Carbon taxes v. cap-and-trade

Among advocates of carbon pricing, there is a long-running disagreement about whether a carbon tax or a cap-and-trade system is preferable. Among economists and environmentalists, there is generally a preference for a carbon tax. Politicians terrified of the electoral implications of creating a new ‘tax’ tend to favour cap-and-trade schemes (partly, because it is easy to give away permits to influential industries under such a scheme).

Economists frequently argue that the trade-off is between price and emissions certainty. With a tax, you know exactly how much more any particular carbon-intensive activity will cost, making planning easier. With a hard cap, you know exactly what your emissions will be. With a tax, you can try to tweak the level to get the emissions volume you want, but you can never be entirely sure. Conversely, a cap assures the emissions outcome selected, but does so at a cost that cannot be known in advance.

A recent letter to The Economist does a good job of laying out some of the advantages of a cap-and-trade approach, arguing that economists and environmentalists have been too eager in throwing their support behind a tax:

First, a “one size fits all” tax requires an impossible calculation of the average cost of reducing emissions over a given period of time. Compare this with an emissions-trading system that works on the free-floating marginal cost of abating emissions. Second, carbon taxes would be levied locally and so impossible to properly administer on a global scale. A global carbon-market price is perfectly pervasive. And third, taxation cannot guarantee a reduction in greenhouse-gas emissions; emitters could opt to pay the tax and continue emitting at will. Conversely, a cap-and-trade solution introduces a carbon ceiling and the price acts as no more than a useful barometer of how close we are to achieving that goal; prices will tend to zero as the requisite level of emission reductions is achieved.

Personally, I think the choice of instrument is less important than the level of genuine political will, reflected in the care taken in regulatory design. Either approach can be set up in a dodgy way, intended to produce the impression of action without actually constraining carbon emissions effectively. A well-designed tax is better than a cap-and-trade system full of giveaways and dodgy offsets. A well-designed cap-and-trade scheme is better than a tax that is too low to be effective, or one where exemptions and rebates undermine the incentive effect. Those concerned about climate change should be willing to support either policy approach, while being energetic in ensuring that the system that is ultimately designed is a fair and effective one where polluters pay for the cost of their damaging activities and the long path to carbon neutrality is started upon.

Author: Milan

In the spring of 2005, I graduated from the University of British Columbia with a degree in International Relations and a general focus in the area of environmental politics. In the fall of 2005, I began reading for an M.Phil in IR at Wadham College, Oxford. Outside school, I am very interested in photography, writing, and the outdoors. I am writing this blog to keep in touch with friends and family around the world, provide a more personal view of graduate student life in Oxford, and pass on some lessons I've learned here.

58 thoughts on “Carbon taxes v. cap-and-trade”

  1. Were those tracks on an active line? Walking along tracks is an easy way to lose your life and an especially bad thing to let children think is okay.

  2. Well I don’t really know the answer. I looked into the cost of flying to Illinois for an upcoming conference. The price ($$) doesn’t reflect the environmental damage. It needs to be seriously painful (in the pocketbook) to fly but it’s not.

  3. Some of the problem with cap and trade are outlined in this film:

    In short – the problems in cap and trade are perverse incentives to cheat, and the fact it gives away rights to pollute to those who already pollute.

    For cap and trade to be fair, the incentives need to be set up against cheating, and rights to pollute need to be distributed equally across the population.

  4. This should be a decision derived from the science of global warming models – not from wished-for economic stimulus systems.

    Until whatever legislative solution decides to monitor or link directly to CO2 levels, then it is just apple polishing, smoke and mirrors posturing.

    We are on the Titanic, and now arguing about what music the band should be playing.

  5. “We are on the Titanic, and now arguing about what music the band should be playing.”

    This is a bad analogy. We are not arguing about music, we are arguing about how to patch the hull. So, a better one might be:

    “We are now on the Titanic, and arguing about whether we should patch the hull in a way that hugely disadvantages the 3rd class passengers, or which takes a modest collection from 1st class passengers.”

  6. “This should be a decision derived from the science of global warming models – not from wished-for economic stimulus systems.”

    This is just insane. The global warming models are not economist’s models – and there is not a single kind of economist. Any solution to global warming is going to involve the economy, and any decision made is going to be the negation of some other decision. Emissions could be reduced by a switchover to a strict command economy (perhaps on the model of the US defence industrial complex, since it seems much more efficient than the former Soviet command economy). Since there are any number of solutions or non solutions, each one must be looked at in terms of who it costs and who it benefits.

  7. But what is the economic connection to climate?
    The human interface to climate is by reducing CO2 emissions. (sequestration does not exist yet)

    Until you define that mechanism, you are just playing with the economy, not the climate. I too, want the most vital and strong economy, but it means nothing if it is not going to change carbon emissions.

    So now all I hear are conjectures on what will work best, it has to be linked to real CO2 levels

  8. This should be a decision derived from the science of global warming models – not from wished-for economic stimulus systems.

    Science cannot tell us which target we should aim for, because the kind of world we want and the price we are willing to pay are not economic problems.

    Say it will cost $X to prevent total societal collapse from climate change. Is it worth five times as much to avoid a significant drop in life expectancy, or to save the polar bear, or to protect small island states from going underwater? The answers to these questions cannot come from climate science, no matter how finely developed it becomes.

    Carbon pricing does have a critical role to play in mitigation. It builds information about emissions into prices, which in turn affect consumer choices. By altering the relative costs of carbon-intensive and low-carbon products and activities, carbon pricing biases consumer choice towards the latter – driving people to do on account of self-interest what they should arguably be willing to do for ethical reasons.

    Until you define that mechanism, you are just playing with the economy, not the climate.

    The economy is the problem: transportation, agriculture, electricity generation, etc. Right now, all these things are done with no real consideration of the climatic impacts. The whole idea of a Pigovian tax is to align private and public interest: whether the aims are health related, environmental, or other.

  9. Oh this is such a great discussion… thank you.

    I have to refer you to a recent draft paper by Harvard economist Martin Weitzman. This is a disruptive paper, because he concludes that we need a full effort, not a minimal one. It is refreshing to see an economist’s viewpoint that is so ruthless. (It is an academic paper, spiced with formula that I skipped. But it has much plain language to get the argument) [did I first hear about this paper from your blog??]

    I see it as a giant actuarial problem. Lets look across a 20, 50 or 100 year view as a simple risk analysis; something simple like: “Identify the threat, Estimate value of the risk, Counter the risk, Manage it, and Repeat analysis.”

    This all may work to argue that the global economic depression is a response to seeing the unacceptable climate risk for the future. Unlike no other time in history, no one can be assured of a sufficiently stable future to permit any high-risk investment. So financial entities are retracting and defending against a grim uncertain future. No wonder that big finance is tight with cash.

    No wonder there is such political upset – the essential solution requires the complete shutdown of carbon capitalism – the biggest game in the casino. We are forced to invent and deploy non-carbon capitalism. The current economic malaise (disease?) reflects a pre-conscious perception of the problem. Almost as if everyone is dimly aware of of the need to change, but unsure just how.

    So now – without political leadership – and constantly sabotaged by the PR from the carbon fuel industry – we are forced to travel into the swamp of behavioral economics. Foreboding, unknown and endlessly fascinating.

  10. The economy is the problem

    This is both wrong and a dangerous thing to say.

    Only those who have the least invested in our current form of societal organization will ever embrace an anti-economy stance. The stance needs to be anti-carbon, and focused on developing a prosperous post-carbon economy. That way, you can take advantage of support for things like decreased dependence on imported fuel.

    Carbon pricing is about tweaking our capitalist political/economic structure in a way that (hopefully) avoids catastrophic climate change. If it is to succeed, at this stage in our political development, it cannot plausibly be an anti-economy, anti-job, hair shirt movement.

  11. In short – the problems in cap and trade are perverse incentives to cheat, and the fact it gives away rights to pollute to those who already pollute.

    None of that is inherent to the idea of cap-and-trade, and many environmentalists have been critical of this little animation for oversimplifying things and suggesting the whole approach is invalid, when all that is required is careful policy design.

    Grist has one piece and Sightline Daily goes through the errors line by line.

  12. This is both wrong and a dangerous thing to say.

    This returns us to a question frequently debated here: can a form of capitalism emerge that is compatible with climate stability?

    If so, your points about strategy stand. We do need to take advantage of the will to reform that exists, and avoid scoring needless goals against ourselves.

    If not, attempts to deal with the climate problem within a capitalist system will never succeed.

    This whole issue is partly simplified by just how urgent it is to get on the path to a zero-carbon global economy. If it does require the abandonment of capitalism, I very much doubt we will be able to avoid catastrophic climate change. Look how difficult it has been to produce even the most modest climate mitigation and carbon pricing policies. Wholesale societal reform is just not in the cards, and would not be guaranteed to solve the problem anyhow.

  13. Odd fact: the first example used to describe a Pigouvian tax related to rabbits:

    Corresponding to the above investments in which marginal private net product falls short of marginal social net product, there are a number of others, in which, owing to the technical difficulty of enforcing compensation for incidental disservices, marginal private net product is greater than marginal social net product. Thus, incidental uncharged disservices are rendered to third parties when the game-preserving activities of one occupier involve the overrunning of a neighbouring occupier’s land by rabbits—unless, indeed, the two occupiers stand in the relation of landlord and tenant, so that compensation is given in an adjustment of the rent…

    All I can say is: bad as rabbits may be, climate change is even worse.

  14. “when all that is required is careful policy design.”

    There is a good chance careful policy design is not possible in our corrupt world.

  15. It is once things obviously become important. We wouldn’t put up with this kind of incompetence in other areas of policy-making.

    The big challenge with climate is that you need to act on anticipation of problems, not once they are bloody obvious and voters are outside your parliamentary offices with torches and pitchforks.

    (Indeed, enacting the kind of carefully designed policies we need poses a greater risk of producing such mobs, though many of their economic fears are narrow-sighted or unjustified.)

  16. The people making the policies have different interests than the ones affected. Climate change mostly hurts poor people. Therefore, there is always an incentive to claim you will limit climate change to some level which would be good for poor people, and then let emissions slide to a higher level.

  17. “though many of their economic fears are narrow-sighted or unjustified.”

    Even Krugman’s mentioned the fact US debt is in own-currency is the ultimate safeguard. Hyper inflation is not an imaginary danger. The growth in American debt as a portion of GDP means that if it is not stabilized, there will be last gasps either of nationalization of assets or monetization of debt.

  18. Inflation is an independent issue. I was making reference to the dire predictions of people who claim a carbon price would instantly ruin the economy and throw everyone out of work.

    As for climate change mostly harming poor people, we don’t have any way to project that with certainty. The poor are probably more likely to be thrown into extreme poverty, but the total losses associated with things like sea rise of over one metre could be massive in rich states. Just imagine large segments of cities like New York and London underwater or regularly flooded by tidal surges.

    If we ever find things at that stage, you can be sure people will be asking why carbon pricing wasn’t introduced back in the 1990s, as it was in some Scandinavian states.

  19. Of course it is terrorism, because it uses the emotion of fear and the payload is violent or toward destructive ends.

    A related question is whether it is treason. It is perhaps unintentional, but the short term gain from using carbon will doom us all And once the science is accepted, then the blame is inescapable.

    The work now will be on making people forget and ignore.

  20. It is definitely not terrorism.

    Greenhouse gas emissions are always caused by people trying to do something other than warm the planet. The harm that will eventually arise is the product of immoral indifference to the suffering of others, not a calculated effort to cause harm to civilians. Also, there is no sense in which the damage climate change will cause is intended to advance a political agenda, or create terror in anyone.

    We are already excessively willing to label things ‘terrorism.’ That is an abuse of language that should end. Terrorism should not be our preferred word for criticizing anything we dislike; nor should it be the only thing we are willing to fight.

  21. The word “Fact” is sure getting thrown around a lot. I wonder if anyone has thought about what it means. Dawkins doesn’t seem to get it – he seems to think it’s just something we’re very certain about. I’ll write about this in a future blog post.

  22. Is this latest comment on the right post? It doesn’t seem like a logical extension of the discussion.

  23. uh….

    “Just as the national academy of science has endorsed the science of global warming, cap and trade is supported by people and organizations who have been fighting for our environment for decades”

    What? What is the analogy here? On the one side we have an organization whose goal is to be disinterested. And on the other, we have groups with (admittedly largely good) personal and social interests.

    Seriously, this film isn’t much more convincing than the one I posted. His conclusion about how “nothing is easy in Washington”, and of large protests, is slightly ironic – most of the bills he mentioned had massive public support (civil rights? social security? – what about the politically impossible yet overwhelmingly popular public option for health care?), but were opposed by significant portions of the elite. He seems to be under the delusion that America is some kind of democracy. I love how crises are used as unending excuses not to fix the democratic deficit in states. No wait, I don’t love that…

  24. The film is called the “Facts” of cap and trade? I think the meaning of the words in the title of the film you referred to are fair topics of discussion. Especially when they are being mobilized as polemics.

  25. No. I see the terrorism in pandering to the fear of “losing jobs” and losing our standard of living. Fear of losing to the Chinese, of losing technical advantage. Of course it is not the fear of global warming, it is the fear of losing our carbon comforts …denialists are promoting the fear of big government, fear of authoritarian control of actions, fear of freedom (to pollute). These are threats. And I heard them plainly spoken in the coal debates of Blankenship v Kennedy just last week.

    The stakes are higher than any one terrorist act. But because they use fear instead of terror, is no reason to excuse it. But the practical outcome is of this action is harmful. That is why I have to call it terror.

    The ONLY use of carbon fuels should be to construct and deploy clean energy. All other uses are directly harmful to our future You and I can enjoy them, and temporarily forget that we are harming the future with these emissions, but they are still harmful. And encouraging us to forget, overlook and delay is a fairly direct cause of greater problems in the future.

    When an oil company encourages people to combust carbon and emit CO2 – what would you call that act? We do not allow tobacco to advertise to children (a very recent action in the US – and still permitted in much of the world.) Is a corporation permitted to promote behavior dangerous to the entire species?

  26. The line-by-line rebuttal that was linked previously is the most comprehensive response to that video.

    Of course a cap and trade system could be badly designed, including in ways that allow special interests to manipulate it. At the same time, a well designed cap-and-trade system could allow us to meet our precise greenhouse gas reduction targets, while reducing the cost of compliance by encouraging those who can cut emissions most cheaply to do so first.

    Given how much the odds of seeing a climate bill in the US have faded, the last thing we need is environmentalists deploying bogus arguments against cap-and-trade.

  27. I’ll go through some of this “line by line” refutation.

    “Deception. A trading market is not a bubble. There are trading markets for US Treasuries, soybean futures, municipal bonds, and stocks in Coca-Cola to name just a very few things that are traded. (Oh, and carbon permits, I almost forgot.) None of these things are bubbles.”

    The US treasury market is not a bubble? Sure…

    ” The trading doesn’t affect the cap. At all. Not even a little.”

    It might not affect the ideal cap, except it does affect the actual Co2 released whenever it sets up incentives to falsely report non-increases in your own firms Co2 production. Or, just plain lying. Of course trading creates incentives to cheat – that’s true in every market.

    “”Instead of just giving permits away to polluters, we could sell them and use the money to:

    build a clean energy economy
    or give citizens a dividend to help pay for higher fuel prices while we transition to that clean energy economy
    or share it with those who are most harmed by climate change. Some people call this paying our ecological debt”
    Deception. The implication here is that existing cap-and-trade proposals won’t do these things. In fact, they will — at least partially.”

    Sure – the capitalists will build it. But the alternative if public ownership of energy production. And, since it’s illegal for corporations to act in the public good for its own sake, and since public ownership of energy production has worked well in B.C. and Quebec, one might think about nationalization as a real alternative if one isn’t a hack.

    “Confusion. Letting the EPA cap carbon should be a last resort. Enacting a cap based on regulatory fiat is almost sure to be the more expensive and unfair way to do it. Command and control regulation would create arbitrary winners and losers, raise prices for consumers, and lack mechanisms to address equity concerns.”

    What is “unfair” about charging corporations for their negative externalities? It might not be efficient, but it’s sure as hell “fair”.

    “Deception. Cap and trade would, in effect, put a price on fossil fuels, thereby reducing their net subsidies. It also provides a revenue stream that can be directed toward subsidizing renewable energy.”

    Ya – let’s reduce the net subsidy of oil production! What? Net subsidy?

    In general this refutation is pretty convincing. But, like any polemic, it goes too far in various places – and mistakes the “practically achievable” for the “sane”. It’s not nearly hard enough on the status quo to help produce the public outcry needed to solve global warming fairly.

  28. Bad-mouthing cap-and-trade in the United States is just about the worst possible use of your time, if you believe that more needs to be done to reduce greenhouse gas emissions.

    If anything, you should be working hard to rebut the notion that a carbon pricing system would destroy jobs, while highlighting how it would eventually help build an energy system not dependent on imports.

  29. There are lots of ways to get carbon trading wrong: there have been problems with the EUs system, they can be made overly complex in a way that aides exploitation, new entrants can be treated in overly lax or unfair ways, and trace gasses and black carbon may not be appropriate to mess together with CO2.

    Arguably, it is also problematic to merge social with environmental policy or reward environmentally beneficial actions taken for other reasons.

    All that said, the sooner there is a price for carbon, the sooner the simplest and cheapest mitigation options will be taken advantage of. Every month we waste adds to the eventual bill for reaching carbon neutrality.

  30. It’s not problematic to merge social with environmental policy. “Social policy” just means justice – and it’s absurd to think any policy can be considered in the abstraction of justice. It’s problematic to affirm the status quo in a world where most world leaders would be executed if they held the standards they hold to others to themselves as well.

  31. What I am talking about in that post is whether carbon pricing and income redistribution should be explicitly combined. In the end, I think not. A hybrid policy has muddled objectives and seems harder to design and justify.

  32. Given the current state of American politics, it just doesn’t seem possible for a well-designed climate change policy to make it through the Senate in one go.

    I think we probably need to accept a flawed bill in the style of Waxman-Markey, then try to strengthen it later. There are many such precedents in environmental legislation, from the US Clean Air Act to the Montreal Protocol on CFCs.

    Once industry is forced to move a bit, it becomes clear that the regulations won’t destroy them, as they originally claimed. It then becomes possible to tighten them.

    Incidentally, to give a sense of what sort of carbon pricing scheme I think would be ideal, I wrote a post on the subject.

  33. Even a deeply flawed cap-and-trade system may not be politically impossible in the US.

    What a massive disappointment, after all the excitement of the Obama victory. It seems like the US Congress is basically going to ignore the most important moral and political issue of our time, at least until some future year when it has become far more painful and costly to address.

    In a few decades, people are going to be bewildered about how we could have responded so stupidly, even after the science had become so clear.

  34. Which makes it both perplexing and frustrating that Mr. Gore’s response to cap-and-trade’s manifest failure is to repeat not only his endorsement of cap-and-trade before Congress last year, but his latter-day criticism of a carbon tax:

    “[T]here is no readily apparent alternative [to cap-and-trade] that would be any easier politically. It is difficult to imagine a globally harmonized carbon tax.”

    This is dreadfully wrong, both substantively and politically.

    Mr. Gore’s substantive error lies in presuming that a cap-based approach could be harmonized globally. Perhaps this is a legacy of his having championed cap-and-trade in the 1997 negotiations that produced the Kyoto Protocol. Yet now, as then, there are no clear grounds for translating a possible U.S. cap on carbon emissions into limits for other countries. Per capita, Americans generate 4 times as much greenhouse gases as Chinese and 14 times as much as Indians. Why, then, should a U.S. commitment to reduce emissions by, say, 2 percent a year, carry any moral authority in China or India? Indeed, India’s per capita emissions could increase by 2 percent a year for more than 60 years and still not match U.S. emissions declining at the same rate.

    A carbon tax, in contrast, is wholly fungible across borders. A fee that raises the price of coal or natural gas by so much in one country will do the same in another. If one country is more efficient in turning energy into goods and services, or enjoys a greater abundance of carbon-free water- or wind-power, then that is an incentive to other nations to step up their efforts and achieve parity. A carbon tax thus creates no unfair comparative advantage. While these facts can’t guarantee global harmonization of a carbon tax, they provide a strong basis for it.

    Politically, Mr. Gore’s dogged support of cap-and-trade sounds tone-deaf. The financial crisis hasn’t merely shaken the world’s confidence in market-based solutions; it has provoked a profound revulsion among Americans against financial speculation, market manipulation and legislative complexity. Yet all of these are intrinsic to cap-and-trade systems built on trillion-dollar markets in volatile emission permits. It is this political reaction, even more than media-driven denial of climate science, that has turned Congress against cap-and-trade. Mr. Gore underestimates its staying power at his own risk.

    There is an alternative to both cap-and-trade and inaction, and it is the very instrument that Al Gore bravely backed for almost two decades: a carbon tax. This is not a market-based approach to be administered by Wall Street insiders, but an incentives-based one applied to all fossil fuels by the U.S. Government. With the revenues redistributed to Americans as monthly carbon checks and the tax rebranded as a carbon fee—as proposed by Mr. Gore’s climate mentor, climatologist James Hansen—a carbon “fee-and-dividend” would be everything cap-and-trade cannot: simple, transparent, effective and, above all, equitable.

    With fee-and-dividend, a majority of us would get back in dividends more than we would pay in the tax, and all Americans would have equal incentives to transition to low-carbon ways of life. Industry would have what it needs to steer the transition: clear, unmistakable price signals to drive investment from dirty coal and imported oil to clean energy and green jobs.

  35. Climate-change politics
    Cap-and-trade’s last hurrah
    The decline of a once wildly popular idea

    Mar 18th 2010 | From The Economist print edition

    IN THE 1990s cap-and-trade—the idea of reducing carbon-dioxide emissions by auctioning off a set number of pollution permits, which could then be traded in a market—was the darling of the green policy circuit. A similar approach to sulphur dioxide emissions, introduced under the 1990 Clean Air Act, was credited with having helped solve acid-rain problems quickly and cheaply. And its great advantage was that it hardly looked like a tax at all, though it would bring in a lot of money.

    The cap-and-trade provision expected in the climate legislation that Senators John Kerry, Joe Lieberman and Lindsey Graham have been working on, which may be unveiled shortly, will be a poor shadow of that once alluring idea. Cap-and-trade will not be the centrepiece of the legislation (as it was of last year’s House climate bill, Waxman-Markey), but is instead likely to apply only to electrical utilities, at least for the time being. Transport fuels will probably be approached with some sort of tax or fee; industrial emissions will be tackled with regulation and possibly, later on, carbon trading. The hope will be to cobble together cuts in emissions similar in scope to those foreseen under the House bill, in which the vast majority of domestic cuts in emissions came from utilities.

    This composite approach is necessary because the charms of economy-wide cap-and-trade have faded badly. The ability to raise money from industry is not so attractive in a downturn. Market mechanisms have lost their appeal as a result of the financial crisis. More generally, climate is not something the public seems to feel strongly about at the moment, in part because of that recession, in part perhaps because they have worries about the science (see article), in part, it appears, because the winter has been a snowy one.

    The public is, though, quite keen on new initiatives on energy, which any Senate bill will shower with incentives and subsidies whether the energy in question be renewable, nuclear, pumped out from beneath the seabed or still confined to research laboratories. So the bill will need to raise money, which is why cap-and-trade is likely to remain for the utilities, and revenues will be raised from transport fuels. A complex way of doing this, called a linked fee, would tie the revenues to the value of carbon in the utility market; a straightforward carbon tax may actually have a better chance of passing.

  36. “The discussion is very similar to that for climate policy. Here is Robert Stavins musing on the (possibly exaggerated) death of cap-and-trade:

    “[T]he most important factor — by far — which led to the change from politically correct to politically anathema was the simple fact that cap-and-trade was the approach that was receiving the most serious consideration, indeed the approach that had been passed by one of the houses of Congress. This brought not only great scrutiny of the approach, but — more important — it meant that all of the hostility to action on climate change, mainly but not exclusively from Republicans and coal-state Democrats, was targeted at the policy du jour — cap-and-trade.

    The same fate would have befallen any front-running climate policy.

    Does anyone really believe that if a carbon tax had been the major policy being considered in the House and Senate that it would have received a more favorable rating from climate-action skeptics on the right? If there’s any doubt about that, take note that Republicans in the Congress were unified and successful in demonizing cap-and-trade as “cap-and-tax.””

    Cap-and-trade became unpopular because it was being targeted by interests opposed to its enaction, and it became a target because its passage seemed feasible. But it was also an easier target because of the many complicating side-deals and special arrangements made to the regime, which were precisely the things allowing its passage to become feasible. A growing chorus of cap-and-trade critics railed against the allowances granted to industry groups and argued in favour of a “simple” carbon tax. But of course any carbon tax would face opposition from affected interest groups until their demands were met, in the form of side-deals and special arrangements. A passable carbon tax would be an extremely complicated carbon tax.”

  37. “For instance, as Mr Stavins has pointed out before, a properly designed cap-and-trade system will limit carbon emissions efficiently regardless of how carbon allowances are allocated. A carbon tax will not. Mr Mankiw derides cap-and-trade as a carbon tax plus corporate welfare, but he seems to miss that its properties make cap-and-trade more passable, and more effective despite the inevitable Congressional tinkering and weakening.

    It’s worth thinking about this in light of the ongoing debate on financial reform. Economists have debated, at length, which policies are most likely to reduce the problem of too-big-to-fail and which will do most to boost the resiliency of the system. But they should ask two things of every policy they consider: how will industry lobbying influence the structure of the bill, and how will industry lobbying influence the enforcement of the law. You can see these questions getting an increased level of attention among pundits, but it would be helpful to develop a more rigorous approach to them—to model and test the resiliency of policy solutions. After all, it’s not like the political process is going to be going away any time soon.”

  38. Some more thoughts on a carbon tax

    Jun 18th 2010, 5:57 by T.C. | LONDON

    THIS week, in advance of its “emergency budget” on June 22nd, we wrote about how Britain might close its deficit, which currently stands at 11.1% of GDP. One idea we advocated was a carbon tax. We commissioned some modeling on the subject from Cambridge Econometrics (who have a model specifically designed for this sort of thing). I wrote up the headline results in a small piece to accompany the main article, but space constraints prevented me going into too much detail. Happily, space constraints don’t apply on the web.

    The Economist has long advocated a carbon tax as the best way to deal with climate change. Carbon taxes are a subspecies of Pigovian tax; taxes that are designed primarily to change behaviour rather than to raise revenue. The idea is to try to manipulate the price of a good or a service in order to capture all the negative externalities it imposes. Pollution is the standard example: neither the owner of a factory nor the buyer of its goods, for example, care very much that the local river is being filled with nasty chemicals as a byproduct of the factory’s work. Those who live by the river do care, but, not being party to the transaction, there isn’t much they can do about it. The uncompensated costs imposed on locals by the factory-owner’s activities represent a market failure. In theory the government would step in and impose a tax on the factory owner designed to compensate the locals for the damage caused by his actions (in the jargon, the government would make sure the private cost of producing the goods was equal to the social cost).

    It’s the sort of dry, neat idea that appeals to professional economists, but there are reasons for advocating carbon taxes in the real world, too. Having one, unchanging price for carbon offers certainty to businesses and the public (unlike cap-and-trade schemes such as the EUETS, which has seen big price fluctuations), an important benefit to industries like power generation, which produces a lot of greenhouse gases and which must be confident that an expensive new power station will stay profitable for several years. And yes, before you rush to the comment button, there are important downsides, too. I’ll explore some of those below.

    With all that in mind, we investigated two different basic scenarios. One applied an economy-wide carbon tax that aimed to raise 1% of GDP in revenue by 2020; the other applied a tax set at a level designed to ensure that Britain meets its commitment to cut emissions by 34%, relative to their 1990 levels, by 2020. In both cases, to keep things simple, we scrapped all the other policies that aim at the same outcome, such as Britain’s membership of Europe’s emissions-trading scheme, subsidies for renewable energy and so on. The results of the first scenario are set out in the print piece, but briefly, electricity prices fall as expensive subsidies for renewable energy are replaced by the carbon tax. That provides an economic boost, the government gets an extra revenue stream, and output is 2.5% higher come 2020 than in the baseline scenario. Somewhat embarassingly, emissions of carbon are slightly higher than in the baseline scenario. But we chose 1% of GDP as our target figure for convenience more than anything else. There’s no reason the tax couldn’t be tweaked a little to reduce emissions, although a high enough tax would presumably start to drag GDP back down again. At any rate, the modeling strongly suggests that a tax would be much more efficient than the present arrangements.

  39. I prefer a carbon tax. At least with government, there is the potential to do something good with the money, such as investments in universities researching clean energy alternatives. Or invest in social programs. Or be given back as a rebate to citizens.

    Otherwise, something as grossly under-regulated as cap-and-trade (especially something watered down enough to be passed into law) will be the target of speculators who will find ways to exploit something designed as environmental policy into unethical financial gain.

    Free market solutions aren’t always better. Just adding my two cents.

  40. A cap-and-trade system can be well designed. For instance, such an approach could be used to limit fossil fuel imports and production.

    You could also have a hybrid system, where fossil fuel imports and production are limited by auctioning permits. That would cover the inevitable CO2 production from burning the fuels. There could then be a tax on supplemental planet-warming activities, such as fugitive emissions of methane and the production of black carbon.

    In the end, if there is strong political will, all sorts of instruments could be made to work.

  41. SIR – When reporting on the latest recommendations on climate-change financing you wrote that some of the possibilities are “mutually exclusive: a cap-and-trade system is an alternative to a carbon tax, for example” (“Green backing”, October 30th). It is true that upstream cap-and-trade, the type that was under consideration in the United States, leaves relatively little room for a carbon tax. In America 80% of greenhouse-gas emissions were expected to fall within the cap-and-trade scope. But other schemes cover only around 50% of emissions. In those cases a carbon tax can and should be implemented to limit diffuse emissions.

    Guillaume Bouculat

  42. Two years ago, if you’d asked me what I thought about something like cap and trade, or a carbon tax, I would have said that they were interesting ideas, but probably not worth the trouble of fighting for. I didn’t think a price on carbon was necessary and, in fact, I was worried it could do more harm than good.

    Doing the research for my book, Before the Lights Go Out, changed my perspective. There are risks to any mechanism you use to put a price on carbon (there are risks to everything we do), and it’s still not something we could institute easily (thanks, politics!), but I’ve come to think that this one thing could be the easiest method to change the way we make and use energy. Energy—and more importantly, reducing fossil fuel use—isn’t intuitive. It’s often hard to see how we’re using fossil fuels, and make decisions about how to use less of them. A price on carbon, however you do it, takes some of the guesswork out of that. Instead of having to become some kind of Super Green Living Expert, all you have to do is do what’s cheapest.

  43. ON Sunday, the best climate policy in the world got even better: British Columbia’s carbon tax — a tax on the carbon content of all fossil fuels burned in the province — increased from $25 to $30 per metric ton of carbon dioxide, making it more expensive to pollute.

    This was good news not only for the environment but for nearly everyone who pays taxes in British Columbia, because the carbon tax is used to reduce taxes for individuals and businesses. Thanks to this tax swap, British Columbia has lowered its corporate income tax rate to 10 percent from 12 percent, a rate that is among the lowest in the Group of 8 wealthy nations. Personal income taxes for people earning less than $119,000 per year are now the lowest in Canada, and there are targeted rebates for low-income and rural households.

    The only bad news is that this is the last increase scheduled in British Columbia. In our view, the reason is simple: the province is waiting for the rest of North America to catch up so that its tax system will not become unbalanced or put energy-intensive industries at a competitive disadvantage.

    The United States should jump at the chance to adopt a similar revenue-neutral tax swap. It’s an opportunity to reduce existing taxes, clean up the environment and increase personal freedom and energy security.

    A carbon tax makes sense whether you are a Republican or a Democrat, a climate change skeptic or a believer, a conservative or a conservationist (or both). We can move past the partisan fireworks over global warming by turning British Columbia’s carbon tax into a made-in-America solution.

  44. The country certainly needs more generating capacity, especially of the low-carbon kind. But it is going the wrong way about encouraging it. Specifying how much power is to be generated from nuclear and from each form of renewable power means picking winners—something that governments generally do badly. Offshore wind and nuclear, the government’s favoured technologies, are among the most expensive ways to get carbon out of the energy system. And all political promises to guarantee energy prices are notoriously unreliable and unlikely to spark investor confidence. In 2011 Germany suddenly decided to shut its nuclear power stations.

    Rather than interfere with and second-guess the market, the government should strengthen it. For investors to view the electricity-generating business with enthusiasm, they must be able to find out what the real price of electricity is. At present that is impossible, because most electricity in Britain is “traded” between the generation and supply arms of the same firms. The government should have threatened to split them up (a gambit that worked wonders with British Telecom) and forced trading onto open exchanges, as happens in Germany.

    The best way to encourage green energy is to tax carbon. Australia took that brave step in 2011, admittedly with plenty of giveaways and exemptions for the early years. Under the European emissions-trading scheme carbon does have a price in Britain, but it is too low to be effective and is hard to increase. If Britain commits itself to unilateral action, the early price would still be low, but the government could promise to increase it over time. It is the price of carbon in 20 or 30 years, not now, that determines investment decisions. This move would encourage cleaner technologies but allow the market to choose which it favours and how much to pay. It is simple and more likely to endure than complex interventions.

    The energy business is changing fast. The price of solar power has fallen; the price of oil has soared. Shale gas is booming. Wave power, carbon-capture technologies and electricity storage could all prove revolutionary. All the more reason to let investors, not Mr Cameron, pick the winners.

  45. Parliament, as you may have heard, is back from its summer recess. Some late-breaking developments: The NDP would like to tax everything, and the Conservatives are big fat liars. No change, in other words.

    The cause of this latest exchange of pleasantries is the Conservative accusation, which I promise you are going to hear six times a day until doomsday, that the NDP would impose a tax on carbon emissions if it were elected — a carbon tax, for short, or as the Conservatives would prefer you call it, a “tax on everything.” Why this is thought to be such a telling line is a mystery. The income tax is the ultimate “tax on everything” — every single thing you buy is paid for out of after-tax dollars — yet when the Conservatives had a chance to cut it they cut the GST instead.

    Anyway, such is the toxicity of the “carbon tax” label after the Liberals’ experience with it in the 2008 election that the NDP leader, Tom Mulcair, was moved to respond in unusually choleric terms. “It’s very rare for me to use this word in politics,” he told the CBC — for normally he is the very soul of civility, as is well known — “but that is a bald-faced lie by the Conservatives.” He insisted Stephen Harper stop his MPs from “lying” about his plans for a carbon tax, which by the way he doesn’t have. Indeed, he said, it is an example of “the big lie” — just like, you know.

    As a matter of terminology, the NDP leader is correct. What the party proposes, and what Mulcair campaigned on in his run for leader, is not a carbon tax, collected from consumers and businesses in the same way as a sales or excise tax, but a system of tradable emissions permits known as “cap and trade.” The government would set both an overall limit on carbon emissions and the amount each business would be allowed to emit; those that could get by on less than their allotted quota would be permitted to sell what was left to others, allowing the latter to exceed their quota by the same amount. The burden of adjustment is thus borne by those who can do at least cost, meaning lower costs for society

    But while the two systems differ in how they are applied, in concept they are identical. A carbon tax raises the price of carbon, which has the effect of reducing its quantity. Cap-and-trade schemes reduce the quantity — which has the effect of raising its price. Either way, the quantity of carbon emitted is less, and the price is higher. As far as consumers are concerned, the result is the same. Indeed, as the economist Stephen Gordon has pointed out, assuming the initial allotment of emissions rights are auctioned, rather than handed out free, the revenue yield to the government is the same as well. (Otherwise, the difference in price is pocketed by the corporations.)

  46. Whether interventions are justified, Buchanan pointed out, depends on whether government officials are motivated by self-interest as well as a sense of public duty. Weighing up the pros and cons of policy choices requires an unsentimental view of government actions, a position he called “politics without romance”. In exploring this he helped create public-choice theory.

    Robert Stavins of Harvard University argues in favour of a cap-and-trade policy to limit carbon emissions over the simple carbon tax many economists prefer. His reasoning is that legislators will inevitably give sops to industry. Under a cap-and-trade system they do so by freely granting, rather than auctioning off, carbon permits to certain interests. But that does not alter the law’s emissions-reducing power. Granting exemptions on carbon taxes, by contrast, would weaken its environmental benefits.

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