24 Aug 2015

Meta-tweet: Carbon tax vs Cap and Trade

One week ago, I tweeted that the Pope (!) should push for carbon taxes instead of cap and trade. In response, John Whitehead (a busy environmental economist and blogger) said "why taxes?" The following tweet exchanges were neither satisfactory nor complete, so here's a post.

Cap (total emissions) and trade (of permits to make those emissions) has a few useful characteristics:
  • Emissions are limited to a "known" quantity
  • Prices are "found" in the market
  • Trade among emitters (even around the world) rewards those who can reduce emissions at low cost
Prototypical example: a Norwegian firm facing a cost of $100/ton CO2e(quivalent) buys an emissions permit from a Chinese firm that reduces CO2e at a cost of $5. The trade price will be between $5 and $100, but emissions are capped.

The problems with cap and trade are well-known:
  1. Hard to know who's emitting what, where (fraud is also a problem)
  2. Too many or too few national permits distort international markets
  3. Political problems with sending "our money" to "them"
    Carbon taxes have different characteristics:
    • Emissions are NOT limited to a "known" quantity
    • Instead, there's a KNOWN price signal for emitting CO2e
    • Revenue goes to local / national governments
    Prototypical example: Dutch car drivers pay a gasoline tax that funds the Dutch government. In 2015, this was EUR 0.77/liter ($3.20/gallon, vs the US gas tax of $0.49/gal)

    Carbon taxes are:
    1. Easy to assess (charged at source/point of entry)
    2. Predictable and adjustable
    3. Sources of revenue to the national treasury (or refunds to citizens)
    One of my students wrote a bachelors thesis on tax vs cap and trade. The results that stood out were BIG emissions reductions from cap and trade (see #1 below) and a BIG revenues from carbon taxes.

    So why do so many politicians like cap and trade over carbon taxes? They can:
    1. Claim big reductions based on (imaginary) baselines that have been capped.
    2. Give permits to favored industries (attracting corruption).
    3. Say that industry is doing something without spending money.
    Carbon taxes are harder to manipulate or dodge.

    But what about driving international improvements in efficiency, etc? Well, I think that theoretical promise has failed due to (1) terrible accounting for permits (e.g., failure of the "clean development mechanism") as well as (2) lots of anger over sending money abroad to get few useful results.

    Thus, I have doubled down in my support for carbon taxes (many prior posts) because they can be...
    • Imposed within nations
    • Used to fund national projects (or given back to citizens)
    • Increased when other countries put them into place
    • Easily integrated into business and personal decisions affecting emissions
    Bottom Line: Let's get real. Carbon taxes can reduce emissions, cheaply ($0.40/gallon!), under real political constraints.