The good and the bad

Why cap-and-trade is preferable to a carbon tax

Posted by Clark Williams-Derry (Guest Contributor) at 11:03 AM on 06 Dec 2007

Read more about: climate | energy | politics | carbon tax | carbon trading

The Washington Post ran an interesting op-ed in its Think Tank Town section last week, arguing for a carbon tax. The nut graph:

The only effective way to begin reducing greenhouse gas emissions and slow global climate change is to make it more expensive to emit carbon dioxide. Unless businesses and consumers pay a price for carbon dioxide, neither will make the investments in technology and changes in energy use needed to dramatically reduce emissions.

Rock on, Think Tankers. But that's just the start of the goodness. The authors -- two researchers from RAND Corporation -- also put forth a nifty idea about how to cushion the economic impacts of new taxes:

[A]ll the proceeds collected by the government would be returned to Americans each year when they file income taxes ...

A carbon dioxide tax with refund is fair because the people responsible for the most emissions would pay the most. The tax would also be progressive. Many Americans with lower incomes would find the refund would more than defray the higher costs of gasoline and electric power.

In short, they call for a per-head tax rebate, kind of like the Sky Trust idea. I looove the concept of the Sky Trust -- it deserves way more attention than it's getting. Ways to make climate policy genuinely fair for low-income folks seem to get short shrift in today's debate.

Still, while the piece does a good job of explaining the virtues of a carbon tax, I think it takes its critique of cap-and-trade too far.

Admittedly, as the authors point out, a tax is a lot easier to administer than a cap-and-trade system. With a tax, there's no auction, no grandfathering worries, and fewer wacky complications within the electricity sector. Taxes are just plain simpler -- and where climate policy is concerned, simplicity is a virtue.

Just so, a tax gives a better guarantee of price stability than cap-and-trade. There's no chance of a carbon "price shock" with a tax, nor of a collapse in carbon prices (as happened in the early stages of the European emissions trading system). And businesses love predictability -- without it, it's hard to plan investments. A cap-and-trade system has to be designed very carefully in order to reduce the chance of wild price swings -- something that a tax does by design. But what I don't like about this op-ed is that it seems to elevate the principle of price stability over effective climate protection.

For example, the authors stress the difficulty of setting the initial emissions limits right in a cap-and-trade system -- particularly, that an emissions limit that's too high or too low may send inconsistent price signals at the outset of the program. That's fair enough, I suppose.

But how is that any more worrisome than a system that sends consistent price signals, if it turns out later that those price signals were too low to be effective? It seems that the much greater risk, over the long haul, is a carbon tax that's never quite high enough to get the emissions reductions we need.

And that's where cap-and-trade really shines -- if done properly, it works like a self-adjusting tax, with the level of the tax always pitched just high enough to guarantee the next incremental emissions reduction. And if implemented through an upstream system with frequent and full auctioning of emissions allowances, a cap shouldn't be all that different from a carbon tax.

I'm willing to be proven wrong here. But it seems every bit as difficult to get the tax level right -- and keep it right -- as it is to get the initial emissions limit right. If we get the taxes too low, we'll need to continually generate the political will needed to adjust the tax rate upwards. And by the time that happens. North Americans may have emitted literally billions of tons of additional CO2.

I, for one, would be willing to accept a little bit of price fluctuation to prevent that from happening.

For story: The good and the bad
9 Comments | Post a Comment

Basically because

1. C&T you set the level you want to achieve, and the market figures out how to get there.
(Rather than the government figuring out an appropriate tax level, and then figuring out how to appropriately spend the income from the tax, and of course collect the tax. In many countries tax collection is a problem.)

2. You can readily set the cap levels appropriately between different nations, in a way that makes it so that less developed nations, or (Those nations with less historical emissions) aren't dinged as much. Which means that they would LIKE to get involved in this voluntary program, because it would be somewhat in this favor.)

-David Ahlport

by GreyFlcn at 11:11 AM on 06 Dec 2007

Integration

Another good thing about cap-and-trade systems is that they should be easier to integrate internationally. Regional systems can be amalgamated into national systems, while national systems can be linked into global systems.

That, in turn, will help limit the degree to which industry in one place or another can complain that their competitors overseas have the 'unfair' advantage of being able to pollute at no direct cost to themselves.

a sibilant intake of breath

by sindark at 11:18 AM on 06 Dec 2007

Consumer feel

I don't understand why a carbon tax couldn't be incrementally increased (remaining revenue neutral through increasing income tax reductions or rebates) over time similar to how the cap in a cap and trade would be incrementally lowered, which would seem to take care of any worries about it being set too low.

Change the world one lunch at a time. Find out how at www.pbjcampaign.org

by BernardBrown at 12:13 PM on 06 Dec 2007

The right focus

Clark,

Right on the money with focus on the need for certainty when it comes to climate policy.

What we know is how far we need to reduce emissions to have our best shot at stabilizing global temperatures; what we don't know is what price on carbon will drive emissions down that far. So we're faced with a choice: certainty of results, or certainty of costs.

If climate policy is going to be about the climate, the choice has to be results, and the best way to guarantee them is a cap. And with cap and trade, we can at least be certain about this when it comes to costs -- they will be as low as possible because companies can hunt for the cheapest reductions.

www.edf.org

by Tony Kreindler at 12:55 PM on 06 Dec 2007

Shape of the curve

The newly posted Grist article on the proposed San Francisco carbon tax has some interesting implications for this discussion. A few local carbon tax experiments could give us a feel for how businesses and individuals (in cases where individuals pay the tax) respond to a given level of carbon taxation and reduce that point of uncertainty in the comparison.

Change the world one lunch at a time. Find out how at www.pbjcampaign.org

by BernardBrown at 1:57 PM on 06 Dec 2007

Back to basics

The driving force is our belief that greenhouse gas emissions are altering the climate in a way that has a net harmful effect. We want to encourage people to make decisions that minimize this damage.

The most simple, direct and transparent way to do that is with a tax on emissions equal to the cost of the damage they do. This will encourage people to choose less damaging alternates, and we can use the tax money to develop better technology.

Now there is great uncertainty in the net cost of the damage done, so start out at say 1/3 above the lower end of the range, and as the analysis tightens up the tax rate will become more accurate. The rate could be tied to a scientific calculation that would automatically adjust each year without a political vote, similar to the consumer price index.

Cap and trade is a game whose rules have not been written. No matter what the rules end up being, tens of thousands of very bright people will dedicate their lives to nonproductive gaming of the system to make money.

There is no way cap and trade can be more accurate than the above proposal, and many ways it could be worse.

Under cap and trade consumers could find themselves spending $1000 on impractical technology to prevent $200 worth of environmental damage, or just the opposite.

Things Everybody Should Know About Energy

by BILL HANNAHAN at 2:13 PM on 06 Dec 2007

Why should gov't profit in proportion to damage?

The most simple, direct and transparent way to do that is with a tax on emissions equal to the cost of the damage they do.

Since this would fund everyone who takes a government cheque in proportion to the damage the emissions do, and some of those people have the power to obstruct us in reducing damage, it would reward them for that obstruction.

Perhaps Hannahan is aware that strict enforcement of highway speed limits would greatly reduce CO2 emissions from cars and trucks, and is not done precisely because such emissions are heavily taxed.

There isn't a life-saving, tremendously capable CO2-free power source that is hindered in its expansion by a multi-year paper chase, is there? That would be too blatant.

--- G.R.L. Cowan, hydrogen-to-boron convert
How shall cars gain nuclear cachet?
http://www.eagle.ca/~gcowan/boron_blast.html

by GRLCowan at 2:40 PM on 06 Dec 2007

A carbon tax is a crummy business idea

You write that:

Just so, a tax gives a better guarantee of price stability than cap-and-trade. There's no chance of a carbon "price shock" with a tax, nor of a collapse in carbon prices (as happened in the early stages of the European emissions trading system). And businesses love predictability -- without it, it's hard to plan investments.

This is exactly wrong. Yes, a cap & trade has a variable price, but this is vastly preferable from a business perspective, because at least it's always there (an advantage of complexity in this case is that it's really hard to undo the regulation once passed). Compare this to a tax, where the amount of the tax - and indeed, it's very existence - blows with political cycles. What is the estate tax going to be next year? How about AMT? What's going to happen to carried interest taxes for private equity firms? No one knows with any certainty. Why should we believe that a carbon tax is less prone to such uncertainty?

As a guy looking to deploy capital in GHG-reduction projects, I don't know how to use a carbon tax. It's great if I can get it, but I never really trust that I can access that revenue, and so I don't build it into contracts and it doesn't affect capital deployment.

A cap & trade, by contrast is much more predictable. Yes, I don't know exactly what the price will be, but I know it'll still be there, and it therefore becomes like any other market. Just because I don't know what the price of grain is going to be next year doesn't mean that I can't plan for it. Indeed, I can even lock in my price in futures markets or other long-term contracting vehicles that clever intermediary brokers have created. They'll no doubt do the same in a cap & trade regime. But a tax never lets that happen.

So I agree with you - but for opposite reasons that only strengthen your argument, since the "pros" for a carbon tax as presented are actually it's biggest weakness.

by Sean Casten at 3:45 PM on 06 Dec 2007

Also frankly

Also frankly Banking of tradable credits tends to make it so that you don't get those market shocks, and it allows for better long range planning.

-David Ahlport

by GreyFlcn at 8:46 PM on 06 Dec 2007
[ Parent ]

ADVERTISING POLICY

You are not logged in. Thus, you cannot post a comment. If you have an account, log in. If you don't have an account, well, by all means go make one! Meet you back here in five.