Carbon trading: a carbon tax, blindfolded and handcuffed, with its shoelaces tied together

Carbon trading it too easily gamed

Posted by Gar Lipow (Guest Contributor) at 10:26 AM on 04 Dec 2006

pickpockets

"Mommy, where do carbon offsets come from?"

"Well, you see sweetheart, when a major polluter and a consultant love money very, very much, they express that love in a special way. Nine months later, the consultant produces an extremely large paper packet."

In theory, carbon taxes and carbon trading yield similar results.(Carbon taxes raise the price of fossil fuels by taxing it. Permits raise the price of fossil fuels by requiring people to buy permits for each unit burned) So why do so many people who support carbon taxes oppose carbon trading? Because in practice they differ catastrophically, something we have good reasons to expect.

The real world record of carbon trading includes:

Extensive use of sequestration offsets.

This means you can claim to remove carbon from the atmosphere and sell the credit to allow someone to burn carbon elsewhere. What's wrong with this? After all, it does not matter to the atmosphere where the carbon reduction comes from.

While in principle there are many forms of carbon sequestration, in practice most carbon sequestration credits take two forms: carbon plantations and coal sequestration.

No one really know how much carbon is sequestered by planting cheap, fast-growing trees in carbon plantations. We do know that a great deal of it is absorbed by soil, which may release greenhouse gases as temperatures rise. We know that tilling such plantations releases old carbon imbedded in soil structure. We know that stable ecosystems upon which local inhabitants depend are often declared degraded lands and replaced by such carbon plantations. We know machinery, fertilizers, and pesticides for such plantations consume fossil fuel energy. We know carbon fixation rates vary tremendously within the same species of plant, depending on micro-climate, soil, pests, and other variables, so we don't know the difference between these plantations and whatever they displace. And we know carbon plantations are often victim of forest fires or other ways of ending plant lifespan -- including harvesting once credit for the sequestration has been sufficiently laundered. So not only is forestry based carbon sequestration highly uncertain, there is good reason to believe in many cases it is a net emitter.

Coal sequestration has a different problem; coal is the enemy of the human race even when "carbon neutral." Mountaintops are blown up to harvest coal, towns undermined. Coal mining and processing poisons lakes and streams, and the poisons released during burning acidify and putrefy rivers more.

Project-based credits in nations without national emission limits.

Since there is no objective baseline against which to measure emission reductions, the credit is granted based on a consultant's assertion that life without a certain investment will pollute more than life with it. The jargon for this is "additionality" -- saving more carbon than a business-as-usual scenario.

As you can imagine, this opens creative vistas. For example, a widely hated pig-iron manufacturer in Minas Gerais, Brazil, wants carbon credits for not switching from charcoal to coal.

Project-based credits subvert the entire advantage normally claimed for market means over regulation -- namely, feedback. How do you know a project will reduce emissions? Some bureaucrat evaluates the paperwork and says so. How do you know after the fact that the project has reduced emissions? Another bureaucrat evaluates the claim. At no point does a market provide micro-information, comparable to sales figures telling a store owner she has mispriced an item. Feedback comes through political means, or (as happened recently) through the collapse of the entire carbon market.

Project-based credits boast neither market-style feedback nor the standardization and economies of scale of a public works or true regulatory approach. It's the worst of both worlds.

Nor is it getting better. Until recently, Clean Development Mechanism (CDM) was the main form of project based credit, which is at least reviewed by a CDM Executive Board. However, Joint Implementation -- an alternative process applying mainly to former Soviet states -- will shortly be subject to direct approval by host countries. A national government can sign a piece of paper and watch its local industry get money from abroad.

Grandfathering.

Under this brand of folly, large polluters are granted a princely share of available permits at no cost! Even better, they are often granted more permits than required for their standard emissions, leaving them surplus permits to sell -- without needing to make a single emission cut.

Large-scale gaming.

Polluters find ways to manipulate permit markets to continue to burn fossil fuels rather than leave them in ground. Huge secondary and tertiary markets in permits -- middlemen, and middlemen's middlemen -- make this kind of gaming much simpler than it would be with a straightforward carbon tax system.

-----

I've had people use my own argument against carbon taxes in support of emissions trading. If carbon use does not respond well to price signals, isn't trading a reasonable alternative? At any rate, shouldn't we use both? But any argument against carbon taxes applies to emission trading as well. Tradable carbon permits are carbon taxes -- only blindfolded, handcuffed, and with their shoelaces tied together.

Since carbon taxes and emission trading are theoretically similar, a computer-based econometric simulation might predict similar results. But politically, gaming a carbon tax is more difficult.

Take "grandfathering." You could hand over a portion of carbon-tax revenue to major polluters, just as we currently gift them with carbon permits. But the outcry from a tax giveaway would be much greater. Electric utility customers who don't pay much attention when someone hands their power supplier something fuzzy and abstract like permits would have a different reaction on seeing billion-dollar cash grants. The obvious reaction would be: "Skip the middleman; give me my share directly."

Similarly, paying for phony project credits directly out of rich nation carbon-tax revenues would attract more rich world attention than when large corporations pay the bill (while actually benefiting from the fraud by gaining cheap carbon credits).

Note the objection is to carbon trading separate from trading in actual carbon. Carbon permits, auctioned off to carbon producers and importers, with the price built into subsequent trading in fossil fuels (along the lines of the Sky Trust proposal), is not something I would object to -- as a supplement to public works and regulation -- in the abstract. Now I spend time in the abstract myself; it is a beautiful place with breathtaking scenery. But none of us live there.

The world we live in includes politics. The opportunity to slip large corporate gifts into the system unnoticed, because there is no explicit cash cost, is overwhelming. (Look at how the McCain-Lieberman bill uses "Sky Trust" rhetoric to promulgate a Kyoto-style cap-and-trade system.) With carbon taxes, any giveaways are obvious and explicitly priced; permitting does not offer comparable transparency. Carbon taxes do not offer as many opportunities to use political judo, to turn your own strengths against the goal of limiting carbon emissions.

If you want to learn more about this subject, there are a couple of books online in PDF form I highly recommend:

Carbon Trading: a critical conversation on climate change, privatization, and power (large PDF), editor and main author Larry Lohman.

Trouble in the Air: Global Warming and the Privatised Atmosphere (very large PDF), edited by Patrick Bond and Rehana Dada.

Parts of this post were self-plagiarized from posts on the MaxSpeak Group Blog, from work in the following posts:
EMISSIONS TRADING AND CARBON TAXES
PROBLEMS WITH CARBON TRADING
CARBON OFFSETS - OFFSIDES

For story: Carbon trading: a carbon tax, blindfolded and handcuffed, with its shoelaces tied together
10 Comments | Post a Comment

Carbon trading is NOT a tax

Your article makes one very large presumption that is NOT correct: carbon trading is in fact not a tax at all. At a very basic level, the primary difference is that taxes are paid to the government and carbon emission offset costs are paid to parties trading on the market. In theory, if not also actuality, such a market-based system is significantly more efficient in an economic sense. In short, the trading system makes it cheaper to control emissions on both the level of the firm and the national economy.

Of course, since the overall limit of permits on an emissions trading market are usually limited by a government then it tends to be a hybrid system. However, the current US carbon trading system is voluntary and managed by an NGO, the Chicago Climate Exchange.

That said, your article tends to be a bit confrontational and yet you shift your target. Is it the bureaucrat or consultant who is guilty of the carbon footprint assessment? You mention both with your accusations.

Bottom line is that you critique the system but offer no alternative that would be better. This tends to imply that you raise issue with emissions regulation in general, not carbon trading in specific.

J. Pittman
Ecological Economist

by jinbman at 11:41 AM on 04 Dec 2006

Emissions regulation

>Bottom line is that you critique the system but offer no alternative that would be better.

Umm no - obviously you did not follow the link to my previous post on the subject.

The alternative I favor is regulation, public works combined with a carbon tax.

And emissions trading is considered by most economists to be very similar to carbon trading, when considered in the abstract. The "platonic form" without giveaways all the things I described is:

One or government body (or many via international treaty) decide on a limit on carbon emissions, to be reduced each year.

Carbon permits are required mainly (but not exclusively) for fossil fuels. To keep this post short I will focus on these. Permits are required for every unit of fossil fuel produced within the jurisdiction, or imported from those outside it without similar rules. Similarly imported goods produced outside the treaty area require permits for the best estimate of embedded carbon emission (carbon emitted to produce them).

These permits are auctioned off by an agency of the government or treaty organization. The price of these permits is then included in the price of the fossil fuel sold. Consumers pay the price of these permits both in the fuel and electricity they buy directly, and in added costs for consumer goods.

Thus they work almost identically to a carbon - in theory. The reality differs so much from this, that apparently there are carbon trading advocates who don't even realize that in theory carbon trading is a varation on Pigovian taxation.

by Gar Lipow at 12:39 PM on 04 Dec 2006

the problem

It seems like the problems you cite are all problems with implementation, rather than problems that are fundemental to the idea of a cap-and-trade system.

It is not surprising that there would be problems with a brand new market like carbon credits. It is, as you have noted, an open door invitation to corruption and giveaways. But this seems to be because it's a new and poorly defined system with little oversight. Similar levels of corruption are quite possible with any government program, including (and especially) direct regulation.

So, there are problems, and they have to be addressed. But I have to wonder if it would be more productive to address the problems that exist with the system currently being established, demand oversight and establish feedback mechanisms, than to simply declare all carbon trading to be fundementally bad. Are you sure that you're not throwing out the baby with the bathwater here?

by GreenEngineer at 4:00 PM on 04 Dec 2006

Babies and bathwaters

>Are you sure that you're not throwing out the baby with the bathwater here?

Yes - because the differences in practice between carbon trading and carbon taxes are really severe. And it is not as though we should expect carbon trading to work significantly better than carbon taxes.

As I said in the post on Carbon taxes - we can't depend upon "giving carbon a price" in any case. The primary means of reducing carbon emissions, of leaving fossil fuels in the ground has to be regulation and public works to jump start the infrastructure. "Giving carbon a price" is the final step, a way to refine the results and avoid micro-management. In that context the difference between a "perfect carbon tax" and a perfect "carbon trading system" would not be great. But carbon trading is more complex, less transparent - it is simply far more subject to political manipulation. Kyoto was not originally expected to include carbon trading. It was added to win the concurrence of the U.S. We in the U.S. never ratified the treaty, but in the meanwhile a huge number of stakeholders developed a self-interest in carbon markets. Emissions trading has been one of the great distractions within the treaty; it is probably one of the reason many Kyoto signatories won't meet their obligations.

by Gar Lipow at 5:48 PM on 04 Dec 2006

problems with carbon tax too

i prefer a carbon tax to an trading system, however, the carbon tax does offer its own set of problems, and weaknesses not present in a trading system.

primarly, a carbon tax is easily repealable. sure, you will have industries that benefit greatly from a carbon tax, and won't want to see it repealed, but you will have many more who suffer from it. you will winners and losers in a trading scheme as well, but what you won't have is such a wide distribution of stakeholders. carbon trading permits represents property in carbon emission, and these permits could be bought and sold by anyone. this is america--"property rights" are sacred. furthermore, if the trading scheme is set-up to return dividends to the general populace, you have about 300 million stakeholders who have property rights in the carbon sink (ie:our atmosphere), who might object to a repeal of the system.

you could approximate the latter example with a payroll tax refund, but taxes are manipulated much easier than private--or even commonly held--property.

just some thoughts...

by pecan tower at 6:56 PM on 04 Dec 2006

Problems with a carbon tax too:

> if the trading scheme is set-up to return dividends to the general populace, you have about 300 million stakeholders who have property rights in the carbon sink (ie:our atmosphere), who might object to a repeal of the system.

>you could approximate the latter example with a payroll tax refund, but taxes are manipulated much easier than private--or even commonly held--property.

The problems with a carbon tax are real. I went into some detail on the fundamental problems that apply BOTH to a carbon tax and carbon trading in a past post.

However your particular objection can be gotten around easily. Implement the sky trust with a carbon tax instead of permit auctioning. That is tax carbon, and distribute the revenue evenly to every citizen. As the Alaska pipeline dividend shows, it is almost impossible to pry that away from people once they get it. Annual checks are popular and held onto as property whether they are called property or not.

by Gar Lipow at 7:58 PM on 04 Dec 2006
[ Parent ]

not my objection

it's not really my objection, it was just a note that things aren't necessarily so rosy on the other side of the fence. like i said, domestically, i prefer a carbon tax, ideally with a citizens dividend, but a payroll tax reduction would suffice. it's really an accident of history that Alaska wound up with the Permanent Fund, and while I wouldn't completely rule out a Sky Trust CD, I just don't know how well that kind of politics will play.

my personally favorite idea is Stirling Newberry's (over at TPM), which combines a Tobin Tax on currency transactions based on CO2 production per PPP/GDP, basically--the more a country emits/sells/produces CO2, the more expensive it is to exchange that country's currency--with a global market of carbon credits.

here's most of the excerpt, or read the whole thing:

----------------------
The sane solution is going to require that America bite the bullet and tax, both its own rich, and the dollar holders of other nations. This will not be accomplished by a single policy, because no one taxing step is large enough. This isn't really a new idea - after all, the internet boom was a kind of tax on those who held older assets - buy Amazon.com, or be left behind. A new economy boom in sustainable energy and social technology is one part, but so too, among other policies, will be a Pigou-Tobin tax.

...

However, the real power of this idea is to combine them - in effect, to tax a country for its externalization, by making it more expensive to do business in that currency. The tax could be structured through the IMF and WorldBank and the WTO, with tariffs being levied, or charges imposed, on transactions on the global forex markets based on the CO2 produced per unit of Purchasing Power Parity GDP.

The object to be taxed would be carbon. In effect, make emitted carbon dioxide a "reverse gold standard" - the more you put out, either directly or indirectly in the form of selling carbon based energy - the higher the tax is paid to enter or leave the currency. Countries could be given the option to spend a tranche of their tax charges on reducing carbon in their own country. In effect, "you fix it, or we will". Combined with a global market in carbon credits - countries still in a protected phase could buy carbon from those trying to trade and grow, and then attract investment to reduce carbon - it would mean that the global monetary system would be based on reducing Carbon Dioxide per unit of PPP.

Poor nations could opt out against each other - which since poor nations don't generate much - and nations would have an incentive to generate internal GDP, since this would "dilute" the cost of the tax. China and Saudi Arabia would feel the burn immediately. So would the United States and Canada. However, all four would have options. The Saudis could spend more at home, the Chinese could retire polluting technology and grow their economy, and the United States and Canada could invest in non-carbon energy.
----------------------

treaties are even harder to get out of than property rights.

by pecan tower at 12:06 AM on 05 Dec 2006

I said it was a Scam.

It is crazy to attempt to create a tax/trading system based upon something that it is virtually impossible to quantify. The politicians are avid for this because they can use it as a milch cow.
Tax something that can be seen - that digusting Lincoln Navigator and its ilk would be a good start.
Give people grants or tax credits for taking up clean options - solar or wind.
I realise that the huge distances travel involves in your country require vehicles but surely they can be smaller and more efficient.
In Britain there is a lunatic who wants to spend 25bn on a replacement for Trident, the same ass who raves about global warming. Think how much of a clean up 25bn would buy.
Very large amounts of cash are going to be required to assist displaced people - though, of
course, you could buy a lot of bullets to keep them at bay.
Incidentally, some of us find that Lincoln ad
blasphemous.

by Cennad at 10:23 AM on 05 Dec 2006

common misconceptions

Emissions trading and Pigovian tax systems are two different things. In the case of the tax, the revenue is levied at a fixed rate and received by a governmental agency and distributed in a way that provides equal benefit for all. Emissions trading systems provide revenue directly to those parties who are reducing emissions and are subject to price fluctuations.

What precisely do you mean by regulation that includes "public works"? This is quite vague and I am not sure that language has the meaning that you intend.

Carbon trading IS a form of emissions trading so they are quite specifically the same thing, not just considered to be so.

While emission credits are sometimes auctioned off at the launch of a trading system, they are then exchanged for payment between parties in the market or retired by other parties. It is not accurate to suggest that the only way to obtain a permit is to purchase it from a governmental agency.

by jinbman at 3:24 AM on 06 Dec 2006

Forget carbon trading or taxes.

Just give a tax credit to every consumer who buys into this solution.

http://amazngdrx.blogharbor.com/blog/_archives/2006/12/6/...

Fund it by cutting corporate welfare to fossil and nuclear power corporations. The payback for consumers will be daily, weekly, and monthly, in lower gasoline bills and lower energy bills. And in a few short years every electric fuel cell car owner will be a tiny power company.

http://amazngdrx.blogharbor.com/blog John Schneider, Northern Wisconsin

by amazingdrx at 9:12 AM on 06 Dec 2006

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