Saturday, June 02, 2007

AEI favours carbon tax over cap & trade

Even the American Enterprise Institute is critiquing the 'cap and trade' proposal: This is one of the better articles (with argument and figures) explaining and advocating the carbon tax.

Establishing allowances and accounting systems for GHG emissions across industries is going to be vastly more difficult and highly politicized. The forest products industry, for example, will reasonably want credits for creating carbon sinks in the trees it plants and harvests, but the manufacturing sector that uses these wood products as a raw material will want credit for sequestering carbon. The difference will have to be split in some arbitrary manner that will surely introduce economic distortions in the marketplace. The auto industry will want credits for GHG innovations, while industries and businesses of all kinds will lobby for credits for reducing mobile source emissions from changes to their auto and truck fleets. There are going to be winners and losers in this allocation process. Multiply this problem across sectors and industries and it becomes evident that a GHG emissions-trading system is going to be highly complex and unwieldy, and too susceptible to rent-seeking influence in Washington. The problem of politically adjusting competing interests will be compounded on the international scale. The long-running diplomatic conflicts that can be observed over purported subsidies for aircraft (i.e., Boeing versus Airbus) and the European Union's agricultural subsidies and trade barriers are examples of the kinds of conflicts that will be endemic to any international emissions-trading scheme.

The favored solution to these problems is to over-allocate the number of initial permits both to ease the cost and to encourage the rapid start-up of a market for trades. This was the course the European Union took with its Emissions Trading System (ETS), and it has very nearly led to the collapse of the system. Because emissions permits were over-allocated, the price of emissions permits plummeted, and little--if any--emissions reductions have taken place because of the ETS. The over-allocation of initial permits merely postpones both emissions cuts and the economic pain involved.

In addition to that, if permits are granted without charge it is a vast handover of a now-valuable public resource (the atmosphere) to the polluting parties themselves with no compensation to the public which must suffer. In other words it is a vast privatisation or enclosure of the commons, and it seems to me that this factor is what drives its 'popularity' ahead of a better solution, the carbon tax.

Most economists believe a carbon tax (a tax on the quantity of CO2 emitted when using energy) would be a superior policy alternative to an emissions-trading regime. In fact, the irony is that there is a broad consensus in favor of a carbon tax everywhere except on Capitol Hill, where the "T word" is anathema....

There are many reasons for preferring a revenue-neutral carbon tax regime (in which taxes are placed on the carbon emissions of fuel use, with revenues used to reduce other taxes) to emissions trading. Among them are:

* Effectiveness and Efficiency. A revenue-neutral carbon tax shift is almost certain to reduce GHG emissions efficiently. As economist William Pizer observes, "Specifically, a carbon tax equal to the damage per ton of CO2 will lead to exactly the right balance between the cost of reducing emissions and the resulting benefits of less global warming."[10] Despite the popular assumption that a cap-and-trade regime is more certain because it is a quantity control rather than a price control, such a scheme only works in very limited circumstances that do not apply to GHG control. The great potential for fraud attendant on such a system creates significant doubt about its effectiveness, as experience has shown in both theory and practice in the gyrations of the European ETS.

The likelihood of effectiveness also cannot be said for regulations such as increased vehicle fuel economy standards....

* Incentive Creation. [otherwise known as Incentive Taxation] Putting a price on the carbon emissions attendant on fuel use would create numerous incentives to reduce the use of carbon-intensive energy. The increased costs of energy would flow through the economy, ultimately giving consumers incentives to reduce their use of electricity, transportation fuels, home heating oil, and so forth. Consumers, motivated by the tax, would have incentives to buy more efficient appliances, to buy and drive more efficient cars, and to better insulate their homes or construct them with more attention to energy conservation. A carbon tax would also create incentives for consumers to demand lower-carbon power sources from their local utilities. A carbon tax, as its cost flowed down the chains of production into consumer products, would lead manufacturers to become more efficient and consumers to economize in consumption. At all levels in the economy, a carbon tax would create a profit niche for environmental entrepreneurs to find ways to deliver lower-carbon energy at competitive prices. Finally, a carbon tax would also serve to level (somewhat) the playing field among solar power, wind power, nuclear power, and carbon-based fuels by internalizing the cost of carbon emission into the price of the various forms of energy.

* Less Corruption. Unlike carbon cap-and-trade initiatives, a carbon tax would create little incentive or opportunity for rent-seeking or cheating.

The article continues, describing a number of other advantages such as Elimination of superfluous regulations, price stabilization, adjustability and certainty, Preexisting Collection Mechanisms, Keeping Revenue In-Country, Mitigation of General Economic Damages. One benefit that is not mentioned is the mere fact of revenue raised, which could be advantageously expended in the form of public transport, research and education, or other essential infrastructure. Instead, in keeping with the overriding dogma that all taxes are bad (which is completely refuted by this whole argument in favour of carbon taxes), the article insists that any carbon tax must be revenue neutral.

The article then gives some useful projection on the impacts of an initial imposition of a carbon tax.

It seems clear enough that the case for the carbon tax has been made, it is only politics in the negative and damaging sense of the word that is preventing this necessary policy from coming forward sooner rather than later. One way of overcoming this political resistance could be to insist that an across the board carbon tax with no exemptions be introduced as soon as possible, but the that rate of the tax initially imposed could be responsive to political pressure.

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