Scoping Out “Plan B” for Climate Change

Scoping Out “Plan B” for Climate Change

October 22, 2009

Beyond the public’s view, major players in the climate change debate are reassessing their options. In fact, as the prospects of Congress approving a cap-and-trade system fade, discussion is shifting to “Plan B.”

One reason is that the version of cap-and-trade which just barely passed the House of Representatives a few months ago, the Waxman-Markey bill, made so many concessions to polluting interests that its support among environmentalists has eroded badly. Here’s one indicator of just how weak the bill is: When it passed the House, bond ratings for coal companies improved — a remarkable development given that coal-generated electricity is the single largest source of greenhouse gas (GHG) emissions. In the Senate, progressives are said to be determined to oppose any legislation that ends up as weak as Waxman-Markey. And the moderates and conservatives who make up a majority of the Senate remain wary of climate-change engineering in a cap-and-trade form, since it would both raise energy prices for average Americans and make those prices more volatile for business. The upshot is that the prospects of corralling 60 votes for the Kerry-Boxer cap-and-trade bill in the Senate have faded to nearly zero.

In truth, the support for a cap-and-trade system always has been limited largely to a handful of sources. There are two large environmental groups — the Natural Resources Defense Council (NRDC) and the Environmental Defense Fund (EDF) — wedded to the notion of dressing up a regulatory cap on emissions with market-based trading in the emissions permits, and the Wall Street institutions eager to get a piece of all that trading and the speculation and derivatives it would throw off. In addition, a few large energy companies with major business lines in trading energy futures, including British Petroleum America and Shell, have been active supporters, as have some other companies confident they can exact the kinds of special exemptions for themselves that ultimately hobbled Waxman-Markey. Even that limited base has been shrinking: Wall Street support has become a big negative in the current political context, and there are reports that in the wake of Waxman-Markey, NRDC is now internally divided over the basic strategy.

With the fate of cap-and-trade in the Senate pretty much sealed — in effect, cap-and-trade’s third successive rejection by the Senate — the debate behind the scenes is moving to the alternatives. The two leading options are direct EPA regulation of GHG emissions or a revenue-neutral carbon tax. The courts recently held that EPA already has the authority to regulate GHG emissions, and the eclipse of cap-and-trade will shine a new spotlight on this approach. The alternative is one which a good share of the environmental community, most economists, and climate-change leaders like Al Gore have all supported: Apply a tax to energy based on its carbon content, and recycle the revenues as cuts in payroll or other taxes. Given how economically costly direct regulation can be — and the uncertainties about what such regulation would look like under the next conservative president, compared to our present liberal one — its prospect could quickly expand support for a carbon tax program. That approach also has the virtue of a successful record: While Europe’s cap-and-trade system has yet to reduce European GHG emissions, Sweden’s 15-year experiment with carbon-based taxes cut the country’s emissions sharply even as its economy grew 50 percent larger.

For its supporters, a carbon tax is simple, transparent, and produces a steady price for carbon which businesses can use to plan large investments in developing and adopting more climate-friendly fuels and technologies. To its opponents, it’s just another tax. That objection should be at least partly neutralized by recycling the revenues through other tax cuts — if the debate remains reasonable. In the end, environmental and business leaders, and ultimately the White House, will have to defend a carbon-based tax against the forces of politics as usual, which in this time seem dominated by the power of entrenched interests and the partisan politics of just-say-no-to-everything. If we can’t manage that, we may well lose the best chance in a generation to take serious action to defend the climate our children and grandchildren will inherit.

Read Rob Shapiro’s latest contribution to “Planet Panel,” The Washington Post’s online discussion on climate change policy: “What’s Really in Doubt.”

Who Really Will Pay for Goldman Sachs’ $23 Billion in New Bonuses?

October 13, 2009

It was an auspicious week for the touchy issues surrounding executive pay. One after another, President Obama’s pay czar, Kenneth Feinberg, announced new restrictions for AIG executives; Goldman Sachs was reported to be putting aside $23 billion for this year’s bonus pool, the largest anywhere, ever; and Elinor Ostrom from Indiana University shared the Nobel Prize in economics for her breakthrough work on how large companies organize themselves, often in ways that encourage executives to put their own financial interests before those of the shareholders.

Starting with Goldman, it’s obvious that annual bonuses equal to 10 or 20 times what an average American earns in his or her entire lifetime, coming from a firm which recently received huge, direct and indirect taxpayer-funded assistance, are certain to spark outrage. That reaction isn’t misplaced, and there’s a sensible response to it based on the core tenets of capitalism, which we will get to shortly. There are other serious matters at stake here, too. In particular, how does a financial services firm like Goldman Sachs earn such huge profits in difficult times? And since the operations of Goldman and a few others like it matter so much to the economy — which is why they got their federal assistance — how do the arrangements which produce such huge bonuses affect those operations, and consequently, the rest of us? The answers suggest that even as Goldman’s top executives and traders put away enough for a royal retirement, their decisions could lay the foundation for future financial turmoil that would leave the rest of us a lot poorer.

We didn’t need this latest and most conspicuous instance of greed at Goldman to know that the compensation provided to the uppermost echelons of American business is out of control. Since 1990, the pay of American CEOs has jumped from 90 times the average workers’ pay to 250 times — compared to 15 to 30 times for British, French and Japanese CEOs. Nobel Laureate Ostrom’s work helps us understand why: CEOs name their own top executives and strongly influence who ends up on their boards of directors — and consequently, the committees that set the terms for all of their compensation. How much they decide to pay themselves, therefore, is essentially limited by the intersection of their own avarice and any vestigial sense of shame they might have. And the shame is usually pretty easy to dispose of, since the terms of their compensation are rarely disclosed publicly.

There’s a fascinating account of some of these pay packages in a current New Yorker article chronicling the efforts of Nell Minow and Robert A.G. Monks to reassert shareholder rights over these modern robber barons. Almost everywhere, most of the pay comes in stock or stock options, so they’re only liable for the 15 percent capital gains tax. (The Goldman executives who will claim stock bonuses worth tens of millions of dollars this year will report taxable “salaries” of less than $300,000.) And if the stock price falls under these executives’ leadership, their options contracts are often revised at a lower strike price. These packages may also include huge “retirement” bonuses for CEOs that leave voluntarily — like the one federal contractor Halliburton gave Dick Cheney when he left to run for Vice President — and even “retention bonuses” for executives who end up in prison. Then there are the extravagant perks. It took public divorce proceedings against GE’s Jack Welch for shareholders to find out that on top of the many hundreds of millions of dollars Welch received in stock and salary, his friendly board had also awarded him lifetime use of the company’s 737 and helicopters; lifetime floor seats for the Knicks and lifetime box seats for the Red Sox, Yankees and the Metropolitan Opera; exclusive lifetime use of a sprawling Manhattan apartment, including fresh flowers, dry cleaning service and even the tips for the doorman; and a catalog of lifetime golf and country club memberships. His and most other executive contracts also now include “gross-ups,” which means that the shareholders also pick up federal and state taxes owed on the executives’ various perks.

These are all examples of what economists call the “agent-principal problem,” in which the interests of agents — they’re the executives — diverge from those of the principals, who here are the owners or shareholders. It’s pretty simple: They enrich themselves at the expense of the shareholders who they ostensibly work for — and those shareholders now include a majority of all Americans. The simple democratic answer to all this, derived directly from the essence of capitalism, is to empower the owners by requiring that boards disclose all aspects of the compensation package of senior personnel and subject the terms of those compensation packages to mandatory shareholder votes, every year.

Last week, I proposed this step on a CNBC business show. The other guest predictably squawked about government control — and then the moderators also tried to dismiss the idea as “impossible.” Come again? Shareholders vote every year on lots of measures — check out your proxy statements. And the mere threat that shareholders might publicly reject a CEO‘s payday should moderate the greed of at least some compensation committees. The House passed a weak version of this proposal recently — annual, “advisory” shareholder votes on compensation. The Senate should strengthen it with stricter disclosure requirements and an annual vote that actually decides the matter. Why, precisely, shouldn’t a company’s owners determine what their executives are paid? And do you think that Goldman’s shareholders, including strapped pension plans and charitable institutions, are eager to see $23 billion in potential dividends go to the firm’s top tiers?

This particular agent-principal problem also affects the rest of us, since the stock and stock options that make up most of these compensation packages are often tied to the short-term gains associated with an executive or trader’s work, without regard to the transactions’ long-term returns. So, hundreds of traders and executives at Goldman and other places on Wall Street have closed transactions and other deals that booked large paper profits this year — and will take home huge bonuses tied to them — but bear no consequences if those deals go sour next year or the year after and cost the shareholders billions. These arrangements directly encourage them to take on enormous long-term risks for their firms and owners, in pursuit of the short-term paper gains that generate their own bonuses. Since risk and return are closely related, these arrangements help explain how Goldman earned enough this year to dole out that projected $23 billion in bonuses. And by creating such strong incentives for risky investments on a large-scale, these same arrangements were a core element of the meltdown that nearly pushed the U.S. and global economies into a genuine Depression, and cost shareholders and taxpayers trillions of dollars.

To prevent a recurrence that could ruin almost everyone, these arrangements have to end. J.P. Morgan Chase has said it will include new “claw-back” provisions that would reclaim part of the bonuses when a deal’s long-term returns are less than expected. It’s a nice gesture, but it’s hardly enough. We need laws and regulations that directly limit the risk levels of the portfolios of institutions deemed “too large to fail,” and specific, claw-back guidelines from the SEC that all public companies will have to follow. The outstanding question is whether Congress has the cajones to force the country’s richest people and institutions to change the ways that made them so wealthy in the first place.

What Washington Should Understand and Do to Create Jobs

October 7, 2009

Policymakers and pundits finally are worried about a “jobless recovery” – and our actual prospects are worse than that term suggests. The initial expansion we may already be experiencing will be notable not for a lack of new jobs, as the phrase “jobless recovery” suggests, but for substantial, continued job losses. Total employment will continue to decline for many months and perhaps as long as two years, as it did after the 2001 recession. Nor is it enough to aim for simply “recovery,” if by that we mean a return to the conditions that preceded this recession, including unstable capital markets and stagnating real wages in the face of strong productivity gains.

The stimulus passed last February has helped to slow job losses – without it, we might well shed an additional one-to-two million more jobs. But fiscal stimulus is a much weaker lever for creating jobs than it used to be, because of changes in the relationship between increases in economic demand (that’s what stimulus does) and creating new jobs to satisfy that demand. In the 2002-2007 expansion, private employment grew at less than half the rate, relative to growth, as it did in the expansions of the 1980s and 1990s. So, Washington boosting demand and growth today has less than half the impact on jobs that it once did.

In the short-run, there’s little we can do about this change. Behind it lies large, structural changes, especially the emergence of more intense competition spurred by globalization, which now limits how much businesses can raise their prices when their costs increase. The good news about this development is the low inflation that’s prevailed across most of the world for nearly two decades, or basically the time frame of modern globalization. The bad news is that when health care and energy costs, for example, rise rapidly, businesses which can’t pass along those cost increases in higher prices have to cut other costs – and they often start with jobs and wages. (These developments are also big factors in why wages now stagnate even as productivity increases.)

This means that the administration’s long-term economic agenda has to include serious steps to reduce how much health care and energy prices rise, or relieve business of some of the burden of those increases. In short, long-term cost containment in health care and the development of alternative energy sources on a large scale both have to be part of the administration’s core economic agenda, with all of the political urgency that implies. Otherwise – and here’s a scary thought – most Americans may fare no better economically under President Obama than they did under his failed predecessor.

There are still a few cards left to play for the shorter-term. The most important jobs measure in the February stimulus was assistance to the states (and through them, to localities), so their own budget squeezes didn’t force them to lay off so many teachers, police, and other public employees. Their budget constraints are still growing worse – an important part, because unemployment is still rising. The most efficient way for Congress and the President to limit additional jobs losses in 2010, then, is to provide perhaps another $100 billion in assistance to the states.

The other measure now getting attention is a tax break for businesses that create new jobs, an idea the President promoted in his campaign but never made it into the stimulus. Here’s how it works: Businesses would receive a tax credit for the first year of payroll taxes on new employees or those moving from part-time to full-time, and a credit for half as much in the second year. It’s not very well targeted, since you end up subsidizing jobs that would have been created without any tax break. (Keep in mind, falling employment is a net result, with some businesses adding jobs and others cutting them.) But it is well focused on jobs, so long as we also include some conditions to claim it. For example, a new business should have to be in place for at least six months before qualifying, to head off scams where people close down existing firms, reopen them, and then use all their existing employees to claim a big tax benefit. And an employer’s total wage costs should have to rise, so people don’t just fire and rehire workers in order to qualify.

We tried a version of this tax break in the 1970s, and most economists who’ve looked at it believe it did some good. It should help again – but not nearly as much as it did last time, because the economy’s natural, job-creating dynamics are much weaker and more constrained under globalization than they were in the 1970s.

Beyond these two measures, the most important step for the administration is to set its political sights on the more difficult, long-term measures required to restore healthy and sustained job creation and wage gains – and to prepare the American people to wait a while for real results.