Cap-and-trade vs. a carbon tax
I don’t know what to say about this article, which is largely a critique of a grandfathered "cap-and-trade" system for reducing greenhouse emissions.
On the one hand, I shouldn’t complain. Any serious discussion in the press of climate policy is welcome. But on the other hand — jeez, is it so hard to get climate policy right?
My problem isn’t so much that the article gets things wrong (though it does). It’s that it tells, at most, half the story of cap-and-trade — not even the important half.
Here are some things that, from my perspective, the article clearly gets right:
- "Grandfathering" penalizes good citizenship. Handing out free "emissions credits" based on a company’s historic pollution may actually reward firms that have done nothing to reduce their emissions. The more you’ve done to limit your emissions in the past, the less you stand to benefit from a grandfathering system. So strict grandfathering sends exactly the wrong signal: delay any efficiency upgrades for as long as possible.
- "Grandfathering" is a legal nightmare. Emissions credits are worth money — so if the government hands them out for free, there’s going to be a mad scramble by everyone to maximize their share. Expect lots of companies to lawyer up, and lots of lawsuits, especially in the early years.
Here’s something it gets wrong:
- “‘A carbon tax is more economically efficient,’ … says [economist Marc Jaccard], since it flows into all types of buying decisions, including those by consumers.” No, no, no! I mean, I agree that carbon taxes are more efficient than a grandfathered cap-and-trade system, since taxes are so much easier to administer. But as for the implication that cap-and-trade doesn’t send price signals throughout the economy, it’s just dead wrong: a carbon cap winds up sending virtually the same set of price signals as a carbon tax. The only exceptions are in tightly regulated markets (such as rate-of-return regulated electric utilities), where firms may not be able to pass on the opportunity cost of allowances to their customers. (I’d be curious to know if Jaccard thinks this, or if it was a boo-boo by the reporter.)
But here’s the big, whopping elephant in the living room — which the article misses entirely:
- Grandfathered cap-and-trade will lead to massive windfall profits for historic polluters. I think this point can’t be stressed enough: even if companies get their emissions permits for free, they’ll still charge their customers for them. The best analogy I’ve heard is that emissions permits are like World Series tickets — they’re something of value, in limited supply. And if the government just gives all the World Series tickets to Exxon, you don’t think Exxon will turn around and give them as freebies to their customers, do you? I certainly don’t.
As it turns out, there’s actual empirical evidence for this last point: when the European Union handed out its emissions permits for its greenhouse trading system, the firms that received free credits still raised prices. (That’s just the way markets work: if firms have something that customers are willing to pay for, they’ll sell it to the highest bidder, regardless of how much they paid to get it.)
So in my mind, the biggest difference between grandfathered cap-and-trade and a carbon tax is this: grandfathering amounts to a ginormous subsidy to any firm that gets free carbon permits. Taxes, or an auctioned cap-and-trade system, have the virtue of at least capturing the revenue for public purposes — reducing other taxes, cushioning price effects on the poor, paying for renewable energy, or anything other than a massive windfall for shareholders. Any critique of grandfathered cap-and-trade that overlooks this fact is really missing the point.