IEEE Spectrum Enters Fray on Carbon Taxation versus Cap-and-Trade

An editorial in this monthâ''s issue of IEEE Spectrum raises the question of whether it would not be preferable, in principle, to adopt a carbon tax rather than the cap-and-trade system that the Barack administration is pushing. Earlier posts in EnergyWise suggested that carbon taxation might fit into a comprehensive program of tax reform and reported that Obamaâ''s economic team initially favored that approach. Economists from the far right to the far left overwhelmingly prefer carbon taxation because of its administrative simplicity, and that even includes economists who have moved from right to left.

Columbia Universityâ''s Jeffrey Sachs, who used to be associated with the shock therapy school but in the last decade reinvented himself as a man of the left, has cogent views on carbon taxation that are reported in Spectrumâ''s editorialâ''along with his resigned attitude about what Congress is likely to do.

The main problem with a carbon tax, as every graduate of Politics 101 knows, is that itâ''s a tax. The advantage of cap and trade is that even though it also drives up energy prices, and by a more or less equivalent amount for equivalent effect, it isnâ''t called a tax. The disadvantages of cap and trade are that it requires a large administrative infrastructure and development of an elaborate trading system, leaves the key economic players in doubt about what the value of emissions credits will turn out to be in the coming years and decades, and invites constant tinkering by politicians.

Attempting to make a virtue of a vice, Fred Krupp argued in the Wall Street Journal last week that â''a well designed cap and trade system will push our economy toward clean, domestic energy in the most flexible way possible.â'' By flexible, he evidently means that a trading system â''is self-adjusting based on economic conditionsâ''â''the price of emission credits will go down when times are tough but go up when they improve. Thatâ''s true, but it implies that when times are toughâ''like right nowâ''investors will have little incentive to invest in green technology, just when such investment is needed most, but the greatest incentive at times when the economy is awash in money anyway.

Krupp is an impressive person who has accomplished much as CEO of the Environmental Defense Fund. But on carbon taxation heâ''s simply wrong. The point of carbon regulation is to induce players to stop doing things that emit large amounts of carbon and to find low-carbon means of generating electricity. The most potent and flexible tool to accomplish that is a tax that penalizes carbon in the exact proportion to which itâ''s emitted, on a long-term schedule etched in stone.

Krupp argues that a carbon taxation bill could end up being just as complicated as a cap and trade bill. True. But this misses the essential point that a cap and trade bill by nature is a very complicated beast that almost inevitably will run to hundreds of pages, while a schedule of carbon taxes could in principle be formulated in one or two long paragraphs.

â''A cap is a legal limit on pollution,â'' says Krupp. â''There is no guessing what will happen.â'' Krupp should know that in Europe, where carbon cap and trade was first introduced, the caps have turned out to be no caps at all. Under the Kyoto Protocol, European countries were supposed to reduced their\ emissions by 7 or 8 percent from roughly 1990 to 2010. So youâ''d think their cap and trade system would set a cap for 2010 thatâ''s 7 or 8 percent lower than in 1990. But thatâ''s not how the political system works. Instead, the European Commission went to each country and asked how much it thought it could reduce its emissions by 2010; then each country delivered a document saying it really couldnâ''t afford to reduce them much. Then the commissions suggested they try just a little harder. The result: high caps, and carbon prices so low they havenâ''t prompted anybody to do anything differently.

Thereâ''s no reason to think politics will work any better in the United States, where green-minded liberals have got in the habit of inventing convoluted ways of accomplishing their ends without using the dreaded tax word. The result, again and again, is a complicated system that turns out to be politically vulnerable. What goes for cap and trade also goes for renewable portfolio standards and the renewable energy credits that give them their muscle. In an interview with the Wall Street Journal that appeared last weekend, Entergy CEO J. Wayne Leonard pointed out that such standards could actually lead to an increase in carbon emissions because green generating technologies would likely displace natural gas, which is expensive but low-carbon, rather than much more carbon-intense coal, which is cheap.

Ironically, countries with strong traditions of social democracy like Sweden and Germany were early adopters of carbon taxation and feed-in renewable energy tariffsâ''straightforward and uniform systems of penalties and incentives that classically trained economists like. In the United States, where socialist ideas are still taboo, liberals have adopted Rube Goldberg workarounds that classically trained economists despise.

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