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Cap and trade vs. carbon tax
Robert Samuelson writes:
Unless we find cost-effective ways of reducing the role of fossil fuels, a cap-and-trade system will ultimately break down. It wouldn’t permit satisfactory economic growth. But if we’re going to try to stimulate new technologies through price, let’s do it honestly. A straightforward tax on carbon would favor alternative fuels and conservation just as much as cap-and-trade but without the rigid emission limits. A tax is more visible and understandable. If environmentalists still prefer an allowance system, let’s call it by its proper name: cap-and-tax.
Mark Thoma gets upset at this passage, here is Ryan Avent, Brad DeLong and Matt Yglesias, all upset. Avent was the fount of the opposition:
Yowza. As any economist worth his or her salt will tell you, a cap and trade plan with auctioned permits is essentially identical to a carbon tax. That also happens to be exactly what Barack Obama is proposing. So, another way for Samuelson to have written this column would have been to title it, “Barack Obama has a good plan to reduce carbon emissions."
But Samuelson is correct here and Avent is misleading. When there is uncertainty about the location of the social optimum, and uncertainty about elasticities, a carbon tax and cap-and-trade are by no means equivalent. If you see very high costs from setting the binding cap too low and choking off growth -- as Samuelson mentions -- you should prefer the carbon tax. The price of carbon is more certain and you bear less risk from uncertainty about how fast solar power and other technologies will develop. Alternatively, you might say that risk is transformed into price risk rather than "you can't exceed this cap no matter what" risk.
Of course the postulated uncertainties are realistic in this context and you don't have to invoke uncertainty about the science of global warming.
If there is very high environmental risk to having emissions above a certain level, and we are unsure about the relevant elasticities (again, uncertainty about the pace of technological development can drive this), that militates in favor of cap and trade. It is then easier to ensure that emissions do not exceed a particular level.
You can see that we are comparing the "growth threshold problem" to the "environment threshold problem." Samuelson is apparently more worried about the former than the latter. Maybe he shouldn't be so sure he is focusing on the right problem, but on the economics he is on the mark in the criticized passage.
Addendum: Here is Mark Thoma with more on the topic, here is Megan McArdle on same.
Posted by Tyler Cowen on June 4, 2008 at 03:09 AM in Economics | Permalink
Comments
The argument has already been made here.
Posted by: Michael Greinecker at Jun 4, 2008 3:59:46 AM
Didn't seem to work. Here´s the URL:
http://gabriel.mihalache.name/ei/article/435/cap-and-trade-carbon-taxes-knowing-demand-supply-schedules
Posted by: Michael Greinecker at Jun 4, 2008 4:00:54 AM
"It is then easier to ensure that emissions do not exceed a particular level."
Easier than what? A Pigouvian tax that does not require the same bureaucratic framework to monitor and implement? (Not that a tax is preferable either...)
Posted by: john at Jun 4, 2008 6:08:49 AM
What will the revenues be used for? We know the answer to that. Gov't horse manure.
Where will taxes be cut to offset the new revenue? Har har.
Where are the demand elasticities in carbon usage?
Where are the current and future bottlenecks to growth?
Posted by: Andrew at Jun 4, 2008 6:55:08 AM
A Pigouvian tax that does not require the same bureaucratic framework to monitor and implement?
To ensure that emissions do not exceed a certain level, regardless of the costs necessary to bring us to that level, john? Yes. The Pigouvian tax is the most efficient way to reduce all emissions up to a certain marginal cost in emissions. Cap-and-trade is the most efficient way to reduce emissions to a specific stated value.
Note that in reality, cap and trade as debated by the Senate includes a "safety valve" to allow the cap to go up if the cost of reduction is high. While this makes it even more theoretically similar to a tax, in practice it may make cap and trade entirely pointless aside from the corporate welfare and rent-seeking behavior. Experience in Europe indicates that when such safety valves are available, the tendency to cheat until the cap has no real effect is strong. (European countries do have strong emissions reductions effects from their fuel taxes, though.)
Posted by: John Thacker at Jun 4, 2008 8:00:37 AM
How will a fixed cap be affected by speculators (or charities) buying up caps? Seems much more likely than the current fear of speculators buying up too many oil futures.
Tyler, do you have an opinion on whether speculators / institutions investing in commodities for diversification are affecting the price of oil?
Posted by: DK at Jun 4, 2008 8:10:23 AM
For the crazy version of this argument, see Senator Inhofe's WSJ op/ed here: http://tinyurl.com/57m2ck
Posted by: David Zetland at Jun 4, 2008 8:37:48 AM
"If there is very high environmental risk to having emissions above a certain level, and we are unsure about the relevant elasticities..."
I'd say it's the opposite. Economics is further along than meteorology.
the fact that...
"You can see that we are comparing the "growth threshold problem" to the "environment threshold problem.""
necessitates that we must...
"invoke uncertainty about the science of global warming."
Also, the question about holding cap and trade permits and not using them raises the key question in my mind. How much will squatting be used, like some patents, to inhibit new competitors into markets? Will the regulators will be completely evenhanded when dealing with existing interests versus yet-to-be-developed ones? That's a question that answers itself, I think.
Posted by: Andrew at Jun 4, 2008 8:41:06 AM
Marty Weitzman had the fundamnetal insight in the Stome Age (when i was in Grad school) and the application to GHG is here (among many others):
http://ideas.repec.org/p/rff/dpaper/dp-98-02.html
Posted by: Jonathan at Jun 4, 2008 9:11:32 AM
Good post, Tyler. I haven't read all the links yet, but I think Avent was assuming Samuelson was being really dumb. In other words, cap-and-trade is equivalent to a carbon tax with certainty, and so Avent may have assumed Samuelson was dumb, rather than assuming Samuelson got the subtleties of elasticities etc.
The CBO analysis (.pdf) was actually pretty good on this, I thought. They spell out quite clearly (with a numerical example) why a carbon tax is better with certain types of uncertainty.
Posted by: Bob Murphy at Jun 4, 2008 9:29:35 AM
See, now you've proven yourself to be an economist not worth your salt. Why? Because Ryan Avent says so. After all, he's an "Economist, Consultant and Writer" and you're just a chaired, tenured professor at a private university.
Hmpph. Shows what you know.
Posted by: jb at Jun 4, 2008 9:46:01 AM
I protest. To first order, carbon tax and cap-and-trade do the same thing. Martin L. Weitzman (1974), ["Prices vs. Quantities",](http://www.jstor.org/page/termsConfirm.jsp?redirectUri=/stable/pdfplus/2296698.pdf) *Review of Economic Studies* 41:4 (Oct.), pp. 477-491, is brilliant, but it is second order--and it is not what Robert Samuelson is writing about. I don't see a single word of argument in there about how the risk that the price will go too high is more worth guarding against than the risk that the quantity of emissions will go too high. Do you? All I see are rants about how environmental controls are big government and big government is bad and we never should have passed the Clean Air Act or established the EPA in the first place...
Posted by: Brad DeLong at Jun 4, 2008 11:11:00 AM
And your "capchas" are too hard...
Posted by: Brad DeLong at Jun 4, 2008 11:11:29 AM
For a good summary on the monstrosity of the Lieberman & Warner cap-and-trade bill see --
http://www.carbontax.org/blogarchives/2008/06/03/not-deficit-neutral-revenue-neutral/
Posted by: Richard A. at Jun 4, 2008 11:18:24 AM
The idea that a tax favors growth while a cap favors the environment exists only in our political context. There is no economic reason that a tax should automatically set pollution abatement lower a cap-and-trade program. In fact, if the government was profit-maximizing, a tax should actually be higher and cause MORE abatement than a cap-and-trade program (assuming there was no auctioning off of permits)
Posted by: Robert Olson at Jun 4, 2008 1:04:41 PM
I protest. To first order, carbon tax and cap-and-trade do the same thing.
An ideal carbon tax and an ideal cap-and-trade, perhaps, Professor DeLong. However, the current Lieberman-Warner proposal (and its host of amendments) helps convince me that a carbon tax is likely to much closer to ideal. The cap-and-trade proposal, while including some auctioning of permits, has a host of side deals and amendments designed to help particular industries, to help industry incumbents against upstarts, lots of other rent-seeking, and a big "safety valve" designed to kick in approximately if the cap-and-trade is doing its job.
What he wrote as far as a tax being more transparent and honest is true. His point about "cap-and-tax" is reasonable as well-- while to first order ideal carbon tax and ideal cap-and-trade are similar (with different things targeted, but if you target the price X that produces the same quantity Y, yes, they're roughly the same), it's also true that people prefer selling cap-and-trade being people don't think of it as being like the tax at all.
Posted by: John Thacker at Jun 4, 2008 1:40:43 PM
Brad DeLong wrote:
Martin L. Weitzman (1974), ["Prices vs. Quantities",]...is brilliant, but it is second order--and it is not what Robert Samuelson is writing about. I don't see a single word of argument in there about how the risk that the price will go too high is more worth guarding against than the risk that the quantity of emissions will go too high.
Give the guy a break, he was writing an op-ed for the Washington Post. And neither you nor Avent mentioned that subtlety, either; if it wasn't worth getting into on your econ blog, why hold Samuelson to that standard in his op ed conclusion?
Samuelson's statement was true. Earlier in the piece, he showed familiarity with the other reasons that mainstream economists favor a carbon tax over cap-and-trade (rent seeking, transparency). You're right, I don't know that he could explain the arithmetic behind the CBO illustration of how a tax can be more efficient, but I think he understands the big picture.
He said this at one point: [The above flaws] would undermine whatever abstract advantages the system has.
So here he seems to perfectly get the (correct) point that under idealized settings, cap and trade is the perfect solution, but in the real political world, a carbon tax is far preferable.
I can't understand why everyone is flipping out when a columnist repeats arguments that tons of economists are making.
Posted by: Bob Murphy at Jun 4, 2008 1:51:10 PM
They are forgetting about the political economy aspect.
The costs of the cap- and-trade system are "hidden" from the society, so it's easier for the federal government to commit to a bi-partisan long term policy.
A carbon tax would be attacked by any challenger to the White House, specially the Republicans.
I think that the credibility that the policy still be "alive" in the long run a central factor to both proposals.
Posted by: Bruno at Jun 4, 2008 5:00:52 PM
what about the distributional effects of a carbon tax or c&t -- between areas that use carbon to produce electricity and areas that use hydro? is this just an "endowment" issue that we easterners will have to get over?
Posted by: hwinva at Jun 4, 2008 5:24:42 PM
"When there is uncertainty about the location of the social optimum, and uncertainty about elasticities, a carbon tax and cap-and-trade are by no means equivalent. "
It's true in regards to uncertainty about elasticities but in the uncertainty on the location of the social optimum is the same for both policies so it doesn't matter for which system one would prefer. I dunno, maybe some weird interaction between the two types of certainties could get you that.
Posted by: notsneaky at Jun 8, 2008 6:45:18 PM
