Don't trade carbon, tax it

Why carbon taxes trump cap-and-trade

Posted by Charles Komanoff (Guest Contributor) at 10:31 AM on 13 Feb 2007

Yesterday Gristmill ran a curious article by Bill Chameides of Environmental Defense, attacking a carbon tax strawman that no one is advocating, least of all the Carbon Tax Center (CTC).

Chameides stated that the "government would use additional tax dollars to subsidize the development of selected low-carbon technologies." We invite him to look at CTC's proposed carbon tax, which is revenue-neutral. Revenues will go to reduce regressive taxes or to finance progressive, equal rebates to all U.S. residents. Contrary to Chameides' charge, we have never advocated targeting tax revenues to any technology, privileged or otherwise. Nor, to our knowledge, have the Washington Post's Anne Applebaum, whom he also took to task, or the dozens of columnists, economists, scientists, and other public figures who support taxing carbon.

Chameides and ED are throwing their weight behind a carbon cap-and-trade system, on the premise that the successful sulfur cap-and-trade model can be extrapolated to carbon. We believe this is flirting with disaster. A model that worked when the parties were limited to a few dozen electric utility companies is ill-suited when the stakeholders -- essentially every business and household in the country -- number 100 million or more. Moreover, electric generators seeking to reduce sulfur emissions had a variety of technological alternatives available. There are no comparable methods available to reduce carbon emissions other than fuel-switching and, perhaps sometime in the future, sequestration.

Chameides claims that the "marketplace does a better job of developing new technologies, and a tax takes money out of the marketplace." That argument was pertinent when the alternative to cap-and-trade was "command and control" regulation of NOx and SO2 emissions, but it's irrelevant to a comparison with a carbon tax. Both a cap-and-trade and a carbon tax provide price signals that encourage polluters to look for ways to avoid the cost of emitting CO2.

A carbon tax actually provides more precise price signals, provides them sooner, and provides them in a more understandable and transparent fashion. To attack global warming, every energy-critical decision needs to be predicated on a trajectory of rising energy prices. A phased-in carbon tax allows this, whereas cap-and-trade will do little to mitigate the price roller-coaster that discourages emissions-minimizing investment.

Not only would a carbon cap-and-trade system provide less effective price signals, it would do so only after considerable delay consumed by protracted negotiations, making a mockery of Chameides' claim that a cap will guarantee climate-stabilizing cuts. Compounding the problem, once a cap-and-trade system is finally implemented, we're likely to be locked into the approach for years, with industry insisting, "Don't change it until we see how it works." Carbon taxes will require no new administrative structures, can be implemented now, and can be adjusted as necessary.

Another serious drawback to cap-and-trade is that its inherent complexity leaves it open to exploitation by special interests, not to mention perverse incentives to "bank" pollution now against future credits. Carbon taxes are relatively immune to manipulation.

Ironically, Chameides' hesitancy about trusting the government with tax dollars applies more aptly to his cap-and-trade proposal. Since the tax proposed by CTC and most other carbon tax proponents is revenue-neutral, there are no tax dollars to spend and potentially misuse. In contrast, even an optimal cap-and-trade system such as the Northeast's Regional Greenhouse Gas Initiative, in which emissions allowances are auctioned, would saddle end-users with the functional equivalent of a tax, along with the same conundrum Chameides raised about how to spend the money. Except worse, because the cap-and-trade model necessarily requires that a chunk of the "tax revenues" be used to provide market participants with a profit paid by consumers.

And that's under a relatively benign cap-and-trade, in which the allowances are auctioned. The alternative, giving polluters the allowances outright, combines the worst of both worlds: a hidden tax on energy users, with all the increased energy costs given to the polluters or other market participants. An explicit tax that offsets other taxes is preferable to a covert tax that goes into someone else's pocket.

Finally, we reject Chameides' defeatism over the chances of Congress passing a carbon tax. On the contrary, the stars are aligned as never before to actually do something about carbon emissions. There is now a general acceptance of the need for action (even Exxon concedes there's a problem), and no less than Wall Street demigod Paul Volcker called last week for taxing CO2. The question is what will work best. For reasons discussed in more detail on our website, we believe that a carbon tax coupled with progressive tax-shifting can be a winner politically.

The last thing we want to do is lock in a suboptimal solution and then have to wait years before the stars are again aligned. Now is the time to work for a real solution that maximizes environmental gains and minimizes hardships.

This article was written with CTC co-director Dan Rosenblum.

For story: Don't trade carbon, tax it
18 Comments | Post a Comment

questions

Good rebuttal, Charles. I appreciate your advocacy for carbon taxes and the Carbon Tax Center website has made a good beginning on presenting the arguments.

I'd like to find an in-depth report on the U.S. experience with cap-and-trade for NOx and SO2 emissions. What were the political factors that led to its adoption, and are there any parallels with CO2 today? How effective has it really been, and would different approaches have worked better?

What is the potential for various nations' carbon tax programs to be harmonized across national borders? Would international carbon tax cooperation be easier or harder than trading permits?

Part of the intention of a carbon tax is direct reduction of demand through price signals. The argument against that is that fossil fuel demand is relatively inelastic, and effective CO2 reduction will require per-ton pricing so high that many industries would be crippled. Yet, a more important effect of a carbon tax may be the incentivizing of alternative technologies, practices and research. Such alternatives may be incentivized at price-per-ton levels that are much lower than what's required for direct demand destruction. Are there any reports that summarize alternative energy investment balancing points and tradeoffs with respect to carbon taxes?

Your point about trajectory of rising energy prices and investment is well taken, but it seems that pricing is in the hands of futures traders. How much can a carbon tax really smooth out volatility and ensure a predictable rise?

Ped Shed Blog

by Laurence Aurbach at 11:13 AM on 13 Feb 2007

Elasticity

The problem of elasticity is a real one, but it applies to carbon trading as well as to carbon taxes. Both work in practice by putting a price on carbon, though emissions trading has all the additional disadvantages mentioned.

The answer is that energy policy has to stand on three legs, like a solid bar stool, not on one.

Giving carbon a price is one of those legs, and a carbon tax is the best way to do that.

Old fashioned rule or quantity based regulation is another. And I wish people would stop useing the word "Command and Control" for a means that has been very successful in certain circumstances. For example, some EU nations have rules for maximum climate control consumption per meter in buildings, along with minimum rules for comfort, so that regulations are not met by causeing people to freeze in the dark. Appliance efficiency rules are extremely effective as well. Efficiency requirements in transportation and industry are useful too. None of these are a substitute for a carbon tax, any more than a carbon tax is a substitute for them. Rules make carbon taxes work better, by increasing elasticity in response to price changes. Carbon taxes make rule based regulation more efficient, by eliminating the need for a great deal of micro-management.

A third leg of the stool are public works. Because there are things markets, even artificial markets can't provide. For example mass transit is an obvious public good that has to be provided via public money. Trains are one example. Bike paths and other infrastructure to make cities more bike friendly is another.

by Gar Lipow at 12:48 PM on 13 Feb 2007

Reaching the target

One thing I like about Bill's argument for cap and trade was the idea of being able to set the reductions you want to achieve in the future. How do we figure out where to set the tax to achieve the same goals? What tax level would you propose to be able to reach the same benchmarks that say the US-CAP coalition support?

by Ana Unruh Cohen at 4:04 PM on 13 Feb 2007

Target 80%

Their cap and trade forcasts something like $100/ton. That is only $0.25 per gallon gasoline, not much incentive.

A carbon tax (tax sounds bad, carbon is bad, the words just go together) ramped to $600/ton would provide powerful market and cultural signals.

by sunflower at 4:21 PM on 13 Feb 2007

What about "Cap and Share"??????

I'm sure you haven't heard of it, since it's quite new, so here:

www.capandshare.org

it's not a carbon tax and isn't a typical cap and trade system either. If you have any thoughts be sure to contact the coordinators.

I've made a quick clip of it here:

http://www.youtube.com/watch?v=ZX9ky8SO8aM

by Brendan Patrick at 4:47 AM on 14 Feb 2007

carbon tax vs. cap-and-trade

A long time ago I was advised: tax the bad stuff (what you don't want) and incentivize the good stuff. Don't tell people how to get there, because they might invent something better than you can imagine.

The carbon tax, particularly as recommended by Komanoff and Rosenblum, seems like a very good way to tax the bad stuff. Our "market" currently externalizes and legitimizes illness and death as acceptable results of production. The carbon tax is a very simple way to begin to address the false accounting of cost that has long been intrinsic to our economy. It is a very basic way for people to start taking responsibility for the consequences of their actions, a responsibility which is supposed to be the basis of our national morality.

Cap-and-trade is very popular with industry, because it is open to the abuses experienced in Europe, cited by others who have responded to the Chameides and Komanoff/Rosenblum comments. As envisioned by Komanoff and Rosenblum, a carbon tax directly and immediately addresses the economic costs of behavior which threatens our very existence, which for too long has incentivized instead of taxed.

by Lois at 10:32 AM on 14 Feb 2007

Some benefits of Cap and Trade

Very interesting thread and discussion. A few comments:

Existing cap and trade programs work very well, sometimes, and involve far more than a "few dozen" utilities as the original author states. The SO2 trading program starting by the 1990 Clean Air Act Amendments has several thousand affected units, has had virtually 100% compliance every year, and has substantially reduced SO2 emissions. It is widely hailed as a success. Richard Cohen has written a very good book on the story of its passage entitled "Washington at Work: Back Rooms and Clean Air"
The issue of elasticity is an important one, and energy demand does appear to be very inelastic, although less so over longer time periods. However, I would argue that this is actually an important advantage of cap and trade over a carbon tax: the cap fixes the total pollutant loading, regardless of demand. Thus, cap and trade fixes the environmental pollution level while letting the price of polluting float. Of course, this can also be seen as a disadvantage if you are worried about potentially sky high carbon prices by setting the cap too low. But for many, a major appeal of cap and trade is it imposes a "hard" limit on emissions, rather than an uncertain one as with a tax. (All of this assumes that fines for noncompliance with the cap are high enough avoid becoming a de facto "tax" rather than a hard cap - this has worked with SO2, where fines are far above the market price for emissions).
I would argue that right now, the key is getting a price on carbon--by any mechanism possible. Both a tax and cap and trade would do this. They have different detailed advantages and disadvantages that are important, but we would be far better off with either than with neither. The issue of what to do with the revenue from the tax or the distribution of permits is also crucial in either system, and the push to make such systems more revenue neutral is a positive one. This was totally missing from the 1990 SO2 debate. Notice, finally, for those skeptical that we will ever auction CO2 permits that the moderate Bingaman cap and trade bill in Congress includes a substantial portion of allowances to be auctioned - something that would have been unheard of in 1990. Some nations in the EU are starting to experiment with small auctions of some allowances under the EU ETS...

- Leigh Raymond

by Leigh Raymond at 11:07 AM on 14 Feb 2007

Smokestack cap-n-trade

Is cap and trade just for power plants and such?

What about building heat, industrial process heat, and transportation fuels, especially aircraft?

by sunflower at 11:44 AM on 14 Feb 2007

Author Responds

Terrific comments, folks, in the 24 hours since posting Dan's and my piece. I'll try to be concise in these reactions (chronological order, from bottom up).

Laurence -- (incomplete answer): Energy's long-term price elasticity is many times greater than short-term. That's a rationale for our ramped-up carbon tax. True, that won't eliminate all volatility, but it will help reduce the relative importance of "natural" price fluctuations in discouraging investments in EE and RE. Re cross-borders, we envision eventual harmonizing of C tax levels (we're optimists!), preceded by a more difficult period in which C-taxing nations may have to impose C-equivalent import duties. As for your info queries, we're searching for same knowledge as you, let us know what you find!

Gar articulates our stance beautifully. I'll add that the rising price trajectory doesn't just tilt the micro-economic calculations for optimizing EE and RE investment, it gets individuals' and institutions' attentions so that the calculations are done in the first place.

Ana -- CTC doesn't put as high a value as you do on the supposed certainty of emission reduction rates with a cap. We feel that knowing the precise response at this time isn't critical. What we need is to maximize reductions, and to fine-tune later. We believe each year's ramp of our proposed starter tax would cause CO2 emissions to be 2-3% less than otherwise (resulting in ~20% less than that moving target, after 10 years). Separate but synergistic EE and RE programs would add considerably to that, and if the politics worked out, the annual ramps could be steepened. But for now we're constrained politically from imposing a higher and more optimal tax (similar to the political constraints on imposing the optimal cap).

Sunflower -- CTC's proposed carbon tax of $37/ton of C, per year, equates to 10 cents per gallon of gasoline, per year (our math jibes with yours). After 10 years, it's $370/ton, equivalent to $1.00 a gallon. Nothing magic about our $370 vs. your $600 -- it's our sense of what today's politics will support. We welcome being shown too pessimistic!

Brendan -- Your Cap and Share Web site is great. I agree totally with your "check marks." I think you were wise not to tout C & S as "easily understandable," though, because I'm not sure it is. While that may now be a liability for a carbon tax, CTC hopes to turn that into an asset.

Lois -- Nothing to add, thanks for stating the case so powerfully.

Leigh -- (1) Thanks for the tip about R. Cohen's book. I'll still maintain that no more than two dozen, and perhaps as few as one dozen, utilities were responsible for >50% of U.S. SO2 emissions in 1990, making it easy to corral the key players and circumvent the nearly endless positioning and deal-cutting we envision for a CO2 cap system. (2) I hope I've addressed this above. (3) Thank you for acknowledging the importance of revenue-neutrality. As we noted on our Web site, we believe that returning virtually all C tax revenues to the people is essential not only for fundamental fairness but for building sufficient political support (and/or avoiding a crippling backlash later on). The revenue certainty that C taxing offers (as opposed to the emissions certainty of a cap) will be crucial to that.

Thank you all! -- CK

Charles www.komanoff.net

by Charles Komanoff at 11:57 AM on 14 Feb 2007

Are the two mutually exclusive?

Perhaps I'm missing something here, but I don't see why international trading/offsets couldn't also be part of a carbon tax regime. If CO2 emissions are taxed at, say, $30/ton, and a Chinese power plant can reduce its emissions for a cost of $10/ton, a US company could purchase offsets and contribute to cleaner development in China. (Of course, if emissions are taxed uniformly, there would be no market incentive to do this within the US.) Such a system would essentially be cap and trade with the US cap set at 0.

Without denying the problems with corruption and evasion, international carbon trading is still one of the only ways we've found to get countries like China and India on board, and for that reason should not be thrown out entirely, at least not until we have something better to take its place.

by eriqa at 1:58 PM on 14 Feb 2007

Refunded taxes?

The following reference provides a different perspective on this topic:

Refunded emission taxes: A resolution to the cap-versus-tax dilemma for greenhouse gas regulation.
http://dx.doi.org/10.1016/j.enpol.2006.10.020

by kjohnson at 10:04 PM on 14 Feb 2007

Ken, will you send me a copy of that paper?

grist.org

by David Roberts at 11:02 PM on 14 Feb 2007

reduction of carbon emissions

Taxes alone are not enough to get the job done. We need requirements of manufactures that are meaningful in light of current technologies. There is no excuse for producing the same old machines, when we have at hand ways to get there without using half as much fossil fuel. During WWII we replaced natural rubber with synthetic rubber in a short time. We can replace fossil fuels with alternates in a short time. Some of these may just be ideas in the minds of scientists now.
First I advocate conservation by every person. We could start in our yards. Get rid of grass! Use native plants that do not require water and fertilizer. Plan trips to the store to make fewer.
Get rid of small engine equipment. Exercise more.
Do yard work by hand, the old fashioned way. Buy energy efficient appliances. Buy vehicles that get at least twice the mileage of your old vehicle when you trade in.

Second create new technologies and invest in the manufacturing processes to make them available at reasonable cost. Solar roofs, plug in cars, smaller commuter cars, and many other innovations.
Let's turn every yard into a bio-mass production facitilty with hydrgen produced by the son.

Bob loves you means he is doing all that he can for the less fortunate and the earth.

by boba12 at 7:52 AM on 15 Feb 2007

Taxing the infrastructure

I agree with Komanoff. But let's take this a step further - we need to recognize the tremendous impact of the city infrastructure in our tax strategy.

It's quite common for those who live in cities to state they do not own SUVs and therefore are part of the solution, but let's look at the true emissions of building, supporting and maintaining the infrastructure to allow that capability.

In other words, don't come after my SUV until you own up to the costs and impacts of your concrete jungle.

by Formosa at 3:21 PM on 15 Feb 2007

Refunded taxes

free download: http://kjinnovation.com/RefundedTaxes.pdf
for mor ...

by kjohnson at 9:57 AM on 16 Feb 2007
[ Parent ]

Refunded taxes

See http://kjinnovation.com/Climate_Policy.html for "more of the same". (For some reason the system keeps cutting off the last part of my post.)

by kjohnson at 10:02 AM on 16 Feb 2007

Comment truncation

Hi kjohnson. Apologies for the technical difficulties. When new comments are posted, long URLs are truncated so they don't increase the width of our pages.

It appears the script that does this is being a little over zealous and incorrectly identifying the text after your link as part of one big long link.

The code has been modified so this hopefully doesn't happen again.

www.grist.org

by Grist at 10:54 AM on 16 Feb 2007
[ Parent ]

cap and share

Sounds a lot like the Sky Trust, no? http://www.usskytrust.org/

by lauramc123 at 10:24 PM on 29 Apr 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.