Saturday, December 13, 2008

Some brief words on a carbon tax

In its post on recent developments in Poznan and America, CGS referred several times to a cap-and-trade system for reducing emissions. Such a system, in which an overall limit on emissions is set, and businesses and organizations buy, sell and trade permits to emit, is the preferred option for developed nations to cut carbon. An Emissions Trading System has already been partially implemented in Europe, and the Obama administration has signaled its intention to institute something similar in America.

But CGS would like to put in a plug for a carbon tax. This would simply tax a set amount per ton of carbon. A carbon tax has the benefit of being economically efficient; it directly imposes a cost on those who burn carbon, reflecting its environmental externalities. The extra cost should encourage people to burn less carbon, reducing the economy's overall carbon intensity. It also avoids the complications of a cap and trade system, including how to allocate permits. At least, in theory. Problems remain, including how to set the price of carbon high enough to reflect its actual externalities.

But before someone (probably an American) tells you taxing carbon will never work, or is anti-freedom, note that several countries, including Finland and Sweden, have imposed carbon taxes for over a decade. Descriptions can be found on the website of the Carbon Tax Center, but for now, suffice it to say that these countries have imposed a carbon tax for some time without political revolts, and while retaining very high rankings in global indices of business competitiveness.

Food for thought.


  1. Scott, let me add some counterpoints (and yes, I am an American)...

    1. Both carbon taxes and cap and trade systems a) are economically efficient, b) impose costs on emitters, and c) reflect environmental and social externalities. Their effectiveness will come down to how a government decides to design the instrument.

    2. A tax does not "avoid the complications of a cap and trade system". To achieve the same level of effectiveness, equity, and credibility, both must have equivalent levels of monitoring, reporting, and verification. Both must have an administrative body to enforce the rules of the program. And both can avoid the politically complicated allocation process (simply auction the allowances to sources as the Northeastern States have done in the Regional Greenhouse Gas Initiative.)

    3. It is very complicated to set a price that leads to the necessary reductions. There is a lot of uncertainty about consumer responses to price changes. Looking at the recent rise (and now fall) in US gasoline prices, it took more than a doubling (to about $4/gallon) before people significantly changed their behavior. They complained from the very start, but a 100% increase was necessary to shift behaviors. Trying to figure out where to set the tax is very challenging. By contrast, a cap and trade program sets emission reduction targets without regard to price.

    I think both instruments have considerable merit and I believe you will likely see a hybrid approach used for domestic programs (especially in the US) that start with a cap and trade program but include a safety valve (ie, price ceiling) that allows companies to pay the "tax" for "busting the cap".

    Whether you choose tax or cap and trade, the programs can be designed to enhance, not hinder, competitiveness.

  2. Thanks, make some good points! And you're right, I think both approaches have merit. But I still believe a carbon tax has distinct advantages. For example, while it's hard to get the price right, taxes are easily (in technical, not political terms!) changed, whereas if you sell permits at the wrong price, your whole cap and trade system is imperiled.

    And as for price signals, fair point, but I think if the tax is at high enough magnitude, it will certainly influence consumer behavior. True it took more than a doubling in gas prices to change US Consumer behavior, but what a change when it did happen: the New York Times reported that use of public transportation exploded, for the first time, in the period 2006-present.

    Finally, I think you're right that both programs can be designed to enhance competitiveness. And that really is the most important thing, politically speaking.

  3. Let me add on to this argument, agreeing with Scott's push for carbon taxes.

    1) The point about needing an accurate tax to get the right amount of reductions is correct. But, it is not as difficult as you imply (as evidenced by the accuracy to which the Regional Greenhouse Gas Initiative was able to predict carbon prices at its first auction). In fact, the support you use is unrelated. The goal of both carbon taxes and cap and trade is not to reduce emissions through changing consumer behavior. They instead create an incentive for electricity generators to become more energy efficient or invest in renewables. These policies are meant to affect power generators, not end-users. It is actually often a goal to affect consumer electricity prices as little as possible, so that the policy is more politically palatable.

    2. Both tax and cap and trade require administration, of course. And we can say that the additional administration required for a market and quarterly/annual/monthly auctions is not significant. But the crux of the problem is that implementation of cap and trade has been abysmal at worst (early years of the EU) and still not 100% auction, at best (not all RGGI states are 100% auction). There is simply far more room for political jockeying and lobbying with a cap and trade than with a tax, and that is why it is concretely worse for the environment. We aren't even going to go into the inefficiencies and corruption that often accompany the partner of cap and trade, the carbon offset. It is only theoretical that carbon emissions are annually reduced to the level that they are "capped" at, which further weakens the argument that a cap and trade will result in more accurate reductions than a tax.

    3. This brings me back to your first, broad point. Yes, both of these options are good in theory. But the tax has been demonstrated to be good in practice (see Scott's examples in the entry) while the cap and trade system has proven, over and over again, to be a poor choice in practice and a nightmare to implement.

    -Yusha, another American