Q: WRI supports a cap and trade program over a carbon tax. Why?
The objective of federal climate legislation is to control emissions of greenhouse gases. This will require Congress to put a price on carbon using one of two options: by mandating a specific price on carbon, via a tax; or by setting a carbon emissions limit—a cap—and enabling businesses to trade allowances to discharge emissions. With a carbon tax, there is little evidence that we could get the price right to begin with, and even less to suggest that Congress would be willing to raise the tax regularly in order to keep emission levels falling. In addition, the actual quantity of reductions that could be achieved through a tax would be unknown in advance.
WRI therefore believes the most effective way to control greenhouse gases is through a cap and trade mechanism that is designed to guarantee steady emissions reductions, encourage innovation, and ensure a measure of fairness to low income consumers and coal dependent regions. A blueprint for such a mechanism was recently submitted to Congress by the US Climate Action Partnership (USCAP), a coalition of 26 corporations and five environmental groups, including WRI. (see www.us-cap.org).
Q: Some are arguing that a carbon tax would be simpler and fairer. What’s your response?
That notion may work in theory, but won’t work in practice. The “simple” tax and rebate that people talk about would in fact create huge regional unfairness - moving money from states that use a lot of coal to generate electricity to non-coal states. Such a tax would never pass the Senate. Efforts to ensure fairness would also create a lot of complexity and opportunities for loopholes. You would have to love the IRS code to believe a tax would be fair and simple.
Q: Why not consider all policy options?
Time is short. The latest science suggests that the impacts of climate change are occurring faster than expected. While there is no large scale model in existence for a fair and effective carbon tax, cap and trade programs for carbon dioxide (CO2) are already the policy instruments of choice around the world and in the United States. Over time these programs could be linked to establish a single comparable global carbon market. This would expand the environmental benefits and lower costs for emitters. A tax is unlikely to yield such an outcome.
Q: What about the argument that emissions trading does not work in practice?
Untrue. Emissions trading systems deliver what they are set up to do. The US acid rain program employed a sulfur emissions cap and trade system and successfully produced a 50 percent cut in emissions - at much lower cost and greater efficiency than predicted. The first phase of the EU trading system was over supplied with allowances due to a lack of data available to governments, and therefore early emissions cuts were not as big as they might have been. There was no design error in the system itself. Three US regions are already implementing successfully, or designing, cap and trade programs for CO2. Europe has a cap, and Australia soon will.
Q: What about the economic crisis? Won’t a carbon cap be bad for already struggling businesses?
Trading systems adjust automatically during market downturns, and carbon trading would be no exception. In just the same way that other commodities prices are dropping, demand for carbon allowances would decline during a recession and therefore prices would fall. Achieving the same result under a carbon tax approach would require government to intervene to lower the tax rate temporarily, which would be more complicated and produce a less desirable long term environmental outcome.
Q: Might a cap and trade system lead to another market failure?
We know that markets can be gamed, and that fraud and false information undermine their efficiency. That is true in commodity markets, equity markets, and credit markets, and will be true in carbon markets. The answer is effective regulation, not elimination of markets. The USCAP blueprint, for example, would create a regulatory system designed to protect against abuse.
Jonathan Lash, PresidentJonathan Lash has led the World Resources Institute as its President since 1993.
7 Comments
Thanks for the many
Thanks for the many thoughtful comments. I would like to respond to a few of the points raised. I believe, above all, that it is urgent that Congress enact effective legislation that sets the US on an immediate path to reduced emissions and rapidly increased investment in clean technologies. WRI has done work on carbon taxes, caps, and technology incentives. We end up convinced that a cap has to be a part of the solution.
First, I repeat that cap and trade programs only deliver what they are set up to deliver. The EU ETS is a good example. The initial EU cap was above actual emissions. The EU cap probably won’t begin to put real pressure on pollution sources for another year or two. Another example of how not to do it is the RECLAIM market in Southern California which included provisions restricting liquidity in the allowance market. Those provisions virtually guaranteed extreme price volatility.
Flawed design doesn’t prove that the concept is wrong. The key question is what lessons can we learn from these early examples?
In my view, a program that starts with strong, long-term cap on emissions overlaid with robust market rules and oversight combined with elements that facilitate liquidity would overcome all these problems. The dynamism and innovation of the US economy would set the price at a point that minimizes cost, optimizes reduction opportunities and adjusts to the changing conditions of supply and demand.
The second point I’d like to respond to is the reference to the American consumer’s response to $4/gallon gasoline. I agree that the reduction in demand and change in behavior that high gas prices triggered last summer is what economists predict should happen when a price is set on carbon. However, the political response to the price spike in gasoline prices was a chorus of proposals that would have increased emissions (coal liquids), or suspended the gasoline tax.
Finally, a tax would be no simpler than a cap and trade program precisely because of the special interests and money in play. The current proposals do nothing to address the regional unfairness against carbon intensive states that a straight tax and rebate would impose. Once the Congress starts to seek ways to address that unfairness loopholes and special interests will replace simplicity.
Cap and trade measures have a strong foundation to build on in the form of the Clean Air Act and we have maturing programs in the states and in Europe from which to learn. We have political leaders in Congress and the Administration that want to see a strong program in place and the world is looking to us to act. It is time to move beyond debate to action.
Hello friends in the
Hello friends in the USA,
This is a letter of an economist from Europe with a firm support for the clear price signal that must be given through a system of carbon and energy taxes. The EU ETS so far has mainly been a game in shadow boxing and trying to save the system is a mirage. The price for the allowances is again crashing, as we had expected, due to low hanging fruit in emission reduction and due to the wide opening for CDM offsets. So far, the EU ETS has had no single impact on the carbon emission reductions. The economic crisis now makes its functioning during its second round superfluous.
Again there is a lot of belief that the next round (2013-2020) will be better, but this belief is not based on facts. The announced auctions are not yet firm, and will be limited to a few sectors not exposed to international competition, e.g. electricity generation. Assume the electricity sector is charged with full auctioning from 2013 onwards. What are the perverse effects of this? At least two: first, EDF will benefit enormously because of its nuclear capacities and plans to extend nuclear (also SUEZ-Electrabel is in the same position); this will be the push for E.On, RWE, Vattenfall to delve up the nuclear option, or: we go to the French nuclear guillotine to be saved from climate change? Second, the auction charges on the power sector will be rolled on fully on captive customers (domestic, small businesses) because large industries are exposed. So we have a biased and non-transparent taxing of some (the weakest) groups.
The comparison of carbon trading with the Acid Rain permit trading in the USA requires control of the various parameters: the scope, the installations and technologies covered, the technical solutions available, etc. It is not because emission trading is in some circumstances a worthwhile, even the best, instrument, that it is useful in the global carbon market.
When I argue in favour of taxing, I mean we should develop a systematic range of carbon and energy taxes within the context of tax REFORM. As the uniform carbon market is a mirage the uniform universal carbon tax is also a mirage. We should negotiate in Copenhagen tax reform quota by country, and leave to every sovereign country the duty and honour to adapt the reform to the own country needs.
Like the other commenters, I really hope that WRI and the other NGOs start to investigate the case thoroughly. From my side in Europe I try to convince WWF, Greenpeace, CAN Europe and even Margot Wallström, to think it through. Each contact there is progress.
Regards,
Aviel Verbruggen, University of Antwerp
Follow the money. Of
Follow the money.
Of course, it's possible to end up with an ineffective or unfair carbon tax. But at least we could see the price and where the money was going. The main (political) advantage of cap-and-trade seems to be to hide the price (and not call it a "tax") and to generate a huge (and growing) stream of revenue to be diverted to favorite projects. Some good, some just awful. Not unlike the stimulus package that Senate Republicans are chewing to shreds as I write.
We need a stiff, clear and expected price ramp-up on fossil fuels to consistently nudge both the private and public sector to conserve and innovate. Otherwise, with cheap fuel, who bothers? Cap-and-trade hides the price and muddies it with volatility.
Economist, former (Clinton Admin) undersecretary of Commerce and chair of the US Climate Task Force, Rob Shapiro put it thus: We're running out of time; we won't get a second chance to get climate policy right. What we've seen [in the EU] suggests that cap-and-trade will take many years to implement and that it will fail [to reduce emissions]. Yale economist William Nordhaus predicts that tradeable permits would become the new currency for guns, drugs and terrorism. And AEI economist Ken Green says cap-and-trade would start the "biggest food fight in history," as corporate rent-seekers vie for free allowances. He predicts it would wreck the economy without reducing emissions.
I beg Jonathan Lash and WRI, please re-think your support for cap-and-trade.
And I urge readers to see the videos, sign a petition and send letters to Congress at www.pricecarbon.org.
Thanks for the many
Thanks for the many thoughtful comments. I would like to respond to a few of the points raised. I believe, above all, that it is urgent that Congress enact effective legislation that sets the US on an immediate path to reduced emissions and rapidly increased investment in clean technologies. WRI has done work on carbon taxes, caps, and technology incentives. We end up convinced that a cap has to be a part of the solution.
First, I repeat that cap and trade programs only deliver what they are set up to deliver. The EU ETS is a good example. The initial EU cap was above actual emissions. The EU cap probably won’t begin to put real pressure on pollution sources for another year or two. Another example of how not to do it is the RECLAIM market in Southern California which included provisions restricting liquidity in the allowance market. Those provisions virtually guaranteed extreme price volatility.
Flawed design doesn’t prove that the concept is wrong. The key question is what lessons can we learn from these early examples?
In my view, a program that starts with strong, long-term cap on emissions overlaid with robust market rules and oversight combined with elements that facilitate liquidity would overcome all these problems. The dynamism and innovation of the US economy would set the price at a point that minimizes cost, optimizes reduction opportunities and adjusts to the changing conditions of supply and demand.
The second point I’d like to respond to is the reference to the American consumer’s response to $4/gallon gasoline. I agree that the reduction in demand and change in behavior that high gas prices triggered last summer is what economists predict should happen when a price is set on carbon. However, the political response to the price spike in gasoline prices was a chorus of proposals that would have increased emissions (coal liquids), or suspended the gasoline tax.
Finally, a tax would be no simpler than a cap and trade program precisely because of the special interests and money in play. The current proposals do nothing to address the regional unfairness against carbon intensive states that a straight tax and rebate would impose. Once the Congress starts to seek ways to address that unfairness loopholes and special interests will replace simplicity.
Cap and trade measures have a strong foundation to build on in the form of the Clean Air Act and we have maturing programs in the states and in Europe from which to learn. We have political leaders in Congress and the Administration that want to see a strong program in place and the world is looking to us to act. It is time to move beyond debate to action.
Ditto to the first three
Ditto to the first three comments. Jonathan sounds panicky to me. Perhaps he hears what I do... that cap-and-speculation may not be the right way forward. Why else would he argue against all other options in his Q&A, and, for instance, reserve rationing and trading for the utility sector? He seems beholden to the USCAP'ers in industry. Let's hold his feet to the fire on this one, and not let him easily off the hook on this.
I'm with the others
I'm with the others commenters (who said it better than I can): to avoid the evasion and market manipulation that plague a cap and trade system, we need to implement a straightforward and transparent carbon tax. www.climatetaskforce.org
This post runs off the rails
This post runs off the rails at the start, with its straw man argument that "With a carbon tax, there is little evidence that we could get the price right to begin with." There is no "right price" and there is no "right cap" either. There is only the terrifying knowledge that atmospheric CO2 levels are already so high that the right price (and cap) would be far more aggressive than anything our political system can deliver.
The argument clatters downhill from there. Congress would be no less "willing to raise the tax regularly in order to keep emission levels falling" than it would be to lower the cap regularly. Similarly, the criticism that "the actual quantity of reductions that could be achieved through a tax would be unknown in advance" is irrelevant, for the reason given above: we don't need "quantity certainty," we need "price certainty" to deliver the maximum possible quantity reduction.
With their diehard support of cap-and-trade, mainstream environmental groups have backed themselves -- and us -- into an untenable corner. On grounds of democracy, transparency, efficacy, speed of implementation, and international transferability, a carbon tax wins, hands down. The hour is indeed late. Will WRI lead us out of this trap?
Thanks to WRI, Jonathan Lash
Thanks to WRI, Jonathan Lash for sharp focus on reducing emmisions that drive global warming. We have no time to lose.
Cap proponents often claim that caps "guarantee" emissions reductions and that carbon taxes cannot. Both assertions are incorrect. Caps have not reduced emissions in the EU even after five years of mighty struggle. And if energy prices spike because demand suddenly hits the cap, the public will demand an end to cap-and-trade, as happened in RECLAIM, the California smog emissions trading program. Even EPA's much-touted SO2 emission cap produces wide price fluctuations.
We know that higher prices reduce consumption and encourage substitution and innovation. Economists measure that effect, called price "elasticity", constantly. For example, we can look at the short-term reductions in gasoline use that followed from $4/gal prices last summer. Trains and buses filled up. Gasoline demand dropped, highway congestion and smog eased. Long term reductions would be even larger if prices had remained at $4 because we'd start changing equipment, travel and business patterns.
Prices under a cap become more volatile. Prices under a tax become more predictable. Predictable prices encourage investment. Volatile prices encourage gambling.
Either a cap or a tax might need to be adjusted (preferably not very often), but we have a good idea where to start. Ecomomists Gilbert Metcalf and Robert Shapiro report a general consensus that a carbon tax starting in the range of $15/t CO2 (which translates to ~ $0.15/ gal of gasoline), increasing gradually to about $100 would produce similar emissions reductions to those advocated by cap proponents.
The Congressional Budget Office concluded that a transparent price mechanism like a gradually increasing carbon tax would five times more effectively than a fixed cap. (The lead author, Peter Orszag is Obama's new Budget Director.)
Caps take a long time to implement, they hide the price and produce volatility, gaming and fraud. Current cap proposals (e.g., USCAP's) would dole out auction revenue in the form of "allowances" and "offsets" as well as direct subsidies to chosen (and powerful) interests.
A carbon tax bill by Rep. John Larson (D-Conn) would use carbon tax revenue to reduce payroll taxes. Rep. Inglis (R-SC) is working on a similar bill. Senator Dodd (D-Conn) campaigned for a carbon tax and Senator Corker (R-Tenn) queried Al Gore about a carbon tax during his testimony to the Foreign Relations Committee last week. A revenue-neutral carbon tax could be bipartisan win-win. Encourage business and employment, discourage carbon pollution.