Taxes al Carbon

14 March 2007 at 1:05 am spostrel 40 comments

| Steven Postrel |

Let’s suppose you’ve been swept up in the recent frenzy and decided that it actually makes sense to apply coercive regulations to reduce human carbon dioxide emissions. Let’s further suppose that you’ve caught up to the 21st century and know that imposing specific technology standards on particular sources of emissions is a sign of policy incompetence: You know that market-ish mechanisms can do a much better job than technology standards of allocating clean-up tasks to the lowest-cost producers; you know that market-ish mechanisms provide incentives for private innovation in emissions control while technology standards stifle better ideas.

Congratulations! You are now about where the public policy debate has fallen these days — naive about the quality of the natural science involved but possessing a sound insight about the smartest way to do a foolish thing.

Still, you have an important decision to make: Should your market-ish mechanism work by taxing CO2 emissions? Or should you instead issue tradeable permits that cap the total amount of human CO2 released? Oddly, there’s been little public discussion about this choice, and certainly very little that applies economic reasoning. Business groups are plumping for permits. Economists are mostly talking about taxes. There are three important criteria to consider in choosing the correct instrument:

1) Which policy is superior from a political economy/public choice point of view? It would be better not to create new incentives for costly rent-seeking behavior. It would be better not to exacerbate existing biases toward growth of the public sector.

2) Which policy is superior from an institutional/governance point of view? It would be better not to adopt systems that are hard to enforce. It would be better not to impose huge transactions costs on firms, consumers, and regulators.

3) Which policy is superior from an information/efficiency point of view? It would be better not to set up incentives that turn out to be wildly off the mark, giving us way too much or way too little emission control.

1) Permits vs. taxes is hard to evaluate on the political-economy criterion, but it leans in the direction of permits. Obviously, giving the politicians a new thing to tax isn’t good for reducing the growth rate of the public sector; new taxes increase the problem of collective action by raising the amount of wealth that can be fought over politically. Worse, a new tax on CO2 could easily drift above its optimal level as politicians see it as another way to raise money to bribe the electorate. Even if we could get other taxes, such as the payroll tax, iniially reduced in return, they would likely creep up again over time. Positive tax rates have no Thomas Schelling-style “bright line,” as you can always add a few tenths of a percentage point without raising a big fuss, whereas zero tax rates on a given activity are easier to defend.

Permits don’t create a continuing revenue source for politicians, although if auctioned off they would generate a one-time windfall. That is a strong point in their favor. On the other hand, there are all kinds of ways that firms can engage in lobbying and rent-seeking in how a permit system is set up. For example, if firms are issued permits proportionately to their current emissions, then current low-emitters get hurt and high-emitters get a windfall when they implement reductions (as they can then sell their surplus permits). Or if firms get permits that reward them for being efficient now, then they can immediately sell them off and make a profit. Probably an auction would be the best way to avoid such arbitrary redistribution (and raising of rivals’ costs), but the chances of that happening are almost nil, as industry would go nuts due to the uncertainty of auction prices and the wealth transfer from their shareholders to the government.

2) On the institutional/governance side, taxes have the advantage. First, they can be applied quite easily to millions of transportation users by taxing at the pump, whereas permits would get pretty complex if imposed at a retail level. Second, the infrastructure for taxation and auditing is already in place, so there would be little additional paperwork involved, whereas for many industries keeping track of permits and emissions would be complex. Third, the government would have strong incentives to enforce taxes because they like getting revenue, while enforcing permit restrictions would be much less motivating. This might be especially true in countries where the public sector is more corrupt or less competent. Fourth, there will often be uncertainty about the future cost of permits, which would make investment planning more difficult than with a tax, which would be more predictable.

3) Here is where I would have expected to hear much more from Mr. Pigou and his friends. The blackboard economics of regulating by price (taxes) or quantity (permits) was first laid out in 1974 in a famous paper by Marty Weitzmann.

The basic idea is that it’s usually very uncertain ahead of time how costly it’s going to be to reduce emissions. If you then have a situation where the marginal benefit of emission reductions falls very sharply at some threshold — e.g., you have a chemical where if it ever gets above 10 parts per million everybody dies, but if it’s less than that there’s no effect — then you want to use a permit system and pin down the quantity at 10 ppm minus your safety factor. The primary welfare issue is getting the quantity right, not accommodating the cost of emissions control. If you put in a tax, the uncertainty in marginal emission control costs means that you could easily overshoot or undershoot, by a lot, the well-defined optimal quantity of emission control. You just aren’t sure what tax to put on to give firms the incentive to hit the quantity target.

On the other hand, if you have a situation where the marginal benefit of emission control falls slowly over a wide range of emissions — e.g., where every part per million removed makes things a little bit better without any thresholds — then the optimal level of emissions control is largely determined by what marginal costs turn out to be. If it turns out that it’s not that expensive to take out emissions, you want to end up with lots of emissions control, and if it turns out to be very expensive, then you want to end up with only a little bit of emissions control. Under these conditions, a quantity ceiling is likely to be way off, either too lax or too stringent. An emissions tax, on the other hand (which is incentive-equivalent to offering the firm a positive price for every unit of emissions control), assures that marginal control costs will be equal to the tax.

Back in 1997, William Pizer, writing for Resources for the Future, analyzed this tradeoff for CO2 control. He looked at a hypothetical international control regime. His conclusion was that the marginal benefit curve for CO2 control was quite flat according to the climate models available at the time (and I have read nothing that suggests that that assessment has changed in the meantime). As a result, taxes were far more desirable than permits, yielding $337 billion in global welfare gains versus only $69 billion for permits. (A hybrid system, with taxes levied on each unit of emissions above the permit limit, could do even better.)

While I would not hang my hat on the absolute numbers generated here, the relative magnitudes are likely to be in the ballpark given the logic of the argument and the flatness of the marginal benefit schedule for CO2 emissions control.

So the final score is: Permits get a moderate edge on political economy/public choice issues; taxes have a big advantage on institutional/governance issues; and taxes deliver a big can of whipass on traditional economic efficiency concerns. So conditional on accepting the weak case for CO2 emissions control, the Pigou people have a strong case against the cap-and-trade brigade. Maybe they should start making it.

Entry filed under: Former Guest Bloggers, Institutions, Myths and Realities.

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40 Comments Add your own

1. Michael Greinecker | 14 March 2007 at 9:39 am

On the third point: Emission permits are usually not first-best efficient on an international level:

Graciela Chichilnisky, Geoffrey Heal 1994 Who Should Abate Carbon Emission? An International Perspective (PDF, 1.3 mb) Economic Letters 44, 443-449
2. Lisa Moore | 14 March 2007 at 4:52 pm

You leave out the most important question:

Which policy is superior from a climate point of view?

A tax, if not high enough, can simply become “pay to pollute”.

Cap-and-trade, on the other hand, is built around guaranteed emissions reductions

(and we know what these need to be in order to avoid the

worst climate changes).
Cap-and-trade isn’t just theory – look at sulfur dioxide, which causes acid rain. Using a

cap-and-trade system, we’ve lowered sulfur dioxide emissions faster and cheaper than

even the program’s proponents expected (as described in this EPA report

[PDF]).

Enviros aren’t the only ones calling for emissions caps – some of the biggest companies

are coming on board, calling for a mandatory, economy-wide cap-and-trade system for

greenhouse gases (read the US-CAP

announcement [PDF]). They recognize the threat of climate change — which is sound

science — and the opportunities under cap-in-trade — which is good business.

Lisa A. Moore, Ph.D.
Climate & Air Program
Environmental Defense
3. Russil Wvong | 14 March 2007 at 5:47 pm

William Nordhaus describes some additional advantages of carbon taxes over cap-and-trade in After Kyoto: Alternative Mechanisms to Control Global Warming.
4. spostrel | 14 March 2007 at 6:37 pm

Russil: Thanks for the link.

Lisa Moore: Hey, I was for marketable permits back when the enviros all stigmatized them as “licenses to pollute” and insisted on prescribing “best available technology” mandates. They’re the inferior approach in this case, which is why I’m trying to warn people not to fall into the trap set by US-CAP, which I believe is engaged in rent-seeking behavior in endorsing cap-and-trade. There are all kinds of ways to rig permits systems to screw competitors or get windfall profits. Tax systems are much harder to manipulate.

The essence of the analysis by Pizer (and Nordhaus, as Russil notes in the comment above) is that we do not have a known threshold of CO2 where the impact goes from benign to severe. There may be a threshold where somehting nonlinear happens, but it would be an abuse of the evidence to suggest that we know what that level is. The idea that we get very little benefit from CO2 control after a known certain point and huge benefit before that point is not very plausible.

Moreover, as Nordhaus points out, the harm from CO2 is purported to be caused by the STOCK of CO2 in the atmosphere, while the costs of emissions are linked to the FLOW of CO2. Thus, EVEN IF we knew about a threshold in the impact of CO2 stocks, the benefits of CO2 control are probably close to linear in emissions flows. Since the costs are nonlinear, we really don’t want to end up with lots of emissions control if it turns out to be really expensive, or too little if it turns out to be really cheap.

Finally, the governance and institutional arguments for taxes over permits seem very strong to me. Have I (and Nordhaus) missed something?
5. happyjuggler0 | 14 March 2007 at 8:11 pm

Ok, assumie once again that one believes in the Greenhouse Effect Hypothesis (GEH).

Then one needs to understand that the goal is not the silly “10% (or so) lower emissions than 1990” standard of Kyoto, but that ultimately one wants to get to in the rough neighborhood of a 75% reduction, if not closer to 100%.

The Kyoto folks for some reason seem intent to making up new tougher standards for a limited time period (a decade perhaps), and then deciding at a time to be named later to mark it down still more. So the first leg is ~10% reduction from 1990, the second leg is currently uncertain but fudge it and guess ~20% from 1990, the third leg fudge it again and guess ~30-40% from 1990 etc.

This approach has some serious flaws. First, the uncertainty is just plain damaging economically. Second, it encourages “too much” emitting behaviour on the part of emitters, at least in the short term. Imagine you are in the EU and think that the third leg will be more expensive for most emitters to handle, much more so than the second leg. You might then be encouraged to buy emissions rights cheap for the seond leg, and hold off on a very cheap emission abatement method for another decade until you can sell those rights dearly. This might even be considerably cheaper than your purchases for the second leg.

An emissions tax not only discourages such inanity, but encourages emitters to make radical cuts ASAP if the price is low enough and their investments in physical plant or whatever are long term.

As such I am also inclined to think an emissions tax would also encourage more R&D investment into substitutions for “naughty” emissions due to avoiding the “tranche” implementation effect of the current Kyoto paradigm. If you invent an inexpensive ultracapacitor for example (an energy storage device, google for eestor), you are much more likely to get car buyers, utlilities etc. to make the investment *now*, not later, thus getting a faster return on your investment, something people not from the finance world seem to radically underestimate the iimportance of.
6. happyjuggler0 | 14 March 2007 at 8:19 pm

Sorry. By the way, an ultracapacitor would be of huge importance for intermittent green technologies such as solar panels or wind technology. One then wouldn’t need the hugely expensive redundancy of a coal power plant for example, since one could store a huge amount of power in reserve for nighttime or non-windy periods of time, as well as for sudden spikes due to heat waves etc.
7. Arem | 15 March 2007 at 7:17 am

People like clean. People pay for what they like. People will pay for clean. If we force clean by taxes, or regulate clean so that people have to go spend money anyway, they have less money that they’ll want to spend on clean. Either way, people use more clean stuff. So I say just let the economy run its course.

-Arem
http://www.seaofire.com
8. sa | 15 March 2007 at 7:23 am

a very illuminating post.defintely goes into my fodler for global warming must reads.
9. Alisha | 15 March 2007 at 10:16 am

It is erroneous to use a single report published in the late 90’s to conclude that there is marginal benefit in reducing CO2 emissions. When considering the costs and benefits, please consider the cost of Hurricane Katrina and other natural disasters. with the wealth of information we have gained about how humans are affecting the environment, and readily available green technologies.

The language used in report released by the UN Framework on Climate Change (one of the first calling for action) seemed to lend the thought that we must state that we can and must limit our CO2 emissions, while taking care to leave the global economy unchanged. This is impossible, and ridiculous, and a source of our inability to reconciile our economy and the environment.

We must shift our economic thinkings from the very short term, and an era of immediate gratification, to a more long-term sustainable mindset that incorporates carbon limiting technologies and societies. Both taxes and cap & trade will affect our economy, and I believe we should incorporate both – as in the long term the benefit will be our SURVIVAL.
10. Alisha | 15 March 2007 at 10:19 am

**the correct post i meant to leave! trouble with the HTML attempts… i apologize.**
It is erroneous to use a single report published in the late 90’s to conclude that there is marginal benefit in reducing CO2 emissions. When considering the costs and benefits, please consider the cost of Hurricane Katrina and other natural disasters. Certainly the relative costs and benefits associated with carbon dioxide and ghg reduction have CHANGED IN THE LAST DECADE with the wealth of information we have gained about how humans are affecting the environment, and readily available green technologies.

The language used in report released by the UN Framework on Climate Change (one of the first calling for action) seemed to lend the thought that we must state that we can and must limit our CO2 emissions, while taking care to leave the global economy unchanged. This is impossible, and ridiculous, and a source of our inability to reconciile our economy and the environment.

THE BOTTOM LINE: We must shift our economic thinkings from the very short term, and an era of immediate gratification, to a more long-term sustainable mindset that incorporates carbon limiting technologies and societies. Both taxes and cap & trade will affect our economy, and I believe we should incorporate both – as in the long term the benefit will be our SURVIVAL.
11. Lisa Moore | 15 March 2007 at 10:36 am

Dr. Postrel,

Thanks for this great discussion. For more information related to everyone’s points, please visit (and comment on!) Environmental Defense’s new blog, http://www.climate411.org.

But let me take on the primary misunderstanding here: contrary to Pizer and Nordhaus’s claims, scientists DO have an increasingly clear picture of the thresholds for catastrophic climate changes (never mind the fact that today’s impacts, which many people ALREADY consider dangerous, are only going to get worse).

Climate change is already happening, and in many cases it is occurring more quickly than scientists had expected. I would argue that the CURRENT impacts are already past being “benign”. We are losing Arctic sea ice, which endangers traditional cultures as well as Arctic species and ecosystems. Warming water is pushing many coral reefs past their thermal limits – in 1998, hot water bleached and killed 16% of the world’s reefs. These ecosystems support tourism and fisheries that millions of people depend on. Scientists calculate that global warming has greatly increased the risk of extreme weather events such as droughts and heat waves, like the one that swept across the U.S. last summer, and the nasty heat wave that hammered Europe in 2003. Mountain glaciers in Asia and South America, which supply drinking water to millions of people, are rapidly disappearing.

Even the most ambitious emissions targets that are being talked about are not likely to be enough to stop some of these threats. The “line in the sand” (or ice) that many people now worry about is the complete melting of the Greenland ice sheet. Scientists calculate from paleo evidence and modeling studies that if global average temperature rises more than about 2 degrees Fahrenheit (a little over 1 degree Celsius) above today’s levels, the ice sheet will begin a slow but inexorable disintegration, eventually raising sea level 20 feet. Because of a lag in the climate system, there is already about 1 degree Fahrenheit of additional warming in the pipeline. So we’re really talking about a much smaller window for action. And, there are other thresholds past that point, at higher temperatures. (Note also that the most ambitious target – stabilizing CO2 at 450 ppm, – does not eliminate the chance of crossing Greenland’s line in the ice. It simply minimizes it to about a 50/50 chance).

As for the difficulty of establishing a cap-and-trade system, of course it won’t be simple. But neither would taxes! And more to the point, there is a real risk that taxes would be set too low. That’s cap-and-trade’s biggest advantage: it keeps the environmental goal front-and-center. Science shows more and more clearly what emissions will need to be to achieve various temperature targets, including that 2 degree F line in the ice up in Greenland. The cap is based on science. Let the market sort out how to meet that goal as cheaply as possible.

Lisa A. Moore, Ph.D.
Environmental Defense

http://www.climate411.org
12. spostrel | 15 March 2007 at 12:19 pm

Lisa: Just to lay my cards on the table, I am accepting the so-called scientifc “consensus” (which I believe is really no such thing) purely for the sake of argument. I am very much unconvinced that there is anything remotely like the level of evidence needed to justify CO2 restriction at all. But I think a fair debate between a policy of watchful waiting (my preference) and immediate CO2 restriction requires me to consider the best possible version of a restriction policy, not a straw man, so I am trying to pin down which of those versions is the best.

On your points about a threshold: The latest IPCC policy summary actually reduces the predicted sea-level rise compared to its previous claims. And no one can say that a given level of CO2 ppm is the critical threshold. I don’t think you could find anybody, from James Hansen to Stephen Schneider to people who specialize in ice sheets, who would tell you differently.

Also, Nordhaus makes the excellent point that even if we knew that 450 ppm was the drop-dead number for the stock of carbon dioxide in the atmosphere, CO2 permits don’t control that–they only control the flow of CO2 from permitted sources. So going over or under these caps does not mean that the CO2 level in the atmosphere will go over or under the drop-dead level.

Let me repeat another point that you will perhaps find more congenial: Suppose we put in a cap and it turns out that we could have done a lot more cleanup because CO2 reductions turn out to be cheap–that would be a large welfare loss. We would have excess coral reef destruction, excess risk of ice-sheet collapse, etc. A tax won’t cause that mistake.

Finally, don’t we have a big problem with sources of CO2 and from individual automobiles and trucks? A tax would get at those, but I don’t see a practical way to run a permit system that atacks those sources. So I think there is a gap between your arguments and the desirability of cap and trade.
13. Lisa Moore | 15 March 2007 at 2:39 pm

Ok, Steve, here are some quick responses. (Again, you can learn more at our blog, Climate 411).

1) There is a consensus that warming must not exceed 2 degrees F above current levels. See for example this UN Foundation Report. The change in the IPCC projection of sea level has nothing to do with thresholds. What we’re talking about here is that if you pass a certain temperature, there is a very good chance the entire Greenland ice sheet will be lost.

2) There is a quantitative relationship between the flow of CO2 into the atmosphere and the build-up in the stock of CO2 in the atmosphere. A cap will slow the flow sufficiently to prevent the stock from exceeding the critical level.

3) You are correct, we don’t know how much it will cost to reduce emissions. A tax may get us to where we need to be and maybe not. A cap will get us there because it is based on the science. It’s that simple.

4) Cap-and-trade works by capping emissions upstream of their end use. It can therefore be made economy-wide (indeed it needs to be, since no one sector can do it alone) and will ultimately impact all uses including those from cars and trucks.

Hopefully the html tags work better with formatting this time! Thanks again for the discussion.

Lisa A. Moore, Ph.D.
Environmental Defense
http://www.climate411.org
14. ech | 15 March 2007 at 3:54 pm

But I think a fair debate between a policy of watchful waiting (my preference) and immediate CO2 restriction requires me to consider the best possible version of a restriction policy, not a straw man, so I am trying to pin down which of those versions is the best.

This is an important debate to have now. Get all the pitfalls out on the table, let everyone ask “Cui bono?” and try to get to a reasonable system.

One point about watching and waiting vs. immediate action. The time constant in the warming process may be long enough that by the time it is obvious that major problems have emrerged, it will overshoot into even more dangerous territory before emission controls can reduce the problem. Because of this, we have to act early.

Dr Moore: I’d be more supportive of your group (and many others) if it wasn’t so dismissive of nuclear power. You’ve bought into the usual canards about waste storage and transport, and are as guilty of muddy thinking as the extreme AGW skeptics are.
15. spostrel | 15 March 2007 at 6:03 pm

Lisa: I’m not prepared to go into a debate about the state of climate science in a comment thread, but I will say that the ED (I keep wanting to say EDF–shows what an old-timer I am) material you link is not representative of anything like a consensus of the scientific community. The latest IPCC summary, which is already somewhat biased to alarmism, has reduced expected sea level increases even in the worst case scenario.

Go over to Roger Pielke’s science blog and look at what he and his colleagues (not a “denier” amongst them) have to say. They do not believe that the kind of precise crystal ball statements ED is pushing are supported scientifically. They believe that this kind of false precision and scare-mongering might be appropriate for politicians like Al Gore (whom they seem to support), but worry that when the claims don’t come true they will destroy the credibility of scientists.

Here is climatologist Kevin Vranes comnenting on the recent NYT article about Gore:

“Mr. Gore depicted a future in which temperatures soar, ice sheets melt, seas rise, hurricanes batter the coasts and people die en masse. “Unless we act boldly,” he wrote, “our world will undergo a string of terrible catastrophes.”

Clearly this is not science, this is agenda. But it is agenda sold on science, and if/when it doesn’t come true, you have diminished the credibility of those producing the science. It’s a big gamble to take. I think perhaps what is neatly illustrated by Mr. Broad in this article is that many big-name climate scientists are willing to take this risk by hitching their wagons to a non-scientist who is doing the selling for them.

It’s a choice for individual scientists to make and I’m not faulting them or Al Gore for running down this path. In fact, I’d bolster my quote in the article praising Gore for getting the message out. I think Gore plays a very important and valuable role in public knowledge on climate change risk. (And FWIW, I’m betting with Roger that Gore will jump into the race, very late, will get all the money that the Clintons and Obama are raising now without having to stress himself to burn-out stage too early, and will stomp Rudy to get the WH. And yea Steve B, by saying this I’m angling for a position in the Gore White House.) But for the scientists they need to realize that Mr. Gore has a great cover if/when the dire predictions don’t materialize: “Hey, I’m not a scientist, I’m just a concerned citizen politician.” The scientists hitching their wagons to the dire messages have no such cover (except for tenure?).””
16. Top Posts « WordPress.com | 15 March 2007 at 6:59 pm

[…] Taxes al Carbon | Steven Postrel | Let’s suppose you’ve been swept up in the recent frenzy and decided that it actually […] […]
17. Zathras | 15 March 2007 at 10:43 pm

I have it on good authority that ED is not always so resolved to declare that we know enough to declare trading the appropriate response for today to environmental problems.

I don’t think in this case that we can overlook the obvious political reality that energy taxes in any form would be highly unpopular, and that this unpopularity affects many people (and organizations, especially those dependent on donated money) besides politicians. Cap-and-trade, by contrast offers to the general public a picture of costs elaborately camouflaged by an intricate and expanding network of government regulation.

I actually believe carbon trading has definite, if limited potential, as does trading to accelerate the provision of ecosystem services more generally. This is potential for the future, however, and no amount of repetition that the science has advanced to the point of justifying the substantial increase in state power that imposing carbon trading and emissions caps on the whole economy would require will make it potential for the present.
18. Owen’s musings » Blog Archive » Should we cap and trade, or tax, to reduce carbon emissions? | 17 March 2007 at 5:24 pm

[…] cap the total and then allow trading, or should we impose a tax on all carbon emissions? Organizations and Markets looks at the economics. Here is the conclusion: So the final score is: Permits get a […]
19. Mitra Ardron | 18 March 2007 at 12:39 am

I don’t think enough emphasis above has been given to the distinction between permits – auctioned or sold in some other way, and cap-and-trade.

My concern is that cap-and-trade provides a large financial incentive to an industry that goes from terrible to simply bad, in competition with energies that are clean from the beginning.

Permits on the other hand would require dirty industries to shell out something that I presume would be similar to the amount that a tax would have to be to achieve the e same effect, with the primary difference between permit v. tax being that collection would be from a smaller number of players who would pass it on via prices, rather than from customers directly at the pump.

So from my perspective either permits or taxes look good, but cap-and-trade is just $$$ to the people who created the problem.

– Mitra
20. spostrel | 19 March 2007 at 12:33 am

Mitra: Cap and trade really is a system of permits (or “marketable discharge rights,” as they used to be called). The essence of it is the cap, a total allowed amount of emissions for the entire regulated area. It only transfers wealth to the emitters if the permits are given away rather than aucitoned off. Admittedly, that is the more likely scenario.

The alternative you seem to be suggesting–setting a fixed price and saying emitters can buy a ton’s worth of emission rights for that price–is the same thing as a tax, because it doesn’t cap the total emissions level. if people buy lots of permits under this scheme, then there will be more emissions. It’s like saying you can only sell a pack of cigarettes if you have a stamp from the government, but the government will sell you as many stamps as you want (which I think is how most state cigarette taxes work, but I’m pulling this out of my ear). You want to avoid confusing the mechanics of how payments are made with the economic constraints imposed.

Personally, I am not so worried about the distributional consequences of cap and trade, for two reasons:

1) The incidence of these wealth transfers to emitters is not clear. Corporations are owned by lots of people, including union pension funds, so making some of them richer has ambiguous effects on the income distribution for individuals.

2) I don’t think carbon dioxide emitters are immoral or undeserving or “causing the problem” as you put it. Not only do I myself tend to exhale, but I and everyone else benefits greatly from the use of fossil fuels to power our civilization. Furthermore, it isn’t even clear that we wouldn’t be better off accepting the CO2 emissions and adapting to any climate changes, rather than making what look to be large sacrifices of output.

My actual concerns with firm rent-seeking through lobbying for favorable cap-and-trade allocations have to do with the deadweight losses incurred. Specifically, a) the monetary waste of lobbying competition and the attendant increased corruption of the legislative and administrative proceses, and b) the distortions caused by giving the wrong amount of permits to different sources in a world of positive transaction costs.
21. Marcin Tustin | 19 March 2007 at 1:12 pm

Is there any room for combining permits with taxes? So, emission without a permit is a serious criminal offence, allowing us to immediately meet our limit at the disaster ceiling, plus taxation on emissions?

This should avoid over-charging for carbon dioxide emissions if the permits are auctioned off, if the tax level is known ahead of time, as bidders will adjust their private valuations (and quantity demanded). Or am I wrong? Would we need to make the permit price paid tax-deductible?
22. spostrel | 19 March 2007 at 2:59 pm

Hybrid systems where you can emit up to your permit level and then pay taxes on anything over that limit can be superior in efficiency terms to either pure approach. This is not surprising since the polar cases of pure price or pure quantitiy regulation are special cases of the hybrid.

Once again, the question of how the permits get allocated initially would have no efficiency consequences in the absence of transaction costs, only distributional effects. If people could buy and sell permits cheaply, find trading partners easily, avoid haggling delays and holdups, etc., then actual emissions levels from different sources shouldn’t be affected by the inital permit distribution–trades would allocate them to where they were most valuable, the only difference being side payments among the sources.

With substantial transaction costs, however, an auction of some sort might be necessary to get efficient outcomes. One could imagine that markets for CO2 permits would develop, as they have for sulfur dioxide in the US. but if this has to work internationally I am highly skeptical that national governments will ever allow the market to function in that way. They will want to protect their local industres and employment bases.

In general, the whole discussion strikes me as somewhat hypothetical, given that China and India are not going to hold back their economic development to slow down global climate change, and there is no way the other developed countries are going to make the huge cutbacks necessary (according to the so-called consensus) to stabilize global temperatures. But that’s another story.
23. Bill Woods | 19 March 2007 at 5:54 pm

S. Postrel: “Finally, don’t we have a big problem with sources of CO2 and from individual automobiles and trucks? A tax would get at those, but I don’t see a practical way to run a permit system that atacks those sources. So I think there is a gap between your arguments and the desirability of cap and trade.”

The emission-permit system — or carbon tax — should be applied at the coal mine and oil refinery level (with adjustments for imports and exports). We can reasonably assume that nearly every ton and barrel will eventually be burned, right? So let the fossil fuel producers dealing with the stuff in bulk measure the carbon content and take care of the paperwork, and pass the cost through to fossil fuel consumers.

I favor the tax myself. How about the equivalent of 5¢ per gallon of gas per year for a decade or two? Not too much at first to kill the economy, but high enough in prospect to change preferences toward nukes, efficiency, hybrids, etc.
24. spostrel | 19 March 2007 at 6:02 pm

Bill: Lots of oil (in absolute, though not percentage, terms) is used as a chemical feedstock. I don’t think it’s a good idea to arbitrarily crater the plastics industries, for example, in favor of glass or aluminum. Talk about distortionary policy! So I’m opposed to an upstream system that regulates production rather than burning of fossil fuels.
25. Bill Woods | 20 March 2007 at 1:13 am

Crude oil, yes, but refined gas/diesel/kerosene?
26. spostrel | 20 March 2007 at 1:01 pm

Now you’re talking about going to refineries and counting how much comes out of which pipe. I guess that’s possible in the US, at least, although I woudn’t expect it to work real well in some of the international environments necessary to affect CO2 levels.

At any rate, the political economy of this approach to permits is worse than consumption taxes. Gas prices will go up without a visible tax being imposed, which will lead the public to blame the oil companies and let the politicians off the hook.

As I’ve mentioned above, I am personally not in the Pigou Club, and I am not in the do-something-to-cut-CO2 emissions camp in general. I just want to compare my preference for watchful waiting to the best, rather than an inferior, version of CO2 restriction.
27. Bill Woods | 20 March 2007 at 6:29 pm

You can, and should, make the tax visible easily enough (if you have the votes to pass it in the first place) by mandating a sticker on the gas pump saying, “This product contains XXX kg of fossil carbon per tonne. The Federal Carbon Tax is $DD per tonne of fossll carbon, or CC¢ per gallon.”

The equivalent sticker for a cap-and-trade system is a little trickier — fill in the market price at the close of the last month or some such.
28. Dallas Weaver | 22 March 2007 at 9:07 pm

The statement: “Fourth, there will often be uncertainty about the future cost of permits, which would make investment planning more difficult than with a tax, which would be more predictable.” may be the dominant term in determining how fast the system responds. With most alternative energy sources (wind, solar, nuclear) and controls like sequestration being hight capital cost with long construction times (including permit and EIR time delays), economic predictability is a key ingredient in decision making. Taxes could be known decades in advance with an increasing rate, where decision makers can plan for a plant or process years before the taxes are high enough to cost justify the plant or process. This could eliminate or decrease the huge time delays involved in the type of projects that will be required to control the CO2 problem.

With the CO2 issue, we don’t have to worry very much about overshooting. Completely eliminating all emissions of CO2 won’t do anything about the inventory that we have already built up in the atmosphere and oceans. With the atmospheric system containing potential tipping points which may be both a function of the concentration of CO2 in the atmosphere and the time at that concentration (lots of lags in the system), the modeled flat marginal benefit curve may not be true.
29. spostrel | 23 March 2007 at 12:26 pm

Dallas: I think overshooting on control is potentially a big, big problem. For example, you point out that completely eliminating all emissions of CO2 may have no effect on whether we cross some tipping point. In that state of the world, ANY restriction is wasteful, making us unambiguously poorer (and incidentally less capable of adapting to shifts in climate).

CO2 restriction only makes sense (assuming you believe the climate models) in the Goldilocks case, where climate is stabilized if and only if we reduce flows today. The flat marginal benefit curve model actually makes restriction look more sensible than the tipping point scenarios do.
30. KYOTO – Dio "jedan" « Cronomy | 2 May 2007 at 12:42 pm

[…] korak je znanstveno-ekonomski dokazati troškove i benefite određenih politika borbe protiv GZ. Trgovanjem CO2 ili porezom na emisije, uglavnom nekim tržišnim mehanizmom jer znamo da je slobodno tržište puno bolji […]
31. John Mathews | 21 May 2007 at 4:20 am

I’m not sure why such an interesting thread died so suddenly. Has everybody run out of things to say on such a challenging topic?
And what does ‘Taxes al carbon’ mean anyway?

Let’s go back to fundamentals. Why would you expect a sensible legislature to choose between carbon taxes and emissions quotas (cap and trade)? If the problem is really as big as the IPCC tell us it is, then surely you’ll need a hybrid system that captures the best of both approaches.
We know how it can be done. What is needed is a system that imposes a tax on carbon emissions, ratified by a global treaty and enforced by a newly created global authority, preferably one that operates outside of the UN system that gave us Kyoto. A tax on carbon emissions sheets home the problem to where it originates, making the polluters pay. But a tax also has its drawbacks, such as its falling most heavily on the most entrenched carbon emitters, giving them few political options other than to oppose it – which they have done very effectively for the past decade, and would no doubt continue to do so. So let us combine the tax with a permit system, under which tradeable permits can be allocated to the most intensive carbon emitters (at less than their current output). The tax in such a system can be imposed in the form of short-term permits that have to be bought from the government, to make up any deficit in carbon permits over carbon emissions.
The proposed hybrid scheme that combines a system of carbon permits with a tax at the margin achieved through the sale of short-term carbon permits, is what the world needs now to get past the Kyoto roadblock. It gets around the endless debates over whether quantitative or price-guided targets are preferred. The answer is: both are needed. This is the basis for a hybrid scheme that has been proposed and analyzed for a decade now by scholars such as McKibbin and Wilcoxen; Pizer; Aldy, Orszag and Joseph Stiglitz.
As expounded by McKibbin and Wilcoxen over the past decade, such a hybrid scheme establishes a system where carbon emissions have to be matched by carbon emission permits, where adjustments at the margin reflect the prevailing price of carbon. The scheme has three core elements: 1) a system of long-term permits (LTPs) to emit one metric ton of carbon per year that can be allocated in any way seen fit to the carbon emitters in a country, and henceforth can be traded in perpetuity; 2) a system of short-term permits (STPs), say annual permits to emit one ton of carbon, that can be sold by the government for a set ‘trigger’ price and are valid only for the specified short-term; and 3) an enforcement mechanism whereby emitters of carbon within the country concerned must have permits (both LTPs and STPs) that match their emissions. Effectively these three elements put an economy on a carbon-price footing, and force emitters to take the price of carbon into all their investment decisions. But it does so in a way that enrols carbon emitters as supporters of the scheme, by allocating the long-term permits to them at the outset (always at a level that forces them to reduce emissions or purchase short-term permits to cover the shortfall). The sale of short-term permits acts effectively like a carbon tax at the margin, generating fiscal revenue for the government and setting a cap on the costs of adjustment for emitters.
A hybrid scheme of the type proposed has the advantage of being national in scope, so that tradeable permits have an origin that is subject to national jurisdiction and control with the national government implementing it in such a way that it conforms to the country’s legal and institutional endowments. This is its huge advantage over the Kyoto system where permits can be created internationally from notional entitlements, such as Russian ‘hot air’ arising from its emissions in the mid-1990s being below its 1990 levels. But if the hybrid scheme is ever to get off the ground in time to save the planet, the details of the scheme will clearly need to be settled at an international conference and then implemented in a coordinated way. The key to coordination lies in adopting a common price for the short-term permits, not so that they can be traded internationally, but so that the scheme imposes equal efficiencies on each economy, and so does not create windfall profits from trade.

I had a letter published in the Financial Times over the weekend on this theme, calling for a global carbon pricing authority in opposition to the international carbon fund proposed by BP’s Browne and Butler.
32. spostrel | 5 June 2007 at 2:33 am

I noted in my orignial post that hybrid schemes theoretically outperform either pure tax or pure permit schemes. The above description of a hybrid scheme seems so complex that it requries almost utopian political conditions for adoption and implementation.

The one realistic political concession–giving permits away to existing emitters to buy off their opposition–opens up a huge can of worms for corruption and manipulation of the system. The proposed allocation scheme for long-term permits rewards the highest-emitting producers and punishes the lowest-emitters. Adjustments for this will allow endless rent-seeking and raising of rivals’ costs.

On a less importan but not trivial matter, the paperwork burden of this system would favor larger organizations over smaller ones, because there are substantial fixed costs of setting up a system to deal with all the permitting activities. it’s been suggested that permits could be applied to the production of fossil fuels rather than their consumption, which would take the burden off small factories, etc., but then you do get into serious issues with inventories of fuel.
33. David Hoopes | 10 July 2007 at 5:04 pm

The URL link is from the WSJ. Rep Dingell (D, MI) has suggested a carbon tax to force environmentalists to deal directly with the costs of taxing carbon emissions.
34. dhoopes | 7 September 2007 at 3:44 pm

http://www.opinionjournal.com/editorial/feature.html?id=110010314
35. Really Stupid Ideas, take two: Hillary Clinton edition. « The Inverse Square Blog | 22 April 2008 at 2:03 pm

[…] her link to Stephen Postrel’s quickie analysis of carbon tax vs. cap and trade economics here. S. Postrel falls into a familiar smart guy trap of opining about stuff he doesn’t actually […]
36. cthulhu | 23 April 2008 at 11:06 pm

As an Econ major myself back in the depths of time, I can’t help but be fascinated about the opportunities for experimental economics, even as I cringe from the overall train wreck inevitably following from policy-making on such shaky premises….Sort of like the Allies’ use of medical information from Nazi prison-camp experiments, I suspect.

Then experimental wrinkle that I would be most interested in involves a de-coupling of “means” and “ends” with regard to energy policy. Have a cap-and-trade, but base the credits on each year’s GAAP income rather than previous emissions — and have each years’ credits depreciate over the next X years. This would make the total annual pool a multiple of the current year’s allocation allotments, but since it’s just the number of slices of the same pie, this shouldn’t be too complex. As a side note, the trades would have to proceed on a single-market anonymous auction basis.

To trace a single thread through this model, a power plant showing a GAAP profit of $100K would have to raise its rates by a large multiple to purchase more emissions allowances. A highly-profitable legal firm, with no prior emissions, would find itself in possession of a number of emissions allowances and a whompingly-huge electric bill. It could cash out its allowances to pay the electric bill and forgo a rate increase because its net would remain roughly equal…

The question is whether such a regime would better reflect total societal system costs by, as it were, “including externalities”….and not create additional economic distortions.

My faith in legislators, bureaucrats, and admistrators is such that I’d much rather this sort of test case be tried-out on somebody else….but it is intriguing.
37. Virginia Postrel on carbon caps « Muse Free | 24 April 2008 at 12:17 am

[…] Here’s the link to the full post. Also you can read Stephen Postrel’s analysis (linked from Virginia Postrel’s post as well) of carbon tax vs. permit economics here. […]
38. Mike Smith | 24 April 2008 at 5:09 am

There is no scientific reason to do any of this.

The fact is that world air temperatures peaked in 1998. The more important measure, ocean temperatures, have been falling for four years. The author of the 2005 paper linking hurricanes to global warming has just published new research questioning the link.

Evidence has accumulated that the sun (combined with changes in the way air temperature was measured) was responsible for the warming of the 1990s. The IPCC’s case has been largely falsified in that if CO2 is the driver of climate, temperatures would now be at record levels. Instead, they are below the levels of ten years ago.
39. joe | 26 April 2008 at 2:29 pm

What kind of tax? Institute a small but continuously increasing over time tax on fossil fuel and eventually alternative energy sources will be economical. If you don’t want to give politicians more revenue distribute the proceeds via social security or tax credits.
40. Does Climate Change Matter: Steven Postrel Edition « The Inverse Square Blog | 29 April 2008 at 7:09 pm

[…] doing so I linked, approvingly, to Steven Postrel’s analysis of the relative policy and economic consequences of a carbon tax vs. a carbon cap-and-trade system […]