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Friday, June 01, 2007

Cap and Trade versus Carbon Taxes

After asking John Whitehead to serve as a referee in a proposed cap-and-trade versus carbon taxes debate, he has had commenters "dogging my sorry ass to death" over the position I attributed to him, so let me give him a chance to explain further:

Why I think there isn't much difference between emissions taxes and carbon taxes: a summary, by John Whitehead: Both emissions taxes and cap-and-trade can:

  1. Achieve optimal emissions at the least cost to society
  2. Provide incentives for firms to innovate and further lower abatement costs
  3. Both carbon taxes and cap-and-trade can raise revenue for the government. Carbon taxes can raise more. Emissions permits must be sold by the government for cap-and-trade to able to raise revenue.
  4. Emissions trading markets might result in more price variability for consumers. This can be resolved with a price control in the emissions market (i.e., a safety valve).
  5. Emissions trading markets can become overly concentrated. If some firms accumulate a large number of permits they could set the price above the competitive level. Government must be sure to promote competition just like it does in other markets.
  6. I'm sure there are other issues and I'm happy to be reminded of them.

#1 and #2 are the big things. The rest are relatively minor issues. I'm happy with either policy since I think that #1 and #2 are the most important (i.e., that is where the most efficiency gains versus the status quo and versus command and control can be found).

I think cap-and-trade has a better chance of implementation so I'm not going to get in the way.

And, John follows up with:

Lynne Kiesling at Knowledge Problem on a carbon tax vs cap-and-trade, by John Whitehead: Lynne takes a firm stand, I should take lessons, and chooses cap-and-trade:

Thus while I am sympathetic to the political economy arguments for the lower implementation costs of a carbon tax, the knowledge problem and the right set of institutions for inducing dynamic efficiency through innovation make me favor pursuing a carbon market, designing it well, and testing it carefully.

It is a long post, please read it, but here is her big point (buried in there is a hint about the Hayekian source of the mysterious blog name):

Finally, but most importantly, how do we know the right level at which to set the tax? This is where we get to the Coasian/Hayekian crux of the problems with Pigouvian taxes that the other commenters did not account for in their analyses. The most problematic aspect of Pigouvian taxes is that they rely on the assumption that the policymaker has sufficient knowledge to be able to set the optimal tax. The knowledge of the optimal level of emissions and the optimal tax rate is not, in Hayek's phrase, given to any one mind. That is the knowledge problem. That means that the policymaker has to have information about production processes, production costs, the epidemiological and other health and consumption effects of the product, and the economic value of those epidemiological and other consumption effects. That is a heroic assumption. No one person or group of people, however well-informed and well-intentioned, can ever determine the optimal emissions or tax through a centralized process. A political process will stumble upon the optimal tax rate by luck; through analysis we can only approximate that rate. If we are wrong and have to revise it, then we violate the above-stated benefit of certainty and transparency. The best mechanism we have for discovering the optimal emissions is through a decentralized process that can aggregate this widespread, diffuse, personal knowledge; this decentralized process is a market.

And don't miss my favorite quotes:

Conversely, Greg Mankiw, citing an AEI paper, has no doubts - he favors (surprise) a carbon tax.

Finally, Scientific American's blog doubts it matters much which policy is best, it appears the Bush administration's strategy is to drag their feet as much as possible and dump the problem in someone else's lap (sound familiar?):

Bush Totally About to Do Something About Global Warming, He Swears, by Christopher Mims: ...[R]eally, can't we do better than non-binding targets, hazy deadlines and a conspicuous absence of a domestic policy for reducing our emissions? (And no, ethanol does not count.) Making speeches is fine, but this reeks of more than a few passages from the Procrastinator's Creed:

I shall never move quickly, except to avoid more work or find excuses.

I firmly believe that tomorrow holds the possibility for new technologies, astounding discoveries, and a reprieve from my obligations.

I truly believe that all deadlines are unreasonable regardless of the amount of time given.

I shall always decide not to decide, unless of course I decide to change my mind.

    Posted by on Friday, June 1, 2007 at 03:33 PM in Economics, Environment, Policy, Regulation | Permalink  TrackBack (0)  Comments (21)


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