24 August 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.


    1. There is another point in favor of a tax over cap and trade. It is a fair proxy for a simple fossil fuel tax. Even AGW skeptics and lukewarmists recognize that fossil fuels are a dirty and depleting resource. We all look forward to the day that they are obsolete. I think most of us would be open to a Pigovian tax on fossil fuels. You could probably get lots of skeptics to the table on a revenue neutral carbon tax. Toss in an end to subsidies on expensive renewables and you might talk them into a rate that will have a meaningful impact on consumption.

    2. Good quick economic analysis of the Carbon Tax vs. Cap and Trade. Once again we agree. I knew I liked your thinking! I recently joined a group called Citizens' Climate Lobby (CCL) whose main goal is to develop the political will to pass Carbon Fee and Dividend legislation on the National level. Here is a link to their web page (http://citizensclimatelobby.org/) and their Carbon Fee and Dividend page (http://citizensclimatelobby.org/carbon-fee-and-dividend/) where you will see a very similar, though more lengthy rationale for the Carbon Tax.

      I liked CCL's approach so much that I co-founded a CCL Chapter in South Lake Tahoe, CA. Now all we have to do is create the political will on the local level so the national lawmakers will feel the heat and see the light. No small task, but still, I think, the most sound approach to reducing carbon emissions.

    3. I’m a big carbon tax fan myself, but I don’t understand this part of what you write:

      The problems with cap and trade are well-known:

      Hard to know who's emitting what, where (fraud is also a problem)

      (1) Seems to me that (fraud aside) the enforcement challenge is basically the same for carbon taxes and C&T. In one case you have to figure out who needs to pay the tax, and in the other case you need to figure out who needs to turn in a permit.


      (2) Also for what it’s worth the California C&T is being used to fund all sorts of projects, so I don’t really understand that part either.

      (3) Mostly I think of the two policies as a lot more similar than they are different. (For a 3rd example, in our CarbonWA.org carbon tax proposal, we’re using part of the revenue to reduce business taxes for manufacturers. Is that “corruption” any more or less than grandfathering permits to manufacturers?)

      1. (1) I was unclear about "hard to know who's... etc." Permits are, by definition, harder to track than taxes, so there's more accounting (higher transaction costs). But permits ARE popular for people allergic to seeing prices..

        (2) California projects "funded by permits" could be more easily funded by (a) users (b) direct grants, etc.

        (3) Revenue rebates are MUCH more transparent than permits that do/don't/do have value (depending on the day of the week).

    4. John Whitehead27 August, 2015 16:02

      It seems to me that a carbon tax at the gas pump would be very easy to administer and enforce. A carbon tax at the power plant would have about the same enforcement costs as cap-and-trade.

      The no brainer is to raise the gas tax.

      1. Agreed. Provided the cap and trade was in a limited jurisdiction e g US or UK etc


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