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It’s simple. It’s easy to enforce. And it provides the right incentives to polluters as well as inventors and engineers working to develop cleaner technologies. -
A cap and trade policy gives business greater certainty about future costs. It also puts a limit on emissions and is more likely to result in a real reduction in greenhouse gases.
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Ed. note: Our climate change debate engendered a lively conversation among readers that pushed the original essays well beyond their starting points.
Gregg Easterbrook
Why we need a carbon tax
It’s a three-letter word that starts with “t,” ends with “x.” Go ahead, don’t be afraid to say the word—“tax.” The simplest, most efficacious, least bureaucratic, and best-for-the-nation initial move against greenhouse gas buildup would be a carbon tax.
This is not a liberal nostrum. Economist Martin Feldstein, once President Ronald Reagan’s chief economic advisor, has been advocating a carbon tax for nearly 20 years. In 2007 N. Gregory Mankiw, former chief economic adviser to President George W. Bush, threw his weight behind the idea, saying that a carbon tax “may be the closest thing to a free lunch that economics has to offer.” Here are the main arguments for a carbon tax:
- Such a system would be far less complex than any cap-and-trade scheme. The McCain-Lieberman greenhouse gas cap-and-trade proposal, which drew 43 votes in the Senate in 2005, was 491 sections long. And that was just the authorizing legislation, not the tens of thousands of pages of administrative orders required to put the bill into force! The Obama plan is likely to be equally complex by the time it wends its way through Congress.
- Because carbon cap-and-trade systems are inherently super-complex, they are nearly certain to be “gamed“—defeated by gimmicks, litigation, and special-favors lobbying. Lawyers will always think of pretexts faster than regulators can repair flaws in the language of complex regulation. America’s approach to environmental regulation is already too steeped in litigation. A carbon cap-and-trade system would make this problem worse.
- Whatever you tax, you get less of. Today America mainly taxes labor and capital—but we want more of both! We don’t want more carbon, so let’s tax that instead.
- Owing to simplicity, enforcing a broad-based carbon tax is imaginable. Enforcing a broad-based carbon cap-and-trade scheme is hard to imagine.
- If carbon is taxed, individuals—not government—will make the decisions about greenhouse-gas reduction strategies. Individuals have a much better track record at economic decision-making than government does.
- Carbon taxes will offer a clear, easy-to-understand profit incentive to those who devise carbon-reduction technology—so inventors and engineers will get to work. Conversely, cap-and-trade programs will offer an incentive to game the system; so pollsters and lobbyists will get to work.
- The only policy failure concern about a carbon tax is that individuals and firms will simply pay the tax rather than reduce emissions. This is possible, but unlikely: experience shows that individuals and firms change behavior to reduce taxation.
But isn’t it totally and utterly politically impossible to enact a tax? Perhaps in the 1990s, when the federal budget was in surplus. Today the federal government is on the worst borrowing binge in its history—the national debt has doubled in a decade! Voters are not fools; they know little twinkling fairies will not come in the night to replace all the borrowed money. Debt must be repaid, and a carbon tax, which would create net benefits to society, may look a lot better to voters than other possibilities.
Carter F. Bales and Richard D. Duke
Carbon caps are better
There are two main contenders for constraining carbon emissions: caps and taxes. Both are market-based approaches that put a price on carbon and other greenhouse gases and provide an economy-wide signal to encourage emission reductions, beginning with the lowest-cost opportunities.
The main difference between the two is that a pure tax fixes the price of carbon (but allows the amount of carbon emissions to vary) while a pure cap places limits on carbon emissions (letting the market price of tradable carbon allowances vary). We argue that a well-designed cap with certain tax-like features is the most efficient strategy to radically reduce emissions. This approach has four advantages.
First, a well-designed cap offers superior investor certainty relative to a tax because it establishes clear, long-term abatement requirements and allows the private sector to estimate the allowance prices needed to get the job done. In contrast, a carbon tax would likely start too low given political pressures and it would be exposed to unpredictable adjustments, as politicians would tend to raise or lower the tax in reaction to economic conditions. A well-designed cap should also include specific tax-like provisions.1 Most important, the government should purchase and delete allowances if the price falls below a gradually rising floor.
Second, a cap on carbon provides more fundamental environmental certainty than a tax, because it is, by definition, a fixed limit on emissions and because the political process to define a cap is less likely to result in emissions loopholes. In particular, the political horse trading involved in defining a cap centers on distributing a fixed number of allowances—with equity and economic productivity implications but with no impact on future emissions levels. In contrast, negotiations to define a carbon tax might result in exemptions for certain sectors, which would allow higher emissions levels.
Third, once carbon caps are in place, all energy consumers share an interest in promoting complementary policies that reduce emissions. For example, all energy consumers will benefit from lower carbon allowance prices if they persuade policymakers to enact and enforce minimum energy efficiency standards for buildings, appliances, and vehicles.
Fourth, carbon caps provide a useful economic shock absorber, since allowance prices automatically soften as soon as the economy enters a recession. In principal, carbon taxes could also be adjusted frequently to make them more countercyclical, but to do this effectively would require an unlikely level of sophistication, objectivity, and alacrity on the part of policymakers.
Experience from the US cap-and-trade system for controlling the sulfur emissions that cause acid rain suggests that a well-designed approach can yield unanticipated cost-reducing innovations. If we do not take action immediately, greenhouse gas abatement costs will rise sharply.
1 See us-cap.org to download the Blueprint for Legislative Action, issued in January 2009 by 25 major corporations and 5 NGOs.
07 May 2010 · 08:42:14 PM GMT
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The most successful tax schemes hit optional purchases, like cigarettes and alcohol. Higher prices on these goods definitely reduces consumption, plus you get the interesting shift in demand to more premium subsegments. Taxes on basic commodity goods, like gasoline, become overly politicized very easily. Remember the furor about a tax holiday for gasoline in summer 2008?
I see carbon emission control more akin to gasoline efficiency and water quality management: policies that cap usage rates as a function of economic performance will work, even though the poorer performers will complain about the “unfair cost of compliance.” Therefore a cap/trade policy will make the most sense, and the trading market for emission credits or investment projects that cancel emissions will fluctuate with both the level of overall economic performance and the creativity of entrepreneurs to identify viable alternatives.
Posted 3 March 2009, 10:28 by Jose Tormo
The argument for a carbon tax seems to be that it is a more efficient systems since it allows for freedom and ingenuity in coming up with solutions.
The argument for C & T seems to be that it’s political digestiblity gives it a greater chance of becoming reality.
I would rather take an action which can be readily implemented rather than design a perfect system which will never see the light of day.
C & T seems to be the quicker ‘escalation prevention’ step, which can be tweaked with time to become more effective.
Posted 2 March 2009, 21:05 by sameer marfatia
Cap and Trade is more likely to succeed and spur the kind of innovations that will have lasting impact… the US acid rain problem was solved using this mechanism and there is no reason why it wouldn’t work for CO2.
A tax system will favor big companies that can pay and still pollute… they will simply look for cheaper and cheaper ways to produce to offset the tax expense… a cap and trade will force businesses to figure out novel ways to cut carbon… your imports from low cost highly polluting countries will count towards your carbon quota…
This argument by itself should be enough to convince you that Cap and Trade is definitely better.
Posted 2 March 2009, 14:46 by Mondher Ben-Hamida
I like both ideas but side with C&T more. It is hard to fathom the point that individual consumers would make decisions in the immediate term that would reduce overall emissions (isn’t that the goal after all?).
To say nothing of the fact that each industry will push for different emission standards as their baseline. While C&T has its own flaws, those flaws are in the design of the caps – we have done it well (SO2) and badly.
C&T might be complex to the lay person – but I would guess it makes ample sense to traders/industry once caps and price floors are set.
Posted 2 March 2009, 14:17 by Aditya Bhashyam
I like both ideas described and they are both valid alternatives to reduce carbon emissions. Although I’m inclined towards a carbon tax, think of “Why do we tax labor (and capital to a lesser extent)?”
Labor and immobile capital (like real estate) is taxed because it is easy to control. How will you avoid high carbon production being shipped to location with no (lower) carbon tax? With import tarifs? It will be a tricky balancing act to not enter into some sort of disguised protectionism.
A world-wide agreement (Copenhagen 2009) on which system to adopt will be far more effective than bickering over the “ideal” system.
Posted 2 March 2009, 13:47 by Chris Vansnick
I am in favor of a tax rather than cap and trade. My reason is that, like George Soros, I am worried that the complexity of a cap and trade opens opportunities for bureaucrats, the coal industry and environmental advocacy groups to manipulate the system in ways that serve their interests but not the public good. A tax is straight forward. We know who pays and for what. It can be adjusted instantly.
I believe we should move toward renewables, conservation and nuclear (instead of coal.) I don’t know but I suspect that the coal lobby is actively supporting cap and trade. I do know that Environmental Defense has staked their reputation on cap and trade and they are cozy with the coal industry.
Posted 2 March 2009, 13:38 by Steve Barrager
Both articles miss the key issue here: a need to fundamentally change the way we think. The solutions presented assume that the majority of the public has accepted the need to reduce emissions in the first place – have we? While there are certainly people who support the need, there is still a mountain of work to be done. Once we get the critical mass of people to agree, then we can have a meaningful debate on how to ‘value’ the emission of carbon. Mr. Easterbrook points out “whatever you tax you get less of,” however, most of us with jobs still get up and go to work every day regardless of the tax burden. I think a more accurate statement would be that people get more creative on how to avoid that tax, especially when they need more of the taxed item.
Posted 2 March 2009, 12:52 by Steve Foran
I can only agree with the carbon taxes. They would be much more simple to implement AND could be coupled with CDM capabilities to generate tax benefits.
My only doubt is to how efficient we can be at calculating the individual carbon emissions for each product, but I think that even that is easy to fix.
Answering to Eddie Correa’s comment on passing the tax to customers, even if the companies did pass everything to the prices, that is actually a GOOD thing. Customers would have increasing incentives to trade from carbon-intensive products and services to ones that involve less emission.
Posted 2 March 2009, 12:44 by Felipe Palha
The premise that placing a tax on carbon-producing companies will cause them to reduce carbon emissions is an illusion. It will not. Because those companies—which need to profit in order to stay in business— will simply pass those costs on to consumers. For evidence that “cap and trade” does not work, we need only look at Europe, which has not reduced emissions since implementing its system.
Posted 1 March 2009, 11:44 by Eddie Correia
I would like to see what Carter Bales means by “tax-like features” that a cap and trade regime could have, but it’s not clear from the footnote, which just links to a long report. If tax fans like me knew what that meant perhaps we’d get more comfy with C & T
Posted 28 February 2009, 19:01 by Matt Miller