Tax or Trade?

The Kyoto Protocol is now largely regarded as a failure: even its modest goal of cutting CO2 emissions to pre-1990 levels hasn’t been met by most countries. One of the biggest problems, of course, is that the largest emitter of Carbon Dioxide – the United States – hasn’t been playing. But since Democrats regained control of Congress, there’s been an explosion of talk about (finally) implementing some kind of Federal restriction on carbon emissions. If any kind of carbon legislation is introduced, it’s likely to follow one of two schemes: a carbon market or a carbon tax.

A carbon market, also called “cap and trade,” utilizes the virtues of a market system to make it profitable to reduce emissions. Under a cap and trade system, institutions are given limits to the amount of carbon they can emit. Companies with poor emissions records can buy “credits” from companies with good environmental performance. The fewer the credits available, the more expensive they become, and the more it makes sense to reduce emissions instead of buying credits. If a federal carbon trading system were to be instituted, it would hardly be without precedent: the Chicago Climate Exchange is a voluntary (read: small) US-based carbon market, while the EU’s principal mechanism for adhering to the Kyoto Protocol is a market called the EU Emissions Trading Scheme.

Carbon Taxes, meanwhile, are somewhat more straightforward: like the name suggests, they would tax institutions (or even individuals) for the amount of carbon they emit through their activities. Again, carbon taxes are nothing new: many Northern European counties now have one, and Boulder, Colorado recently became the first US city to introduce a carbon tax for its citizens, though the amount each person pays per year – around 14 dollars – makes the measure is largely symbolic as a means of encouraging a more sustainable lifestyle.

The Carbon Tax Center is a new NYC-based non-profit dedicated to – you guessed it – advocating for a federal tax on carbon emissions. So far, they haven’t given too many specifics on how the tax would play out, so it’s too early to tell if they’re for real. However, the site does include a great article explaining the advantages of a tax over a carbon market: simplicity, transparency, and expediency are some of the big ones.

Though it might be a better means of reducing our CO2, a carbon tax would probably be all but impossible to sell politically at the moment. Still, even if we had to wait a couple years for a more receptive administration and general public, the mid- to long-term effects of a carbon tax on our emissions would be far better.

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6 thoughts on “Tax or Trade?

  1. danlewer says:

    Thanks for this overview. In the UK, we are struggling with a similar debate between regulation and fiscal measures.

    While transparency and simplicity are certainly advantages of using tax to price carbon, I personally favour regulatory approaches. This is because we cannot risk the possibility that we will simply be prepared to pay the higher price for a similar level of carbon emissions. With cap-and-trade, we can explicitly decide how much carbon is safe.

    http://inbalance.wordpress.com/

  2. Nelson Harvey says:

    I agree on both counts, Adam, a carbon tax would be far better from an emissions standpoint, and it would be politically difficult to implement even with a friendly presidential administration. The idea of taxation has simply aquired too much of a stigma in this country, and a market mechanism that carries with it the possiblity of turning a little profit on the road to green is much more in line with the national ethos right now. Of course, a trading mechanism will need to be very well designed in order to actually result in emissions reductions. This is something that both the UN Clean Development Mechanism (CDM) executors and the the European Union have struggled with. See the following link for an explanation of how companies participating in CDM are paying far more than the cost of the projects they are financing, raising questions about where the money is going and who is accountable:

    http://www.nytimes.com/2006/12/21/business/21pollute.html?ei=5088&en=3cc7d8f20bf8a449&ex=1324357200&pagewanted=print

    I am far less familiar with the problems of the EU model, but The Economist magazine this week is supposed to have a good article on how America can avoid making their mistakes in designing a carbon market. The EU flooded the market with too many credits when its program began, depriving them of potential revenue and depressing the value of credits. If the U.S. is to design a comprehensive trading system (and I have little doubt that we will), it would be worth adhering to the old dictum that “if its worth doing, its worth doing well.

  3. Daniel Dempsey says:

    Nelson, that NYTimes articles is very misleading and is obviously written by a reporter as opposed to an economist. They say it costs $500m to buy a $5m incinerator, which might be the case, but that fact is completely irrelevant. If it costs $500m to reduce those emissions in China it probably costs $1b+ to accomplish the same thing in Europe. It doesn’t matter where a GHG is emitted, that is the nature of the beast. The firms that do CDM work are making business decisions, they aren’t trying to throw money away. If I run a power plant, I can’t force people to drive more efficient vehicles to generate my credits, I will put my money into the cheapest alternative – in this case China. These guys are much sharper than that article gives them credit for. The effect of the actions of every firm that must comply with Kyoto combined with raising fuel efficiency standards and other “command and control” measures will have a big effect by 2012 (if not earlier).

    Suggesting Kyoto has failed is ridiculous because it hasn’t even started yet (2008)! It doesn’t have teeth until next year and the preliminary market needs time to mature. Yes, I think they set the baseline a little high but that will fix itself and doesn’t mean the model is flawed. If you want evidence that cap-n-trade works look at the Nox and Sox markets, Kyoto was modeled after them for a reason. I honestly believe this pre-emptive judgment and pessimism is coming from the very industry that is upset that they have to comply with Kyoto. So many people know so little about markets and how it works that they get sucked into the pessimism by shoddy reporting and anti-Kyoto propaganda.

    Yes, I believe we should have a nuanced approach that tackles GHG from multiple angles, but you have to remember that cap-n-trade IS a carbon tax, the tax is controlled differently is all.

  4. Daniel Dempsey says:

    Another note. The problem with most carbon taxes is people don’t understand how they are supposed to be designed (especially policymakers). A carbon tax is supposed to be high (because demand is generally inelastic) in order to price a carbon producing activity and discourage its use. Most people view a carbon tax as a means of generating funding to put towards alternative energy, which may be a secondary effect but is not its purpose. Instituting a carbon tax that will operate the way it should would be tantamount to political suicide because it would be so high. A cap-n-trade system allows you to institute that tax through the backdoor and allows the market to raise it over time through competition and baseline reduction. A market based system allows politicians to get what they want without losing the support of their constituents.

  5. Daniel Dempsey says:

    Ignore my typos. I wrote those responses pretty fast without double checking because I was in a rush to get to a super bowl party 😉

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