A Lot of Hot Air
One of the arguments that pro-“cap and traders” like to make against a carbon tax is that the outcome of a tax is too uncertain. Like Goldilocks, you may end up with a tax that is too weak or too strong. If it’s too weak, the desired environmental emissions targets may not be met; too strong, and we crush the economy like Goldilocks sitting on the little bear’s chair. But this argument is pretty weak coming from advocates of a cap-and-trade plan. After all, what makes cap-and-trade so likely to result in certain outcomes?
There are two fundamental flaws with the federal cap-and-trade plan, as it is currently constituted, that make the outcome of the program look about as certain as George W. Bush trying to answer a question at a press conference. First, the offsets. Simply put, there are way too many of them (Ann has discussed this issue on this blog). With over two billion offsets allowed, they will almost certainly undermine the integrity of the program by allowing polluters to pay their way out of emissions reduction through largely unverifiable reductions elsewhere.
But even if we assume the offset problem won’t materialize, there is a second and more important flaw in the system: the cap itself will probably be sky high. Why? Because in order to set the cap, we need a baseline as to what the emissions are today from the 7400-odd sources that will be regulated. And how do we get that baseline? Well, we’ll just ask the regulated companies how much they currently emit. They won’t overestimate, will they? Of course not. That never happens. Except in every cap and trade program we’ve seen, from RECLAIM to the EU.
Let’s look at the EU: the New York Times Green Blog describes the problems that the EU program is now facing due to a glut of pollution credits. The EU cap-and-trade meltdown is attributed to “accounting rules” rather than actual emissions reductions. The glut has resulted in “hot air” credits that were essentially meaningless. So GHG emitters under the EU plan can now pay quite cheaply for their pollution with little incentive to reduce them.
The same problem occurred with the RECLAIM program in L.A., an unmitigated disaster that rarely gets mentioned by cap-and-trade boosters so mesmerized by the so-called success story of the acid rain program. With RECLAIM, the program relied on self-reporting to establish the baseline and the subsequent cap. The result was a sky-high cap that led to low initial prices and non-compliance once the cap ratcheted down to adjust. That program has since been abandoned in favor of regulations.
My prediction for the federal plan? We’ll have a ton of hot air with a sky-high cap, and it will take years to realize the full extent of the problem. Once the cap comes down (IF it comes down), like with RECLAIM, businesses will be unprepared for it and unable to comply. Oh well. By the time we get this sorted out, it may already be 2020 and we’ll have lost valuable time.
There are better options. First, environmental advocates can admit what many of them say privately, which is that a carbon tax makes a lot more sense. It would be easier to implement than cap-and-trade (although it would contain some of the same monitoring and enforcement problem, but not on nearly as big a scale). And it would lead to actual results, particularly if we did a slow-phase in. Plus, imagine the kind of investment in renewable technology we could do with the revenue. But, as everyone seems to say, it’s politically unrealistic. Well, is there a harm in at least trying for the better policy and admitting this cap-and-trade emperor has no clothes?
Second, we could focus on policy efforts that actually will result in GHG reductions. That includes a strong federal renewable portfolio standard, and not the watered down one in the federal versions now under debate in the Congress. These policy efforts should also include a focus on the transportation reauthorization bill next year, which gives us an opportunity to stop subsidizing highways and instead invest in mass transit and compact real estate development. Clean energy, less driving, and more compact development will take us a long way toward getting out of this climate mess. Intricate, opaque, and ineffective cap-and-trade programs, filled with hot air, ain’t gonna do it.
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About Ethan
Ethan Elkind is the Director of the Climate Change and Business Program, with a joint appointment at UC Berkeley School of Law and UCLA School of Law. In this capacity, h…
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There is no climate mess. Grow up.
Ethan, but what about Goldman?
PS–Tim, “grow up”? Obviously, you’re an adult.
Red: presumably there would be less trading of allowances with a sky-high cap, so a company like Goldman would not profit from this arrangement. But the sky-high cap could create havoc on the derivatives market as investors gamble on the wild price swings that are likely to occur as regulators toy with the cap. Goldman and other brokers would likely profit from this end of the trading scheme.
Great post, Ethan.
Yes, you can score points against Cap-and-Trade by comparing an ineffectual cap and trade program with an effective tax. The political reality is that neither program is likely to be adopted in a way that is likely to be effective. Yes, the cap in a cap and trade is likely to be way too high, and rendered meaningless with offsets and other gimmicks. But the tax in a carbon tax system is likely to be way too low, and any carbon tax makes government an economic partner in the GHG producing activity.
My question for tax advocates: how much should a gallon of gasoline cost (with the carbon tax) in order to cut gasoline consumption nationally by 85% Keep in mind that when gas prices doubled from $2 to $4 two years ago, vehicle miles traveled declined . . . by all of 2%. My gut level guess is that it would take gas prices of about $25 or so per gallon to get the fundamental change necessary to reduce gasoline consumption by 80%. Is this any more likely than an effective, offset free, carbon cap at 20% of 1990 levels? And is a carbon tax realistically any less likely to be adorned with subsidies and exemptions for favored agricultural and industrial interests than cap-and-trade?
I think an effective cap-and-trade program is at least more plausible on a theoretical level — that is, I have more confidence in scientists establishing the proper cap than I do in economists establishing the proper tax rate. But neither is even close to plausible politically at this point.
–Karl
Karl: I agree with you on the political realities dogging both options (cap-and-trade and carbon tax), but if we’re going to go down fighting, I would prefer to go down pushing for a tax policy that we know at least won’t make things worse, versus a cap-and-trade program that could actually cannibalize other more effective methods of GHG reductions. But my recipe for reducing GHG emissions includes a carbon tax as only one component. Here it is: 1) effective EPA regulation of the major emitters (which may unfortunately be preempted by a cap-and-trade bill), 2) a carbon tax that could generate revenue for clean technology investment like electric cars and solar, 3) re-prioritizing our federal transportation funds away from highways to mass transit, and 4) a strong federal renewable portfolio standard.
The only advantage I can see of a cap-and-trade program is that it puts a price signal on carbon. But a carbon tax, even a weak one (as you assume it will be), will accomplish the same goal. And the revenue from the tax should fund research on the technologies that will move us away from (or at least help us conserve) a carbon-based energy system.
Re: your question about the proper level of gas prices, I think it’s remarkable that we saw even a 2% reduction in VMT in two years. Reducing VMT is really a “bending the curve” kind of exercise, as businesses, residents and shippers can’t just pack up and relocate overnight to adjust to high gas prices. The infrastructure we’ve built around cheap gas is simply too immense. But with continued high gas prices, maybe at $5-$6 a gallon, you would see a long term movement away from far-flung suburban living and warehouses in the middle of nowhere. You would see more voter willingness to subsidize mass transit and more demand for compact communities. It won’t happen immediately, but we can get there over time.