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.
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.
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
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)?
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.
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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