5 Reasons Why Cap and Trade is Preferable to a Carbon Tax
Posted January 20, 2009 in Curbing Pollution, Green Enterprise, Moving Beyond Oil, Solving Global Warming
It is often asserted that a carbon tax would be simpler, more transparent, and have fewer special provisions, accommodations, or loopholes than a cap and trade system. The fallacy, however, is to compare a "real-world" cap and trade design with an idealized carbon tax design.
Indeed, every pressure for special accommodations seen in the legislative process for developing a cap and trade system would be present in the legislative process for adopting a carbon tax. The following is a list of five reasons why cap and trade is preferable to implementing a carbon tax as a means to achieving our expressed goal of an 80% or greater reduction in greenhouse gases by 2050:
1) Guarantees Emission Reduction
If the goal is to reduce the amount of greenhouse gases in the atmosphere by 80% or more, a cap and trade program that gradually reduces the amount of CO2 permits available to emitters over a 40 year horizon is far more effective at achieving this goal than a tax. A carbon tax can only attempt to change consumer behavior and is therefore one or more steps removed from actually affecting the desired emission reductions within an acceptable time frame. In other words, a cap directly regulates the quantity of dangerous pollution, whereas the emission results of a tax are less certain.
2) Creates Better Economic Certainty for Investment
In order to make the investments in clean energy needed to achieve our goals, investors need a clear price signal. Cap and trade provides a 40yr framework of economic certainty that will allow investors to base their investments on what industry thinks the price of carbon is today and will be far into the future. A carbon tax would only offer what government thinks a carbon tax rates needs to be on a year by year basis in order to best attempt to affect the desired emissions reductions.
3) Program Costs are Countercyclical
The price of carbon under cap and trade legislation will fall as the CO2 output from the economy slows and will rise as the CO2 output from the economy accelerates. In other words, carbon prices are countercyclical and wouldn't provide an undue burden on the economy during periods of economic stress. This makes cap and trade far more effective than a carbon tax, which needs to take into account how much progress the carbon tax has made historically before it can decide whether or not to provide economic relief during an economic slowdown.
4) Less subject to Political Intervention
While the regulation of a cap and trade market for CO2 is likely to be reviewed every five years, the program itself will be designed for nearly four decades and will not be subject to the intense political pressure that a carbon tax during periods of economic stress. As it is politically advantageous to under-estimate the amount of tax needed to affect a certain change in behavior, it is likely that a carbon tax program would be persistently behind on its reduction targets and constantly confronted with calls to either reform or abandon the program. Further, during periods of nascent economy growth, politicians will constantly struggle to determine the amount of increase in carbon taxes needed to avoid derailing the recovery.
5) Better Advances Goals of Complementary Standards
Under a carbon tax, innovation in one area isn't rewarded as predictably as it is under cap and trade program, as carbon taxes don't directly affect emissions reductions but rather consumer behavior. This makes cap and trade more effective at stimulating investments in complimentary standards which measure their economic value based on known carbon prices.
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Comments
David B. Goldstein — Jan 21 2009 01:28 PM
Argument 2) is even stronger than as presented here: a low cap makes it clear that long-lived carbon-intensive investments such as coal plants that don't sequester carbon or highways that induce new auto travel will have to be written off prematurely because current levels of consumption will be larger than the whole cap in a known future year.
James Handley — Jan 26 2009 01:56 AM
Andy,
1) "Emissions certainty" under a cap would require broad, effective enforcement. (I served as EPA enforcement attorney, I'm skeptical that EPA could enforce a cap.) An upstream carbon tax on coal, oil and gas producers and importers would be simple to enforce. And we saw what happened last summer when gas prices hit $4. There's no doubt that higher prices reduce emissions by encouraging conservation and innovation.
"Emission certainty" also assumes that the public would support a cap when whipsawed by wild price spikes for energy, especially coal-generated electricity. In California's RECLAIM smog cap-n-trade program, electricity prices shot up. The governor popped the cap. End of "emissions certainty."
2) Investment certainty. Unpredictable prices under a cap mean more, not less risk. A steadily increasing carbon tax would make investments in innovation and alternatives more attractive. Cap-n- trade's volatility (as evidenced by the EU system and 50% swings in SO2 cap's permits prices) creates uncertainty and deters rational investment.
3) "Counter-cyclical" is another way of saying: there's no price on carbon when the economy is in the tank. The slowdown in the EU means they're meeting the cap without doing anything to reduce emissions. When carbon prices are slack, the signal is to build wasteful infrastructure, inefficient houses, cars and businesses, and then we'll get slammed against the cap ceiling when the economy turns around.
4) Political intervention. A carbon cap is a hidden tax. And the Ways & Means Committee (and the US Constitution) seem to agree. Congress can change either a cap or a tax; that's a fact of life. But a cap that strangles the economy would provoke more ire than a gradually increasing revenue-neutral carbon tax that distributes revenue to every household in the country.
5) Cap proponents hope auction revenue can be diverted into subsidies for energy efficiency and renewables without going through an appropriation process. I doubt it. Furthermore, government isn't good at picking technology winners, especially this early in the race. (Ethanol subsidies?) We'd get much more for our money by letting price signals water the flowers of innovation in the private sector rather than government trying to pick and fund the right technology horse.