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Cap and Trade as Futures Market
Daniel Hall at Common Tragedies has an interesting argument for cap and trade over a carbon tax. Cap and trade with bankable and borrowable allowances can respond much more quickly than Congress to new information.
[I]magine that in 2015 we get some bad news from the scientific community about climate change: the risk of truly damaging climate change are higher than previously thought. Although it would likely take Congress a few years to act on this info and revisit the question of what the cap should now be, firms would start banking more allowances today in anticipation of the government intervening to tighten the cap, and thus prices would rise immediately. Conversely, if new scientific info suggests the risks from climate change are lower than previously estimated, firms would start borrowing against future allocations (assuming borrowing is allowed) and prices could slacken in response to new info.
Posted by Alex Tabarrok on December 10, 2007 at 07:15 AM in Economics | Permalink
Comments
Sounds like an interesting argument, but I don't really see the point in allowing borrowing against future allocations. From who? If you borrow from other people with allocated rights, that's basically the same as buying their rights and paying in futures, and it doesn't increase the total amount of emissions for a certain timespan or decrease its price.
On the other hand, if you borrow from the government, or some other 'rights-creating' institution, and keep borrowing in the future to make up the deficit, you would increase the amount of emission rights, but that undercuts the whole point of cap-and-trade. Of course, the government could charge an 'interest' payment on these extra amounts of emission rights. But charging an amount of money for an extra amount of emission rights is exactly the same as a carbon tax.
Posted by: GreatZamfir at Dec 10, 2007 8:05:31 AM
A problem with this argument is that it assumes companies put a financial trader in charge of these decisions, which is usually not the case.
Posted by: matt at Dec 10, 2007 10:29:10 AM
The big complaint that I had heard about cap-and-trade with carbon is that it is hard to verify offsets. Thinking back to Ronald Coase, he talked a lot about how contracting and verification being a large part of transaction costs. If someone plants some trees and gets carbon credits, how does one make sure that in the future, the trees aren't burned for fuel or used in another activity that re-releases the carbon. It seems to me the question whether a tax or cap-and-trade is better comes down to monitoring and transaction costs. Its relatively simple to charge a tax on purchases, its much harder to track the carbon emissions of 300 million people.
Interesting link.
http://www.economist.com/finance/displaystory.cfm?story_id=9337630
Posted by: Sam at Dec 10, 2007 10:42:38 AM
Its an interesting argument, but it could easily be circumvented in a carbon tax by tying carbon tax levels directly to global temperatures, as has been suggested by several sources.
Also, in my mind, cap and trade have three problems that outweigh nearly any benefit:
1. It is incredibly easy to finagle by politicians for all kinds of ends
2. The accounting is almost impossible, with it very easy to double or triple count offsets. we can already see that here
3. It favors incumbents in any industry, by giving incumbents a starting supply of permits, usually for free, to match its market share but new entrants must buy permits to gain a similar sized market share.
Posted by: coyote at Dec 10, 2007 11:43:36 AM
Has it stuck anybody else that there is a similarity of these devices for dealing with the "sins" of carbon (and other) emmisionsto the purchases of "indulgences" in a past age (which had unintended consequeces)?
Posted by: R. Richard Schweitzer at Dec 10, 2007 2:32:32 PM
This isn't really an argument for cap and trade, it's an argument that, in one particular way, cap and trade could be better than a carbon tax. Even if he's right about this one thing (and I have some doubts), a carbon tax might, on balance, be better. A real argument for (or against) cap and trade has to take into account all the plusses and minuses of each system.
Posted by: Alan Gunn at Dec 10, 2007 5:20:34 PM
How is the adjustment of firms different under cap and trade than under a carbon tax?
If firms expect the carbon tax to increase in the future (or credits to decrease) they still begin to act on this information today, gradually increasing prices. In oth cases firms still respond to anticipated policy changes before they occur.
I think the below paragraph still makes sense:
[I]magine that in 2015 we get some bad news from the scientific community about climate change: the risk of truly damaging climate change are higher than previously thought. Although it would likely take Congress a few years to act on this info and revisit the question of what the *carbon tax* should now be, firms would start *incresaing prices / decreasing profits* more today in anticipation of the government intervening to *raise the tax*, and thus prices would rise immediately. Conversely, if new scientific info suggests the risks from climate change are lower than previously estimated, firms would start borrowing against future *increased profits* (assuming borrowing is allowed) and prices could slacken in response to new info.
Except now prices refer to prices of goods and services (what, presumeably, we care about) and not prices of credits.
Posted by: R at Dec 10, 2007 7:03:10 PM
A carbon tax would also provide incentives for companies to look into alternative energy. If new information came out in 2015 that said that carbon emissions were to be worse than expected, than the market would expect the government to raise the carbon tax, and would begin to allocate more resources into non-carbon-emitting energy sources. A cap-and-trade policy might provide a lucrative market for insiders to predict the movement of how the government will react, but that only further proves Greg Mankiw's fundamental theory that,
Cap-and-trade = Carbon tax + Corporate welfare.
Posted by: Andy McKenzie at Dec 10, 2007 10:31:55 PM
The big complaint that I had heard about cap-and-trade with carbon is that it is hard to verify offsets.
Both cap-and-trade and a carbon tax with offsets involve these transaction costs. And viewed abstractly enough they are the same kinds of transaction costs -- monitoring and enforcement costs. But when we look closer, there are may be major institutional differences between monitoring and enforcement of property rights and the monitoring and enforcement of a tax. It's possible, for example, that property rights allow firms to monitor their competitors more easily, reducing the burden on governmental officials to monitor emissions and offsets.
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