permit price through 2016 relative to the two other cases, with a faster rise in wholesale and consumer price through 2016.  However, once the safety-valve price becomes binding at the H.R.5049A level, this case tracks the H.R.5049A wholesale and consumer price impacts.

Inflation, Unemployment and the Federal Funds Rate

Figure 3.4 focuses on the H.R.5049A case, showing the relationship between changes in projected inflation, the unemployment rate, and the Federal Funds rate.  With higher energy prices going though the economy, the price level of the economy continues to rise through 2017 and then levels off at a higher level relative to the reference case, but the rate of change in the price level–the rate of inflation–decelerates after 2017.  For example, the inflation rate between 2016 and 2017 in H.R.5049A is 3.12 percent as compared to 3.01 percent in the reference case.  The difference in the inflation rate for 2017 is 0.11 percentage point.  After 2017, with the slowing in the rise in energy price due to the safety valve, the difference in the inflation rates diminishes and in the 2025 to 2030 period where the inflation rate is below the reference case.

The responses of inflation and unemployment tend to be asymmetric over time.  There is a lag between the two effects, with output and employment effects lagging behind price effects by roughly a year.  Prices rise in the economy in response to the initial energy price increase then in response to secondary price effects as the costs of intermediate goods and services rise.  Businesses, in response to rising prices and lower aggregate demand, absorb the near-term output loss but eventually reduce their use of labor.  The Federal funds rate first rise above reference case levels in response to rising prices in the economy.  As the impact on the inflation rate lessens, but with the unemployment rate still above reference cases levels, the Federal funds rate falls below the reference case in order to lessen the impact on output and employment in the economy.    

Impacts on GDP and its Components

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In the long run, higher energy costs would reduce the use of energy by shifting production toward less energy-intensive sectors, by replacing energy with labor and capital in specific production processes, and by encouraging energy conservation. Although reflecting a more efficient use of higher cost energy, this gradual reduction in energy use would tend to lower the productivity of other factors in the production process.  The ultimate impacts of greenhouse mitigation policies on the economy will be determined by complex interactions between elements of aggregate supply and demand, in conjunction with monetary and fiscal policy decisions. As such, cyclical impacts on the economy are bound to be characterized by uncertainty.  Raising energy prices and, as a result, downstream prices in the rest of the economy could introduce cyclical behavior in the economy, resulting in employment and output losses in the short run. The measurement of losses in actual output for the economy, or real GDP, incorporates the transitional cost to the aggregate economy as it adjusts to its long-run path. Resources may be less than fully employed, and the economy may move in a cyclical fashion as the initial cause of the disturbance— the increase in energy prices—plays out over time.  Figure 3.5 shows the impact on GDP in the three cases.¹³

Considering the H.R.5049A case, the loss in GDP increases throughout the entire period, but the most rapid loss occurs between 2009 and 2017.  This coincides with the steady upward increase in the allowance price.  However, when the allowance price reaches the safety-valve price, the impact on GDP is moderated.  By 2020 the loss in GDP is $27 billion, or approximately 0.15 percent, relative to the reference case level in that year.  By 2030, the loss in GDP increases to $38 billion, or 0.16 percent of the reference case value which also growing over time.  Measured over the entire forecast period, the average annual loss in GDP is approximately $20 billion out of an average annual $17.5 trillion economy between 2009 and 2030.  This represents a loss of 0.11 percent in the cumulative GDP in the H.R.5049A case over the 22-year period, relative to the reference case.  If the results are computed on a present value basis (starting in 2009 and going through 2030 using a 4-percent discount rate), the average loss in GDP is $11 billion and represents a one-tenth of 1 percent loss in cumulative GDP.

As pointed out in the discussion of the impacts on aggregate prices in the economy, the H.R.5049B case, with a higher safety-valve permit price, and the H.R. 5049C case, with lower availability of abatement for GHGs outside the energy sector, show slightly larger GDP impacts.  The view cutting across the three cases reveals that the projected GDP loss in 2030 ranges from $37 to $49 billion (0.16 to 0.21 percent) out of a $23 trillion economy. 

The bill’s safety-valve provision has an important role in limiting projected adverse economic impacts.  In the No-Safety case the allowance price is $30 per metric ton carbon dioxide equivalent in 2030, over three times as high as the safety-valve price.  The loss in GDP in that year is $137 billion as compared to $38 billion in H.R.5049A.  The average annual loss is $43 billion, 0.24 percent, in the No-Safety case, compared to a loss of $20 billion, 0.11 percent, in H.R.5049A.

Figure 3.6 focuses on the H.R.5049A case and highlights the relative impacts on components of actual GDP.  As discussed above, the loss in GDP reaches $27 billion in 2020 and by 2030 is $38 billion.  However, the pattern of impacts varies considerably by component.  Consumption of goods and services shows the largest loss over the period, falling by $25 billion in 2020 due to the rise in energy prices and a decline in disposable income.  However, after 2020 the impact on consumption is moderated as inflation begins to stabilize to near reference case levels.

Investment is typically a relatively volatile component of GDP.  When the economy is growing rapidly, there is a great incentive to invest in order to expand plant and equipment to meet expected new product demand.  However, if the economy slows, investment is postponed until the economic outlook is better.  Along with these real output effects on investment, interest rates play an important role in business investment incentives.  In the H.R.5049A case, investment declines in the 2009-2017 period, in part because of the loss in output in the economy and in part because of an increase in interest rates.  However, beginning in 2018, with the impact on consumption moderating and interest rates beginning to move toward, and then below, reference case rates, business investment begins to pick up.  This trend continues through 2030.

One of the key provisions of the bill calls for the Department of Energy to use 25 percent of the revenue distributed for advanced research.  This represents in increase in Federal government consumption expenditures.  The nominal dollar values range from $0.3 billion in 2010 to $25.9 billion in 2030.  This is reflected in the Government line in Figure 3.6 and is expressed in constant 2000 dollars.  By 2020, government expenditures are $10 billion above reference case levels, and although the rate of increase tapers off, government expenditures in 2030 are $14 billion above reference case levels.

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Consumption Impacts

Whereas GDP is a measure of what the economy produces, ultimately consumers are interested in purchasing goods and services, which is measured by consumption.   As noted above, the loss in consumption represents the largest loss of the four major elements of GDP, consumption, investment, government, and net exports.  The top charts in Figure 3.7 show the dollar value loss in consumption over time and the average loss over the entire 2009 to 2030 period.  In general, the losses increase faster during the period before the safety-valve price constrains the rise in the permit price, then grow more slowly after 2017 through 2030.  The H.R.5049C case shows somewhat larger impacts early but then are similar to the H.R.5049A case after 2017.  The H.R.5049B case is identical to the H.R.5049A case through 2017, but then is slightly worse given the higher safety-valve price.  By the end of the forecast period, the consumption losses are all between $38 to $46 billion below the reference case.  The average impact for H.R.5049A case reflects a loss of $19 billion, while the other two cases are between $21 and $22 billion.

From the perspective of a percent change in consumption relative to reference case levels, the loss is relatively small.  By 2030, the three cases range between 0.24 and 0.30 percent below reference case levels.  The average percent loss in consumption is between 0.16 and 0.18 percent of the reference case.

Another way to look at the impact on consumers is to calculate the loss in consumption on a per capita basis, as shown in Figure 3.8.  By 2020, the loss in consumption is between $71 and $83 per capita, with the loss in 2030 between $103 to $126 per capita.  For the entire period the H.R.5049A shows an average loss in consumption per capita of $55, H.R.5049B $63, and H.R.5049C $60.

Impacts on Industry Output and Employment

The implementation of H.R.5049 impacts all production activities.  The purchase of allowances increases the cost of the emitting sectors, increases in energy prices raise the factor input cost for all industries, and changes in demand for goods and services, as reflected in the final demand categories of consumer spending, investment, government spending and trade, require industries to adjust their production accordingly.

Figure 3.9 shows the trajectories of projected loss in gross output (production in real value terms) in the H.R.5049A case.  The energy-intensive manufacturing industries¹⁴ are impacted the most.  As the producer prices of fuel and power rises steadily in the first 10 years of implementation to about 6 percent above the reference case, the gross output of this group of industries is expected to be lower by 0.8 percent when compared with the reference case.  When the energy prices level off in the latter part of the forecast period, the loss in gross output stabilizes to around 1 percent.  The non-energy-intensive manufacturing industries are also affected by the rise in energy prices and fall in final demand, reaching a reduction of 0.6 percent by 2030.  The loss in the non-manufacturing industry sector, which covers agriculture, mining, and construction, is expected to be around 0.4 percent and gradually improving to a loss of 0.2 percent below the reference case.  Mining of fossil fuels is projected to fall considerably, but the other industries in this group are not affected as much by the bill. Finally, the projected output loss in the services sector varies between 0.1 and 0.2 percent.

Figures 3.10 shows the average loss in gross output for the broad sectors and the detailed industrial sectors for the period 2009-2030 for the H.R.5049A case. Production of the energy-intensive manufacturing sector is projected to be reduced by an average of 0.64 percent, non-energy-intensive manufacturing by an average of 0.43 percent, non-manufacturing industries by 0.26 percent, and services by 0.11 percent.

Among the detailed energy-intensive industries, aluminum production, which is a heavy user of electricity, is expected to fall by 4.7 percent on average (Figure 3.10).  Production of glass, iron and steel, and basic inorganic chemicals are also expected to fall by more than 1 percent. The largest sector in this group, food products, is only marginally affected.

Among the non-manufacturing industries, coal mining is projected to fall by 5.4 percent, followed by oil and natural gas extraction at 0.5 percent.  Construction, the largest industry in this group, is expected to have a small impact, as investment in structures recovers quickly in the latter part of the forecast period.  Crop production, which includes corn for production of ethanol, is projected to increase slightly.

H.R.5049 is projected to have a smaller impact on employment than output.  First, a portion of employment is not engaged in direct production.  Second, the level of direct labor input, especially in the short-run, may be less flexible than the level of production.  Also, in the long-run, higher energy prices will induce some substitution from energy to other inputs such as labor, resulting in a higher labor-to-output ratio.  Table 3.2 shows the average loss in employment for the period 2009-2030 under the H.R.5049A case.  The average loss of total employment is projected to be 58 thousand, or 0.04 percent.  Estimated average job loss in the manufacturing and non-manufacturing industries is 70 thousand, or 0.28 percent.  Part of this loss is compensated for by an increase in jobs in public service, covered under the service sectors.

3. Impacts on the Economy Tables

Notes and Sources