In a New York Times column, Nobel prize winning economist Paul Krugman has written some commentary on the Waxman-Markey legislation that proposes to introduce an emissions trading scheme in the United States. It is well worth reading. In his column, when Krugman discusses some of the objections to the scheme, he states:
One objection — the claim that carbon taxes are better than cap and trade — is, in my view, just wrong. In principle, emission taxes and tradable emission permits are equally effective at limiting pollution. In practice, cap and trade has some major advantages, especially for achieving effective international cooperation.
Not to put too fine a point on it, think about how hard it would be to verify whether China was really implementing a promise to tax carbon emissions, as opposed to letting factory owners with the right connections off the hook. By contrast, it would be fairly easy to determine whether China was holding its total emissions below agreed-upon levels.
I agree with Krugman that cap and trade has major advantages in terms of achieving international cooperation. This is the main reason why I support cap and trade. However, because carbon dioxide is more or less a stock pollutant, it has been argued that setting a price by introducing a carbon tax will be more likely to reduce emissions by an appropriate amount. I therefore disagree with Krugman that setting a tax is equivalent in principle to having tradable permits, because of uncertainty.
A cap and trade system with a price floor has the same advantages to emissions trading when it comes to international cooperation; it also has the same advantages of carbon taxation (and is probably superior to carbon taxation) when it comes to managing uncertainty. Unfortunately,it is very to find a serious discussion about price floors in the peer-reviewed economic literature since 1976 (but Roberts, M. J., Spence, M., 1976, ‘Effluent Charges and Licenses under Uncertainty’ is well worth reading). Most of the discussion on hybrids between cap-and-trade and carbon taxes has been about schemes with price ceilings.
See also:
Update: The Waxman-Markey bill does in fact have a price floor.
May 20, 2009 at 11:02 am
Thanks for posting this Peter. Krugman justifies trading over taxes because it ‘enhances international cooperation’ … this is merely asserted … but this is the weirdest:
“Not to put too fine a point on it, think about how hard it would be to verify whether China was really implementing a promise to tax carbon emissions, as opposed to letting factory owners with the right connections off the hook. By contrast, it would be fairly easy to determine whether China was holding its total emissions below agreed-upon levels.”
Huh???
It’s funny how quickly things are moving in the US – exactly the same debate as we’ve been having here playing out 10x faster.
May 20, 2009 at 11:36 am
I’m not sure how easy it would be to verify an aspect of China’s taxation policy compared to verifying emissions. What is clear is that international climate agreements will need to have strong and transparent verification mechanisms. An issue that makes taxation policies difficult to negotiate is the variability of exchange rates.
Cap and trade approaches do enhance the credibility of targets being negotiated internationally. There is much more certainty about a target being met under cap and trade than there is about a target being met under carbon taxation or ad hoc measures.
The problem with cap and trade is that emissions are unlikely to be less than the target. This could be addressed with a price floor.
You are right about how fast things seem to be moving in the US at the moment.
May 20, 2009 at 5:20 pm
Coming from Climate Progress, I am just discovering your site.
Can you give me an exponation about the following major objection against cap and trade? It is that the individual efforts are useless because the only consequence of these efforts will be to give these savings as aditional quotas available and then a decrease in the CO2 price (the basic rule of the market; something more available is less expensive!).
The huge effort we will have to perform the cut of our CO2 emission (divide by 4 for France, by 6 or more for USA) cannot be achieved if the individual efforts are not on board.
This objection is crystal clear and I would like to know your response to it.