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mates by various experts concludes that gasoline prices would se from almost 30 percent to over 50 percent and that elec tricity prices would go by anywhere from 50 percent over 50 percent (see Figure 4). Predictions tv the Clinton Administration Council of Economic Advisers (a 2.7 percer: increase in gasoline prices and 3.4 percent rise in prices for electricity) are far below those of widely respected climate policy modelers.

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U.S. COMPETITIVENESS IN ENERGY-INTENSIVE SECTORS AND AGRICULTURE

Several studies, including those by Dr. Brian Fisher and his colleagues at ABARE, University of Colorado's Professor Thomas Rutherford. DRI's Dr. Brinner, and WEFA's Ms. Novak, have concluded that near-term emission reductions would result in the migration of energy-intensive industry from the United States to non-Annex B countries (sometimes called "carbon leakage").

The 1999 study by Professor Manne of Stanford University and Dr. Richels of EPRI also analyzed this question. The Manne-Richels model results suggest that the Kyoto Protocol could lead to serious competitive problems for energy-intensive sector (EIS) producers in the United States, Japan, and CECD Europe. Meeting the emission targets in the Protocol would lead to significant reductions in output and employment among EIS producers, and there would be offsetting increases in countries with low energy costs. U.S. output of energy-intensive products such as autos, steel, paper, and chemicals could be 15 percent less than under the reference case by 2020. In contrast. countries such as China, India, and Mexico would increase their output of energy-intensive products. In its present form, the Protocol could lead to acrimonious conflicts between those who advocate free international trade and those who advocate a low-carbon environment, Professor Manne and Dr. Richels conclude.

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U.S. agriculture would also lose competitiveness if the United States complied with the Kyoto Protocol. A study based on the DRI model by Terry Francl of the American Farm Bureau Federation, Richard Nadler of K.C. Jones Monthly, and Joseph Bast of the Heartland Institute (FNB) predicts that implementation of the Protocol would cause higher fuel oil, motor oil, fertilizer, and other farm operating costs. This would mean higher consumer food prices and greater demand for public assistance with higher costs. In addition, by increasing the energy costs of farm production in America while leaving them unchanged in developing countries, the Kyoto Protocol would cause U.S. food exports to decline and imports to rise. Reduced efficiency of the world food system could add to a political backlash against free trade policies at home and abroad.

The FNB analysis, which concludes that U.S. agriculture would be adversely affected by the Kyoto Protocol. stands in sharp contrast with the May 1999 report by the U.S. Department of Agriculture (USDA), which finds that the Kyoto Protocol would have "relatively modest" impacts on U.S. agriculture. The USDA report is seriously flawed for two reasons, according to a recent analysis by Mr. Francl. First, the USDA report relies on the unrealistic assumptions about the impact of the Kyoto Protocol on energy prices contained in the Administration's 1998 CEA analysis. Second, the USDA report makes the heroic assumption that U.S. farmers will have unrestricted access to carbon credit trading.

FLAWS IN THE CLINTON ADMINISTRATION CEA ANALYSIS

The Clinton Administration Council of Economic Advisers July 1998 economic analysis of the impact of reducing carbon emissions to 7 percent below 1990 levels, mentioned earlier, is seriously flawed for three

reasons.

First. CEA cost estimates assume full global trading in tradable emission permits (including trading with China and India). Most top climate policy experts conclude that this assumption is extremely unrealistic, because the Protocol does not require developing nations--who will be responsible for most of the growth in future carbon emissions-to reduce their emissions, and many have stated that they will not do so.

Second, the CEA's cost estimates assume that an international carbon emissions trading system can be developed and operating by 2008-2012. This assumption is unrealistic, according to analysis by

Massachusetts Institute of Technology's Professor A. Denny Ellerman.

Third, the cost estimates are based on the Second Generation Model (SGM) developed by Battelle Memorial Institute. The SGM appears to assume costless, instantaneous adjustments in all markets; the model is not appropriate for analyzing the Protocol's near-term economic impacts, according to CRA's Dr. Montgomery. As Massachusetts Institute of Technology Professor Henry Jacoby observes, there are no short-term technical changes that would significantly lower U.S. carbon emissions.

Finally, a former Clinton Administration official acknowledged that the CEA estimates understated the cost of the Kyoto Protocol by a factor of ten in a USA Today article (June 12, 2001).

EUROPEAN UNION UNABLE TO MEET TARGETS

Even though several EU members continue to support ratification of the Kyoto Protocol, a number of recent studies document that the EU will not be able to achieve its Kyoto CO2 emission reduction targets by 2008-2012 (see Figure 5). These studies include:

European Commission, "Towards a European Strategy for the Security of Energy Supply" (November 28, 2000). The EU's own report shows that their CO2 emissions will be 15 percent above their Kyoto target by 2010, rising to almost 20 percent above by 2020. While stressing the need to reduce CO2 emissions, the EU report cautions that climate change policy should not be allowed to "endanger economic development."

The Pew Center on Global Climate Change, "The European Union & Global Climate Change" (June 2000). In an analysis of five major EU member states (Germany, United Kingdom, Netherlands, Austria, and Spain) responsible for 60 percent of CO2 emissions in 1990, Pew concludes that only the United Kingdom has a good chance of meeting its targets and Germany will find it "difficult." The other three countries are "not on track"; emissions in the Netherlands currently exceed 1990 levels by 17 percent, Austria has no plans in place to meet its target; and Spain is already close to reaching its allowed growth in CO2 emissions (a concession to its relative poverty), meaning that Spain is likely to be well above its emission target by 2010.

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ABARE

EIA

EU

MIT

WEFA

Source: Figure compiled by Margo Thorning, Ph.D., ACCF Center for Policy Resear, Washington, D.C., www.accf.org. Data source references can be found at the end of this report.

MIT Joint Program on the Science and Policy of
Global Change, "Carbon Emissions and the Kyoto
Commitment in the European Union" (February
2001. According to the results of the MIT Emis-
sions Prediction and Policy Analysis model, CO2
emissions in the EU will rise by 14 percent above
the 1990 levels in 2010 instead of decreasing by 8
percent as required by the Kyoto Protocol.

The Australian Bureau of Agricultural and Resource
Economics, "Climate Change Policy and the Euro-
pean Union" (September 2000). ABARE's report
concludes CO2 emissions in the EU will increase by
an average of 0.3 percent per year from 1990 to 2010
unless stringent new measures are undertaken. (In
other words, emissions will rise by about 10 percent
rather than fall to 8 percent below 1990 levels).
U.S. Department of Energy, Energy Information
Administration, International Energy Outlook
(March 2001). The EIA analysis predicts that by
2010. emissions in Western Europe will be almost
25 percent higher than they were in 1990, falling
far short of their Kyoto targets.

WEFA, "The Kyoto Protocol: Can Annex B Coun-
tries Meet Their Commitments?" (October 1999).
WEFA surveys five other government reports,
including an EU study (as well as its own analysis),
and concludes that Western Europe is unlikely to

meet its targets. Emissions would need to fall by 15 percent to 30 percent, which would constrain economic growth in politically unacceptable terms.

While a new European Commission report from the European Climate Change Programme (June 2001) analyzed measures affecting all sectors of their economy and concluded that "the potential of cost-effective options is twice the size of the EU's required emission reductions," the EU's new report is flawed for several reasons, including:

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"Cost-effective" is defined as policies that cost no more than 20 euros per metric ton of avoided CO2 emissions, or $62 per metric ton of carbon in U.S. dollars. Most experts consider $62 per metric ton of carbon "expensive." (Some of the suggested policies cost up to $312 per metric ton of carbon to put in place.)

The policy yielding the largest impact affects buildings. The costs of these policies was calculated with a very low discount rate (4 percent), a rate of return that no private investor would accept.

Thus, the new EU study is actually a "wish list" of policies the environmental ministry "wishes" that businesses and households would adopt, but that are not likely to be undertaken voluntarily because of their high costs.

SCIENCE OF CLIMATE CHANGE NEEDS TO
BE BETTER UNDERSTOOD

Despite the United States' intensive investment in climate change science over the past decade, numerous gaps remain in our understanding of climate change. The National Academy of Sciences' National Research Council identified critical uncertainties about the science of climate change in its white paper, Climate Change Science: An Analysis of Some Key Questions:

Conflict between global atmospheric and "surface" temperature measurements (see Figure 6); Uncertainty about how much carbon is sequestered by oceans and terrestrial sinks and how much remains in the atmosphere;

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These science questions must be addressed before the United States and its allies embark on a path as nonproductive as that of the Kyoto Protocol. (For more detail, please see the Appendix to this testimony.)

GREENHOUSE GAS EMISSION TARGETS PREMATURE AND UNJUSTIFIED

According to scholars such as Brookings Institution economist Dr. Robert Crandall, setting targets and timetables for U.S. greenhouse gas emissions is premature. He bases this conclusion on:

The uncertainty about whether or the extent to which global warming is occurring (see Figure 6); new data from climatologist and U.N. Intergovernmental Panel on Climate Change author Professor Jchn Christy of the University of Alabama demonstrates that while surface-based measures show warming, satellite data shows little warming; and The high cost of foregone investment if the United States sacrifices badly needed economic growth to reduce emissions.

In a 1999 report, Dr. Crandall observes that the economic estimates of the costs and benefits of reducing emissions to 1990 levels that are in the literature are not particularly supportive of going ahead immediately with any policy of abatement. For example, as an analysis by Brookings Institution fellows Drs. Warwick McKibben and Peter Wilcoxen points out, the estimates of the costs of capping emissions at 1990 levels generally range from 1 to 2 percent of GDP per year,

while the benefits, estimated at most to be 1.3 percent of GDP, will not arise for at least 30 to 50 years. Dr. Crandall notes that "Every dollar dedicated to greenhouse gas abatement today could be invested to grow into $150 in the next 50 years at a 10 percent social rate of return, even at a puny 5 percent annual return, each dollar would grow into $12 in 50 years. Therefore, we need to be sure that the prospective benefits, when realized, are at least 12 to 150 times the current cost of securing them. Otherwise, we should simply not act, but use our scarce resources in other ways." Moreover, the climate models generally forecast that it would require far greater reductions than a return to 1990 emissions to stabilize the climate. Dr. Crandall concludes, "We cannot justify a return to 1990 emissions based on the average estimates in the literature, no matter how efficiently it is done."

It is clear that the marginal costs of abatement in low-income societies such as China and India are substantially below those in developing countries, Dr. Crandall notes. Economists envision a marketable permits program as being global in scope. The United States, France, Japan, and Germany, for example, would buy permits from China, India, or Bangladesh. The latter would, in turn, reduce their CO2 or other greenhouse gas emissions by his amount over the levels that would have occurred without the permits policy in all future years. The diculties involved in such a future program would be immense: measuring emissions from millions of sources from motor scooters to

bovine animals; forecasting emission levels for the uncontrolled scenario; and, finally, enforcing the reductions from these myriad sources. If enforcing nuclear nonproliferation treaties is difficult, enforcing a global greenhouse gases trading program would be incomparably more complicated.

Yale University Professor William D. Nordhaus has also analyzed the costs and benefits of CO2 emission limits. Dr. Nordhaus' research shows that the costs of even an efficiently designed emission reduction program exceed the value of environmental benefits by a ratio of 7 to 1 and that the United States would bear almost two-thirds of the global cost.

Targets and timetables for emission reductions would also tend to discourage businesses and households from investing now in new equipment and processes that would reduce greenhouse gas emissions. This unfortunate result stems from the fact that tax depreciation schedules for many types of investments that could reduce CO2 emissions are very slow. Slow capital cost recovery means that investments that are deemed "risky" because of possible future emission caps face a much higher hurdle rate to gain acceptance than would an investment whose cost could be recouped immediately through expensing (first-year write-off). The prospect of emission constraints in the future will tend to retard the very type of capital expenditures that many believe would facilitate emission reductions without curtailing economic growth.

TAX POLICY FOR VOLUNTARY ACTION

Current U.S. tax policy treats capital formation—including investments that increase energy efficiency and reduce pollution-harshly compared with other industrialized countries and with our own recent past. For example, before the 1986 Tax Reform Act (TRA '86), the United States had one of the best capital cost-recovery systems in the world.

Under the strongly pro-investment tax regime in effect during 1981-85, the present value of cost-recovery allowances for wastewater treatment facilities used in pulp and paper production was about 100 percent (meaning that the deductions were the equivalent of an immediate write-off of the entire cost of the equipment), according to an analysis by Arthur Andersen LLP (see Table 1).

Under TRA '86, the present value for wastewater treatment facilities fell to 81 percent for pulp and

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paper, dropping the U.S. capital cost recovery system to near the bottom ranking of an eight-country international survey. Allowances for scrubbers used in the production of electricity were 9 percent before TRA '86; the present value fell to 55 percent after TRA '86, ranking the United States at the bottom of the survey. As is true in the case of productive equipment, boch the loss of the investment tax credit and the lengthening of depreciable lives enacted in TRA '86 raised effective tax rates on new investment in pollutioncontrol and energy-efficient equipment. Slower capital cost recovery means that equipment embodying new technology and energy efficiency will not be put in place as rapidly as it would be under a more-favorable tax code. A variety of tax incentives such as expensing, accelerated depreciation, tax-exempt bond financing,

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