Free Emissions Permits ≠ Costless

Now that it's officially McCain vs. Obama in the general election, the race is on to compare and contrast the candidates' policy positions. One difference I expect the media to feature prominently is how the candidates would allocate emissions permits under their respective cap-and-trade proposals. McCain wants to initially allocate most of the permits for free based on past emissions; Obama wants to allocate the permits through an auction.

It's important to remember that handing out emissions permits free of charge does NOT mean that the companies receiving them bear no cost. An emissions permit received free of charge still entails an opportunity cost. The opportunity cost of a permit handed out for free is the price for which the company can sell the permit.

Once emissions permits are handed out free of charge, then every company can either keep its allotment of permits or sell them to another company. Assume that Company X receives 10 emissions permits, but it only needs 7. Assume further that Company Y is willing to buy permits for $1,000 each. If Company X decides to keep all 10 permits, then the opportunity cost of keeping the 3 permits it doesn't need is price for which Company X could have sold those permits to Company Y -- in this case, $3,000. Similarly, if Company X only values the remaining 7 permits it needs at $500 each, then the opportunity cost of not selling those 7 permits to Company Y is $3,500 ($500 × 7).

I think Obama's proposal to auction off the emissions permits is superior, especially given our current budget deficit. But McCain's proposal to allocate most of the permits for free based on past emissions is not necessarily a hand-out to big corporations less efficient [ed: poor word choice originally on my part]. I hope the difference is portrayed accurately in the media. Wishful thinking, I know.