Why cap-and-trade is preferable to a carbon tax
The Washington Post ran an interesting op-ed in its Think Tank Town section last week, arguing for a carbon tax. The nut graph:
The only effective way to begin reducing greenhouse gas emissions and slow global climate change is to make it more expensive to emit carbon dioxide. Unless businesses and consumers pay a price for carbon dioxide, neither will make the investments in technology and changes in energy use needed to dramatically reduce emissions.
Rock on, Think Tankers. But that’s just the start of the goodness. The authors — two researchers from RAND Corporation — also put forth a nifty idea about how to cushion the economic impacts of new taxes:
[A]ll the proceeds collected by the government would be returned to Americans each year when they file income taxes …
A carbon dioxide tax with refund is fair because the people responsible for the most emissions would pay the most. The tax would also be progressive. Many Americans with lower incomes would find the refund would more than defray the higher costs of gasoline and electric power.
In short, they call for a per-head tax rebate, kind of like the Sky Trust idea. I looove the concept of the Sky Trust — it deserves way more attention than it’s getting. Ways to make climate policy genuinely fair for low-income folks seem to get short shrift in today’s debate.
Still, while the piece does a good job of explaining the virtues of a carbon tax, I think it takes its critique of cap-and-trade too far.
Admittedly, as the authors point out, a tax is a lot easier to administer than a cap-and-trade system. With a tax, there’s no auction, no grandfathering worries, and fewer wacky complications within the electricity sector. Taxes are just plain simpler — and where climate policy is concerned, simplicity is a virtue.
Just so, a tax gives a better guarantee of price stability than cap-and-trade. There’s no chance of a carbon "price shock" with a tax, nor of a collapse in carbon prices (as happened in the early stages of the European emissions trading system). And businesses love predictability — without it, it’s hard to plan investments. A cap-and-trade system has to be designed very carefully in order to reduce the chance of wild price swings — something that a tax does by design. But what I don’t like about this op-ed is that it seems to elevate the principle of price stability over effective climate protection.
For example, the authors stress the difficulty of setting the initial emissions limits right in a cap-and-trade system — particularly, that an emissions limit that’s too high or too low may send inconsistent price signals at the outset of the program. That’s fair enough, I suppose.
But how is that any more worrisome than a system that sends consistent price signals, if it turns out later that those price signals were too low to be effective? It seems that the much greater risk, over the long haul, is a carbon tax that’s never quite high enough to get the emissions reductions we need.
And that’s where cap-and-trade really shines — if done properly, it works like a self-adjusting tax, with the level of the tax always pitched just high enough to guarantee the next incremental emissions reduction. And if implemented through an upstream system with frequent and full auctioning of emissions allowances, a cap shouldn’t be all that different from a carbon tax.
I’m willing to be proven wrong here. But it seems every bit as difficult to get the tax level right — and keep it right — as it is to get the initial emissions limit right. If we get the taxes too low, we’ll need to continually generate the political will needed to adjust the tax rate upwards. And by the time that happens. North Americans may have emitted literally billions of tons of additional CO2.
I, for one, would be willing to accept a little bit of price fluctuation to prevent that from happening.