Standards-based regulations and public investment are superior to either carbon taxes or cap-and-trade. But we need some form of carbon pricing to reinforce public action, and a carbon tax is superior to carbon trading.
The main policy advantage cap-and-traders offer over a carbon tax is certainty. They claim that it is better to fix the ceiling on emissions and let the price vary than to fix the price and hope it produces the reduction you want. However, most cap-and-trade advocates favor an escape clause, a price ceiling which would trigger the issue of more permits, either because they see it as the price you have to pay to get a bill through, or because they honestly favor the policy. In either case, once you have an escape clause, you no longer have the certainty advocates tout so highly.
What, you think you can set the ceiling high enough that the permit price will never reach it? Then you think we can guess pretty well what carbon price will produce what reduction, but a carbon tax could be set at the same level. So when David Roberts talks of “minimizing the use of offsets and off-ramps” he implicitly acknowledges that the main policy advantages claimed by trading advocates have to be traded away to get an actual bill passed. Later in this post I will describe why those advantages are imaginary to begin with. But even if they exist, they seem to be the first policy items to go in any actual cap-and-trade bill likely to pass.
Giving up the cap also gives up the biggest political advantage. Because an auctioned permit bill with a price ceiling that undermines any nominal cap is just a highly inefficient carbon tax with an unpredictable price. The political advantage no longer comes from not being a carbon tax, but from not being called a carbon tax. And an efficient carbon tax could do the same thing.
You could take Charles Komanoff’s proposal and rename it a “climate impact fee”—call it “Chicken soup” if that is politically advantageous. Mind you polluters would still complain about it. “I had to pay my quarterly chicken soup last week. Too damn much chicken soup and bureaucracy!” What, you say we could never get away with it? We have the same chance of passing a well designed carbon tax as a “carbon impact fee” as carbon trading advocates have of calling a badly designed carbon tax “cap-and-trade.” Let’s delve further into both policy and politics:
Roberts claims in the same post that “a well-designed C&T system is preferable to a well-designed tax.” With what advantages? Absent the “escape clause” compromise, perhaps he means the certainty. A cap-and-trade provides “certainty” via an automatic escalator. You issue a certain number of permits. Those permits expire. You replace them with fewer permits. The fewer permits expire. Rinse, lather, repeat until you are down to zero or nearly zero permits. The key for this to work: don’t negotiate the permits each time. When you first pass the law, include a schedule of emission cuts so that attempts to push for additional permits will have to repeal or modify the existing law rather than stymie negotiations for the next phase.
How can a tax provide the same emissions certainty? Pass a law setting an emissions reduction schedule with an escalating emissions tax intended to produce reductions on that schedule. Include a formula that recalculates the rate-of-increase if emissions do not drop to or below target. A bit complicated?
Permit auctioning has its own problems that add complexity: volatility. Trading is simply another form of carbon pricing. Yes the nominal driver is the cap. But from the point of businesses and consumers, what drives their behavior is how much it costs to buy a permit. Just as a carbon tax can be set too low, even a carbon cap whose ultimate target is stringent can be set with too high an initial ceiling. And, as happened with RECLAIM, too high an initial cap results in too low an initial price. Too low an initial price means that when caps ultimately tighten, the needed investments will not have been made, and so the cap won’t be complied with. Ultimately in the RECLAIM case, new schedules were set. Command-and-control standards were put in place. And emissions reductions fell behind schedule just as they can with a carbon tax. The early, excessively low prices led to excessively high prices later, and non-compliance.
Now there are ways to prevent volatility in cap-and-trade. Put on a minimum price as close to what you expect the ultimate clearing price to be as you can calculate for the number of permits you intend to sell. Note that this is exactly the calculation made for a carbon tax
There are other problems with cap-and-trade. One is the “trade” part. That is not “trade” as in “omygod someone is buying a permit.” But “trade” as in the permit passes through the hands of five carbon traders before it reaches the hands of the polluter, and derivative traders and hedge fund managers leverage carbon permits at ratios of 30 to 1. If emission permits end up controlled by the same people who created our current crash, than this is a problem. One problem with duplicating things of real value by means of a wilderness of mirrors is that the real things can lose value alongside the phantoms when the impostor is detected. In the meantime the real things will share the natural volatility of the counterfeits. More fundamentally, even if the same exact same infringements that led to the current depression are not repeated, this rule still applies: get into bed with financial industry, and wake up a eunuch.
If nothing else, creating a carbon trading sector creates an entire subset of the financial sector opposed to fast emissions reductions. First, past a certain point a successful emissions reduction policy will reduce volume faster than prices increase. Secondly, even if values hold constant (and values holding constant will be a sign of failure) all things being equal, traders like volume. More volume equals more trading opportunities. One-thousand shares worth $100 a piece will (on average) generate more trades than 100 shares worth $1,000 a piece. For that matter, more volume tends to generate more total value. (Consider stock splits. What advantage do they have other than if you take 1,000 shares worth $100 a piece and split then into 2,000 shares worth $50 a piece, you can count on them rising to $75 a piece pretty quickly? ) We have enough problems with our current carbon lobby. We don’t need to grow our own problems as well.
Now there are ways to minimize this. Start by selling permits as far upstream as possible (something we should do with a carbon tax as well). Make it easy to bypass traders by auctioning most permits quarterly and the remainder (one-fifth or less) daily on the Internet. Put a 0.25 percent tax on each resale of a carbon permit to discourage constant trading of the same permit. Put in place a rule which forbids resale of instruments derived from a permit—you could loan money on a permit, or buy an option on it. But then you have to collect the loan, and you have to choose to exercise or not the option. You cannot term and resell them and turn them into financial instruments.
Now if you do all this you may indeed have something superior to a carbon tax because you have both the certainty a cap provides and the lower volatility of a carbon tax. But you no longer have a simple cap-and-trade proposal. You have a hybrid system with features of both, hung with more restraints than Rhianna in the “Disturbia” video. And it is true that an absolutely perfect cap-and-tax proposal is superior to either a carbon tax or a cap-and-trade alone.
But you are not likely to get a perfect system. The best you can hope for is a good system, or maybe a mediocre system.
A good cap-and-trade will have 100 percent auctioning of permits—no offsets, no escape clause, expiration dates for permits, and maybe a very low floor. It may auction quarterly, but is unlikely to have restrictions on resale. That means you end up with a lot of volatility and a large carbon trading sector that will join the carbon lobby to try and weaken the first iteration of cap tightening. A good carbon tax will have both scheduled escalation and special escalation when emissions drop more slowly than intended.
A mediocre cap-and-trade will auction 80 percent or more of permits, allow few offsets, and have lengthy or zero expiration dates for permits. Banking will reduce volatility a little, but at the expense of keeping prices lower on average. Offsets and grandfathered permits will increase volatility much more than banking will reduce it. And the imaginary reductions produced by offsets will both lower permit prices and real emissions reductions. A mediocre carbon tax will only have scheduled escalation, and it will require legislative intervention to raise carbon prices more than that.
So while a perfect cap-and-tax system is better than either cap-and-trade or carbon tax alone, a decent carbon tax is simpler and more workable than a decent cap-and-trade. A mediocre carbon tax is definitely preferable to a mediocre cap-and-trade.
A lot of people think we won’t get any kind of carbon price this year. Maybe what we should focus on in 2009 is really pushing for green infrastructure, paid for the moment by 10-year bonds with a 3 percent interest rate. As I said at the beginning of this post, public investment and regulation are more important anyway.
Feed the world sustainably by 2050? Yes, we can!
Comments
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Curtis Moore Posted 9:48 pm
29 Jan 2009
Swedes, et. al. have enjoyed greatest success with "feebates" in which relatively high polluters pay into a fund that sends the money to relatively low polluters. Was a tremendous success with sulfur in vehicle fuels and industrial NOx emissions. The key is that such a system must be completely revenue neutral, with the government keep none of the money. Used in the context of global warming, dirty coal-fired powerplants would start paying money in, while cleaner ways of generating electricity--not just wind and solar, but higher efficiency coal technologies like IGCC and PFBC--would get money back.
In terms of non-CO2 causes of global warming, old fashioned command and control is the best, as the Californians are demonstrating with their increasingly stringent diesel soot and NOx standards. There is no reason, for example, why SF-6 in excess of the minimum technologically required amount should not simply be banned. Existing stocks should be removed and destroyed.
Similarly, Europeans are banning -134a as a refrigerant in motor vehicles starting with model year 2011. The U.S., or acting individually, states could do the same. The Montreal Protocol is non-preemptive, and since -134a is neither a fuel nor a defined pollutant, the Clean Air Act is non-preemptive as well.
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SallyVCrockett Posted 10:38 pm
29 Jan 2009
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amazingdrx Posted 11:30 pm
29 Jan 2009
Do the coal, oil, nuclear, and agrifuel industries need over 50 billion in corporate welfare per year?
Don't ask for a carbon tax until that giveaway is stopped and the money is put into renewable energy and conservation. If it's not enough to get green jobs going fast enough to save the economy, take some of the cash that would be waste propping up wall street "banks", say another 50 billion per year, and put it to work building out green energy infrastructure.
All the way from individual home solar cogeneration panels and ground source heating/cooling systems ... to local and regional smart grids...up to wind/solar powered high speed electric train corridors that double as a coast to coast High Voltage Direct Current (HVDC) smart power grid.
Let the free market buy and sell the power and invest in high speed trains that run on the tracks. Government should own and control the backbone, just like the federal highway system. Commerce should be free of monopoly control and fair for all. Big and small.
When you can buy your electricity from a wind farm 1000 miles away at competitive prices, that'll be a real free market. No more monopoly exxon-like mob hovering over the economy like a dark cloud.
http://amazngdrx.blogharbor.com/blog John Schneider, Northern Wisconsin
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liberalnun Posted 1:24 am
30 Jan 2009
I do disagree, though, on whether green infrastructure is an adequate substitute for carbon pricing. Green infrastructure creates clean alternatives to traditional dirty sources of energy, transport, etc. But I think you need carbon pricing in order for people to actually make the effort to switch to those green alternatives. In my mind, green investment and carbon pricing are complementary - green investment creates the means to lead a cleaner lifestyle, and carbon pricing creates the will to do so.
While regulation also creates such will, it can only cover certain activities, and it's a relatively blunt instrument. Regulation can't create the sort of blanket incentive to reduce GHG emissions in all areas of modern living the way carbon pricing potentially can.
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ttcmm Posted 3:15 am
30 Jan 2009
By contrast, a carbon tax would maintain incentives to reduce emissions whether the economy is growing or contracting.
This to me is the most potent advantage of a carbon tax, yet out of fear of the ramifications of suggesting the prospect negative growth, or to hew to the conventions of USCAP-driven political debate, no policy analysts care to address it. That's a shame, because as green advocates we are missing an opportunity to expand key economic issues relevant to the question cap-and-trade versus carbon tax, rather than try to demonstrate to industry representatives that we understand their models and account for their concerns. Meanwhile, nobody knows better than they do where business-as-usual emissions will be in the next few years.
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amazingdrx Posted 3:22 am
30 Jan 2009
In Texas where consumers can choose their power sources, wind is in short supply, it's actually cheaper. There's a waiting list.
Because of the nature of fuel irself, carbon based energy sources will continue to rise in price. This dip in oil and other fuel commodities is temporary, manily due to the global recession.
Consider ground source heating/cooling, this form of energy conservation can vastly reduce utility bills, with some mass production cost reduction this and other systems like solar cogeneration panels will come down in price.
Subsidizing renewable energy and conservation with 5 cents per kwh would put the payback period to free power and heating at only a few years. that's a powerful incentive, add in free kwhs to charge your plugin hybrid and it's like having another part time income for the family.
Gasoline and utility bills can be expensive, mortgage busting costs. Wouldn't it be nice to retire without them someday?
http://amazngdrx.blogharbor.com/blog John Schneider, Northern Wisconsin
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GreyFlcn Posted 3:48 am
30 Jan 2009
Since what we're really after is Green Infrastructure Investment.
-David Ahlport
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GreyFlcn Posted 4:02 am
30 Jan 2009
My biggest concern with "dividend", is that you'd need to raise the "pricing" pretty high in order to achieve a significant downward pressure on carbon intensive industries.
That said, dividending may be the only politically paletable way to do that.
But I guess the real question is what do we want the policy primarily to do?
Upward pressure on Green Tech
Or Downward pressure on Carbon Tech
-David Ahlport
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Gar Lipow Posted 4:37 am
30 Jan 2009
>our analysis of certainty is one-sided. Like the silliest of backward-looking economic models, it assumes economic growth, even we learn that U.S. GDP fell 3.8% and Chinese electricity output fell 6% year-over-year last quarter.
Did you read my post? I thought I refuted the certainty argument pretty well. It seems like you and I are having a robust -- agreement? I was comparing the "theoretical certainty" with real uncertainty. My point is that "Cap & Trade" certainty can fail well short of declining economic growth.
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Gar Lipow Posted 4:45 am
30 Jan 2009
I do disagree, though, on whether green infrastructure is an adequate substitute for carbon pricing. Green infrastructure creates clean alternatives to traditional dirty sources of energy, transport, etc. But I think you need carbon pricing in order for people to actually make the effort to switch to those green alternatives. In my mind, green investment and carbon pricing are complementary - green investment creates the means to lead a cleaner lifestyle, and carbon pricing creates the will to do so.
Clearly a case where I got the balance wrong between avoiding repetition and remembering most people don't follow the links. Key phrases "~75 percent of U.S emissions come from sources where "command and control" measures are superior to prices for reducing emissions." and "in most sectors, emissions pricing will work better as reinforcement than as the primary instrument of greenhouse-gas policy." (counting carbon trading, carbon taxes, and "feebates" all as pricing mechanisms".
The argument seems to be that what we need to do first is get through a pricing mechanism. Infrastructure spending and regulations are reinforcement. Whereas the reverse is true. What is most urgent is green infrastructure, and regulations. Carbon pricing is reinforcement.If we can do everything at once, great. But if in the real world of politics some things have to take priority over othes, then Infrastructure and regulation should be the priority.
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GreyFlcn Posted 6:03 am
30 Jan 2009
Wouldn't it be more prudent to focus on promoting federal support for Green Infrastructure Banking?
And Regulations that make things harder for new development of Coal, Shale, Tar Sands, and Deforrestation.
Hell, federal support for Utility Decoupling could go a long way.
-David Ahlport
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rb3035 Posted 10:59 pm
31 Jan 2009
While I would otherwise be in favor of a global, harmonised carbon tax, I don't see that happening within an international framework. Given historical emissions and the right of developing countries to develop, there is hardly a chance we can ask the E5 and G77 to apply the same carbon price to their production that we in the G8 enjoy. Lacking this however, results in leakage and arguable greater emission intensity.
In this light, I am all for cap and trade in the states. Particularly given the EC's recent call to integrate any new federal C&T system with the ETS; this would be a significant step towards a global market. The only feature of a cap and trade system that truly matters with regards to environmental efficacy is the cap. Windfalls aside, grandfathering vs. auctioning produces no effect on environmental performance of the market. I am certain that given the resources in America and its culture of litigation, more than adequate historical records are available to construct a declining cap with a price floor (as mentioned, however I don't believe it needs to be "Low").
With regards to carbon pricing, I disagree that infrastructure is needed before setting a price. Industry and the private sector need a price to incentivize R&D as well as forecast the risk of continuing along a fossil fuel intensive path. Without a firm carbon price, progressive spending on infrastructure cannot and will not happen.
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rb3035 Posted 11:01 pm
31 Jan 2009
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GreyFlcn Posted 3:02 am
01 Feb 2009
And this is where I'd disagree.
The private sector is already doing plenty of R&D, and what's more, for foundational R&D that's often best served by Federal programs and Universities anyways.
What we need is demand. Not supply.
Also the carbon price will never be set high enough to be prohibitive, so that's silly.
-David Ahlport
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bfraser Posted 12:46 pm
01 Feb 2009
I want to make a case for carbon pricing over the kind of standards you are promoting. The biggest problem with command-and-control is that it fails to allow for flexible responses to the problem. For example, raising the CAFE standards would make cars more efficient, but doesn't encourage moving closer to your job, carpooling, or bicycling.
bill
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GreyFlcn Posted 4:10 pm
01 Feb 2009
Yes it wouldn't encourage that, but then again, neither would a weak auction, or tax system either.
So it's a rather moot point.
Besides which, the thing that does that most isn't behavior, or price signals. It's urban planning. i.e. Command and Control "Central Planning".
So doubly a moot point.
-David Ahlport
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liberalnun Posted 4:20 am
02 Feb 2009
For example. Suppose we invest a lot of money into renewable electricity. This would cause people to buy more renewable electricity, which would be a good thing. But because such investment would increase the supply of renewable energy without decreasing the supply of dirty energy, overall energy supply would rise, and overall energy prices would fall. This would cause people to consume more energy, of both the clean and dirty varieties. However, if you increased the price of dirty electricity by putting a price on carbon, then energy consumption would actually shift from dirty to clean without rising overall. So in this scenario, green investment is necessary to get people to start using renewable energy, but a price signal is necessary to get people to stop using dirty energy.
(I suppose that in this scenario, you could prohibit new coal plants from being built or set a shut-down date for existing coal plants - but neither of those seem as effective as a gradual phase-out of coal-fired electricity through a ramp-up of prices.)
I do, however, agree that green investment should come first, as it seems that would help everyone adjust effectively to a higher carbon price.
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Gar Lipow Posted 5:18 am
02 Feb 2009
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