CONSERVATIVES FOR A CARBON TAX

Climate Change: Caps vs. Taxes; Which climate policy approach will succeed the Kyoto Protocol: cap-and-trade or a carbon tax?
Kenneth P. Green, Steven F. Hayward and Kevin A. Hassett (w/ Nicole Passan), June 2007 (American Eneterprise Institute)

SUMMARY
With the Kyoto Protocol expiring in 2012 and the international community working to develop a successor agreement, passing climate change legislation with an emissions reduction plan is key to the Obama administration's intent to take a leadership role in the process.

As its emissions reduction plan, the Obama administration is backing Congressional plans to institute a cap&trade system in the U.S. along the lines of the European Union (EU) Emissions Trading Scheme (ETS). Many economists and conservative thinkers believe a tax on greenhouse gas emissions would be a better choice.

Climate Change: Caps vs. Taxes; Which climate policy approach will succeed the Kyoto Protocol: cap-and-trade or a carbon tax? by Kenneth P. Green, Steven F. Hayward and Kevin A. Hassett (with Nicole Passan) of the American Eneterprise Institute (AEI) is an attempt to evaluate the strengths of the tax and the weaknesses of the cap&trade system approach.

From the AEI paper. (click to enlarge)

In “a classic chicken-and-egg problem” the U.S. has been reluctant to participate in the international greenhouse gas emissions (GhGs) reduction agreement and potentially put itself at a competitive disadvantage to China, India and other emerging economies but those nations will only come into an emissions reduction agreement if the U.S. participates.

The AEI authors warn against a U.S. treaty commitment to the international community such as the Kyoto Protocol that limits U.S. businesses’ freedom. It is ambiguous on the urgency of acting due to global climate change and it glosses over the leadership role needed from the U.S. if the world is to take action.

The authors discuss the potential complexities of a cap&trade system and a tax system.

From the AEI paper. (click to enlarge)

They also discuss the history of effective uses of cap&trade and the limits of its effectiveness, detailing the system used to control the acid rain problem of the 1980s and 1990s.

The AEI authors offer a lengthy and detailed description of emissions allocations and trading price fluctuations in the EU ETS.

The authors assert that negative impacts on U.S. competitiveness by cap&trade would compromise U.S. businesses’ commitment to compliance. A recent report concluded, however, that cap&trade would not compromise U.S. competitiveness. (See CAP&TRADE, INDUSTRY AND CONGRESS)

The paper offers lengthy arguments for why a tax would:
(1) Be more effective and efficient;
(2) Create more incentive to cut emissions;
(3) Be less vulnerable to corruption;
(4) Require less complicated regulations;
(5) Precisely stablize the price of emissions;
(6) Allow for ready certainty and adjustability in the emissions price;
(7) Require no new system to collect and record revenues;

Another recent study found effects on competitiveness from cap&trade would be modest. (click to enlarge)

(8) Keep the revenue use domestic;
(9) Allow for ready response to economic harms;
(10) Allow for exploring the parameters of the taxation mechanism;
(11) Provide predictability impacts;
(12) Coordinate behavior, costs and revenues;
(13) Making the impact revenue neutral;
(14) Creating an efficient system.



COMMENTARY
With most of the world already committed to a cap&trade system and the limited likelihood of bringing the entire world to participation in an emissions tax system, advocacy for the tax becomes, in effect, obstruction of international agreement on unified action to fight global climate change. For AEI, a group that stands for few principles more wholeheartedly than the "no new taxes" principle, to take up advocacy of a tax - knowing it will impede action against global climate change - is little short of blatant hypocrisy.

From the AEI paper. (click to enlarge)

Opposition to cap&trade and advocacy of the tax also come from idealists who see the obvious shortcomings of cap&trade and prefer advocacy of the perfect instead of commitment to the good.

A convincing argument for cap&trade is in the combination of it being politically doable and amenable to refinement. No system, cap&trade or tax, will be instituted without stumbling. The choice is between a system that will require refinement and is politically within reach and a system that would require refinement but is not politically achievable.

Another recent study found effects on competitiveness from cap&trade would be modest. (click to enlarge)

In describing the relative complexities of a tax on GhGs and a cap&trade system, the authors make a decent case for the tax but essentially prove that either choice carries with it complexities that must be managed.

In critiquing the price fluctuations in the cap&trade system used to curtail the acid rain problem, they highlight the market dynamism of cap&trade that drives emissions reductions but describe it as objectionable.

Another recent study found effects on competitiveness from cap&trade would be modest. (click to enlarge)

They accurately describe the relative simplicity of the SO2 problem in comparison to the problem of CO2, which is why the simpler cap&trade system used to combat SO2 as well as the EU ETS must be aggressively studied as models for a new international emissions reduction regime. Many problems remain to be solved. On the other hand, is there anywhere a model of how to institute an international tax without resistance and corruption?

The failure of the RECLAIM (Regional Clean Air Incentives Market) emissions-trading program in Southern California adds crucially to an understanding of cap&trade.

Radical price fluctuations in an emissions trading system attached to a hard cap would likely be a serious problem. Regulatory adjustments would be needed. If, however, emissions prices fluctuate as they trend upward, it would be an indication the system is responding to the “cap” part of the concept as intended.

From the AEI paper. (click to enlarge)

The paper points out that a wide variety of authorities and economists favor a tax over a cap&trade system but recognizes that a tax is politically “anathema.” Thus, advocating a tax is tantamount to blocking the possibility of an imperfect emissions reduction regime by calling for a superior emissions reduction regime.

The paper observes, in passing, that Al Gore favors a tax. In fact, Gore favors both concepts but considers the tax politically unlikely (see quote above).

Though the paper puts forward arguments for why a tax would be superior in 14 points (see above), the arguments are no more convincing than arguments in favor of a cap&trade system. One almost irrefutable argument in favor of cap&trade that the EIA authors cannot make is that a cap&trade system, by definition includes caps that can be made progressively more severe while a tax depends on actions of a command and control federal authority that the marketplace could quickly find intolerable.

click to enlarge

(1) More effective and efficient? Conservatives favoring the effectiveness and efficiency of a tax over the marketplace?
(2) Create more incentive to cut emissions? More incentive than hard caps and fines for violations?
(3) Be less vulnerable to corruption? All markets can be gamed. Regulation is necessary. Is taxation at the federal level any less vulnerable to political gamesmanship?
(4) Require less complicated regulations? The IRS code suggests otherwise.
(5) Precisely stablize the price of emissions? Only with very heavy-handed action by a federal authority.
(6) Allow for ready certainty and adjustability in the emissions price? Yes. But without allowing for the effects of the marketplace, putting the government in the position of “picking winners.”
(7) Require no new system to collect and record revenues? Yes, but a whole new system to audit emissions and another for the neutralization for the revenues.
(8) Keep the revenue use domestic? First, the objective is to participate internationally. GhGs know no borders. Second, the use of revenues from allowance auctions can be focused domestically just as readily as tax revenues.
(9) Allow for ready response to economic harms? Yes. The response would be by the command and control central authority instead of the marketplace.
(10) Allow for exploring the parameters of the taxation mechanism? Yes. Cap&trade allows for exploring the parameters of the marketplace.
(11) Provide predictability of impacts? Predictability of impacts is not possible. This point more than any other suggests what an authoritarian fantasy those who dream of a tax are actually having.
(12) Coordinate behavior, costs and revenues? The revenues of a cap&trade system or a tax system MUST and CAN ONLY BE neutral.
(13) Making the impact revenue neutral? Both systems must be.
(14) Creating an efficient system? Once again, conservatives are calling a tax more efficient than the marketplace. Somebody make a note of this for when the national health insurance debate comes around.

click to enlarge

QUOTES
- From the AEI paper: “…Two general policy approaches stand out in the current discussion. The first is national and international greenhouse gas (GHG) emissions trading, often referred to as "cap-and-trade." Cap-and-trade is the most popular idea at present, with several bills circulating in Congress to begin a cap-and-trade program of some kind. The second idea is a program of carbon-centered tax reform--for example, the imposition of an excise tax based on the carbon emissions of energy sources (such as coal, oil, and gasoline), offset by reductions in other taxes…”
- From the AEI paper: “Given these policy uncertainties--and other uncertainties about the eventual impacts of climate change in terms of severity, distribution, and timing--there are two guideposts policymakers should keep in mind. The first is that the United States can only effectively impose a national regulatory regime (though such a regime could eventually be harmonized with international efforts). The second is that, given the current uncertainty, policy should conform as much as possible to a "no regrets" principle by which actions undertaken can be justified separately from their GHG emissions effects in the fullness of time, such that nonparticipation by developing nations will disadvantage the United States in the global marketplace as little as possible.”

From nationalwildlife via YouTube.

- From the AEI paper: “A GHG emissions-trading scheme on an international level will be even more vulnerable to these kinds of unpredictable outcomes. To the extent that a GHG emissions-trading program results in international cross-subsidization of the economies of trading partners, it is going to be politically unsustainable in the long run. An international emissions-trading program is also unlikely to survive noncompliance by some of its members…”
- From the AEI paper: “…[Cap&trade] fails the "no regrets" test. It is considered bad form nowadays to express doubt or skepticism about the scientific case for rapid and dangerous global warming in the twenty-first century. If warming is either less pronounced than some current forecasts predict or if emissions reductions have limited effect in moderating future temperature rise, however, a severe global emissions-reduction policy through emissions trading (on the order of a minimum 50 percent cut by 2050) could turn out to be the costliest public policy mistake in human history, with the costs vastly exceeding the benefits…”
- From the AEI paper: “…we conclude that if aggressive actions are to be taken to control GHG emissions, carbon-centered tax reform--not GHG emission trading--is the superior policy option.”