eduction in energy use would tend to lower the produc

vity of other factors in the production process. The Derivation of the long-run equilibrium path of the economy can be characterized as representing the #potential" output of the economy when all resources

bor, capital, and energy-are fully employed. As such, otential GDP is equivalent to the full employment conept in other analyses that focus on long-run growth while abstracting from business cycle behavior. Figure S16 shows the losses in the potential economic output, s measured by potential GDP, for the three carbon eduction cases. The shapes of the three trajectories irror the carbon price trajectories.

he ultimate impacts of carbon mitigation policies on he economy will be determined by complex intersctions between elements of aggregate supply and demand, in conjunction with monetary and fiscal policy lecisions. As such, cyclical impacts on the economy are bound to be characterized by uncertainty and conroversy. However, raising the price of energy and

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 actual GDP, represents 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.

Collection of money from a permit auction system necessitates a careful consideration of appropriate fiscal policy to accompany the carbon reduction policy. Two alternative fiscal policies are analyzed, both returning collected revenue back to agents in the economy: a cut in personal income taxes and a cut in social security taxes as they apply to both employers and employees. In both cases, the Federal deficit is maintained at reference case levels. The personal income tax cut essentially returns collected revenues to consumers, helping to maintain personal disposable income. Like the personal income tax cut, the social security tax cut returns collected funds to the private sector of the economy, ameliorating the near-term impacts of higher energy prices. Although consumers and businesses still would face much higher relative prices for energy than for other goods and services, disposable income is maintained near reference case values to the extent that funds flow back to consum

ers.

In the fiscal policy settings, higher prices in the economy place upward pressure on interest rates. The Federal Reserve Board seeks to balance the consequences of higher energy prices on the economy and possible

adverse effects on output and employment by makin adjustments to the Federal funds rate. The adjustmen would be designed to moderate the possible impacts o both inflation and unemployment, and to retum the economy to its long-run growth path.

Figure ES17 shows the projected impacts on both actu and potential GDP for the two hypothetical fiscal pol cies (income tax and social security tax cuts) in t 1990+9% case. The figure indicates that, in the 2008 2012 period, the short-run cyclical impact on actual GDP is larger than the long-run impact on potential GDP. however, the two output concepts begin to converge by 2015, and by 2020 they have merged into a steady-stair path reflected by potential GDP. Monetary policy is instrumental in balancing inflation and unemploymex impacts through the adjustment period, acting in a men ner to bring the economy back to its long-run growth path.

The choice of the accommodating fiscal policy is also key to the assessment of the ultimate impacts on the eco omy. While the personal income tax option moder the impacts through a return of funds to consumers, the social security tax option has cost-cutting aspects of lowering the employer portion of the tax, which serves reduce inflationary pressures in the aggregate economy On the employer side, the reduction in employer cont butions to the social security system would lower cost to the firm and, thereby, moderate the near-term price consequences to the economy. Since it is the price effect that produces the predominately negative effect on the economy, any steps to reduce inflationary pressures would serve to moderate adverse impacts on the aggre gate economy.

Another way to view the macroeconomic effects is by looking at the effects of the carbon reduction cases on the growth rate of the economy, both during the period of implementation from 2005 through 2010 and then over the entire period from 2005 through 2020 (Figures ES18 and ES19). In the reference case, potential and actual GDP grow at 2.0 percent per year from 2005 through 2010. In the 1990+9% case, the growth rate in potential GDP slows to 1.9 percent per year, and the growth rate in actual GDP slows to 1.6 percent per year when the personal income tax rebate is assumed or 1.8 percent per year when the social security tax rebate is assumed. However, through 2020, with the economy rebounding back to the reference case path, there is no appreciable change in the projected long-term growth rate. The results for the 1990+24% and 1990-3% cases are similar. Aggregate impacts on the economy, as measured by potential and actual GDP, are shown in Table ES7 in terms of losses in GDP per capita. In the 1990+9% case, the loss in potential GDP per capita is $106; however, the loss in actual GDP for in the 1990+9% case is $567 assuming the personal income tax rebate and $305 assuming the social security tax rebate. Again, the lower value (loss in potential GDP) represents an unavoidable loss per person, and the higher values (loss in actual GDP) reflect the highly uncertain, but significant, impacts that

Individuals could experience as the result of frictions within the economy. To provide perspective, actual GDP per capita averages $31,528 in the reference case between 2008 and 2012.

Sensitivity Cases

This analysis includes several sensitivity cases designed to examine alternative assumptions that may have significant impacts on energy demand and carbon emissions over the next 20 years, including higher and lower economic growth, faster and slower availability and rates of improvement in technology, and the construction of new nuclear power plants. The sensitivity cases illustrate how such factors influence the results of the carbon reduction cases. With the exception of the nuclear power case, the sensitivity cases are analyzed relative to the 1990+9% case.

Because each sensitivity case is constrained to the same level of carbon emissions as the case to which it is compared, the primary impact is not on the carbon emissions levels, or even on aggregate energy consumption, but rather on the carbon price required to meet the emissions target. For example, in the high technology case, projected carbon emissions during the

compliance period are the same as in the corresponding reference technology case. What differs is the cost of meeting the target, as reflected in the required carbon price.

Macroeconomic Growth

The assumed rate of economic growth has a strong Impact on the projection of energy consumption and, therefore, on the projected levels of carbon emissions. Two sensitivity cases explore the effects of higher and lower economic growth on the cost of reducing carbon emissions to the 1990+9% level. Higher economic growth results from higher assumed growth in population, the labor force, and labor productivity. resulting in higher industrial output, lower inflation, and lower interest rates. As a result, GDP increases at an average rate of 2.4 percent a year through 2020, compared with a growth rate of 1.9 percent a year in the reference case. With higher macroeconomic growth, energy demand grows faster, as higher manufacturing output and higher income increase the demand for energy services, resulting in higher carbon emissions. Assumptions of lower growth in population, the labor force, and labor productivity result in an average annual growth rate of 1.3 percent in the low economic growth case, resulting in lower carbon emissions.

With higher economic growth, both industrial output and energy service demand are higher. As a result, carbon prices must be correspondingly higher to attain a given carbon emissions target. In the high macroeconomic growth case, the carbon price in 2010 is $215 per metric ton, $52 per metric ton higher than the carbon price of $163 per metric ton in the 1990+9% case with reference growth assumptions (Figure ES20). In the low Figure ES20. Projected Carbon Prices In the

macroeconomic growth case, the carbon price in 2010 is $128 per metric ton. The higher carbon prices necessary to achieve the carbon reductions with higher economis growth have a negative impact on the economy and the energy system. Nevertheless, total energy consumpton in 2010 is higher with higher economic growth, by 2.2 quadrillion Btu relative to the 1990+9% case, which assumes the same economic growth rate as the referente case. In the low economic growth case, total energy consumption is lower by 2.2 quadrillion Btu in 2010.

In order to meet the carbon reduction targets with higher economic growth, there is a shift to less carbonintensive fuels and higher energy efficiency. On a sedi ral basis, higher economic growth affects total energy consumption in the industrial and transportation sectors more significantly than in the other end-use sectors Total consumption of both renewables and natural gas is higher, primarily for electricity generation but also in the industrial sector. Coal use for generation is lower. and the use of nuclear power is higher as a result of the higher carbon prices. Petroleum consumption is also higher with higher economic growth, both in the transportation and industrial sectors.

Total energy intensity is lower in the high economic growth case, partially offsetting the increases in the demand for energy services caused by the higher growth assumption. With higher economic growth there is greater opportunity to turn over and improve the stock of energy-using technologies. In addition, the higher carbon price induces more efficiency improve ments and some offsetting reductions in energy service demand, moderating the impacts of higher economic growth. With higher economic growth, aggregate energy intensity declines at an average annual rate of 1.9 percent through 2010, compared to 1.6 percent with re erence economic growth. The opposite effects on energy intensity occur with lower economic growth, with the decline in energy intensity slowing from 1.6 percent t 1.3 percent between 1996 and 2010.

Technological Progress

The rates of development and market penetration of energy-using technologies have a significant impact on projected energy consumption and energy-related carbon emissions. Faster development of more energy efficient or lower-carbon-emitting technologies than assumed in the reference case could reduce both com sumption and emissions; however, because the reference case already assumes continued improvement in both energy consumption and production technologies. slower technological development is also possible.

To analyze the impacts of technology improvement. high technology assumptions were developed by experts in technology engineering for each of the energy-consuming sectors, considering the potential

impacts of increased research and development for more advanced technologies. The revised assumptions included earlier years of introduction, lower costs, higher maximum market potential, and higher efficiencies than assumed in the reference case. Also, this sensitivity case assumed the availability of carbon sequestration technology for coal- and natural-gas-fired power plants, which would remove carbon dioxide and store it in underground aquifers; however, the technology is uneconomical relative to other technologies because of its high operating and storage costs.

These technological improvements were developed under the assumption of increased research and development, and they are distinct from the more rapid adoption of advanced technologies that occurs with higher energy prices in the carbon reduction cases. It is possible that further technology improvements could occur beyond those in the high technology sensitivity case if a very aggressive research and development effort were established. The low technology sensitivity case assumes that all future equipment choices are made from the end-use and generation equipment available in 1998, with new building shell and industrial plant efficiencies frozen at 1998 levels. Comparing this sensitivity case to a case with reference technology assumptions demonstrates the importance of technology improvement in the reference case.

Because faster technology development makes advanced energy-efficient and low-carbon technologies more economically attractive, the carbon prices required to meet carbon reduction levels are significantly reduced. Conversely, slower technology improvement requires higher carbon prices (Figure ES20). With high technology assumptions, the carbon price in 2010 is $121 per metric ton, $42 per metric ton lower than the carbon price of $163 per metric ton in the 1990+9% case with the reference technology assumptions. With the low technology assumptions, the carbon price increases to $243 per metric ton in 2010.

In the high technology sensitivity case, total energy consumption in 2010 is lower by 2.1 quadrillion Btu, or about 2 percent, than in the 1990+9% case with reference technology. Delivered energy consumption in both the industrial and transportation sectors is lower as efficiency improvements in industrial processes and most transportation modes outweigh the countervailing effects of lower energy prices. In the residential and commercial sectors, the effect of lower energy prices balances the effect of advanced technology, and consumption levels are at or near those in the reference technology (1990+9%) case. In the generation sector, coal use for generation is 40 percent higher than with

reference technology assumptions, due to efficiency improvements and the lower carbon price.

In the low technology sensitivity case, the converse trends prevail. In 2010, total energy consumption is higher by 1.5 quadrillion Btu than in the 1990+9% case with reference technology assumptions. Delivered energy consumption is higher in the industrial and transportation sectors and lower in the residential and commercial sectors, suggesting that industry and transportation are more sensitive to technology changes than to price changes, and the residential and commercial sectors are more sensitive to price changes. With the higher carbon prices in the low technology case, coal use is further reduced in the generation sector, and more natural gas, nuclear power, and renewables are used to meet the carbon reduction targets.

Nuclear Power

In the reference case, nuclear electricity generation declines significantly because 52 percent of the total nuclear capacity available in 1996 is assumed to be retired by 2020. A number of units are retired before the end of their 40-year operating licenses, as suggested by industry announcements and analysis of the age and operating costs of the units. In the carbon reduction cases, life extension of the plants can occur if it is economical; and there is an increasing incentive to invest in nuclear plant refurbishment with higher carbon prices. However, these cases do not allow the construction of new nuclear power plants, given continuing high capital investment costs and institutional constraints associated with nuclear power. A nuclear power sensitivity case examines the impact of allowing new plants to be constructed. Because nuclear plants still are not economically competitive with fossil and renewable plants in the 1990+9% case, the nuclear power sensitivity case was analyzed against the 1990-3% case. In addition to allowing new nuclear plants, the higher costs assumed in the reference case for the first few advanced nuclear plants were reduced in this sensitivity.

Relative to the 1990-3% case, 1 gigawatt of new nuclear capacity is added by 2010 in the nuclear power sensitivity case, and 41 gigawatts, representing about 68 new plants of 600 megawatts each, are added by 2020. With most of the impact from the new nuclear plants coming after the commitment period of 2008 through 2012, there is little impact on carbon prices in 2010. By 2020, however, carbon prices are $199 per metric ton with the assumption of new nuclear plants, as compared with $240 per metric ton in the 1990-3% case with the reference nuclear assumptions. In 2010, total energy consumption is about the same in this sensitivity case as in