A Question for the Pro-Carbon-Tax Crowd

The CBO’s

testimony on cap-and-trade is out. Greg

Mankiw likes it, because the CBO supports including given-away emissions

permits in the national accounts. I don’t like the testimony, becaues the CBO

supports the concept of a "safety valve", which defeats the entire

purpose of a cap-and-trade system, which is the cap. Deborah Solomon’s preview

of the testimony in today’s WSJ is OK, I guess, although the headline is

dreadful: the study does not "cast doubt" on a cap-and-trade system,

it just talks about the budgetary treatment of emissions rights once such a

system is in place.

The testimony does have one argument in favor of a carbon tax over a cap-and-trade

system which I haven’t seen before:

In terms of the impact on the climate, it does not matter greatly whether

a given cut in emissions occurs in one year or the next. From that perspective,

a tax has an important advantage: It allows emission reductions to take place

in years when they are relatively cheap. Various factors can affect the cost

of emission reductions from year to year, including the weather, the level

of economic activity, and the availability of new low-carbon technologies

(such as improvements in wind-power technology). By shifting emission-reduction

efforts into years when they are relatively less expensive, a tax can allow

the same cumulative reduction to occur over many years at lower cost than

can a cap-and-trade program with specified annual emission levels.

I’m hoping that a pro-carbon-tax blogger (Komanoff?

Mankiw?) will explain this argument for me in a bit more detail, since I’m not

sure I entirely follow it. Isn’t it an advantage of a cap-and-trade system that

emissions steadily decline, as opposed to a carbon-tax system where emissions,

could, in theory, continue to rise indefinitely?

In fact, it might be worth backpedalling a little and asking a question I’ve

had in the back of my head for some time, and have never seen explicitly answered.

Consider a cap-and-trade system where you impose a hard cap, C, on carbon emissions,

and the government auctions 100% of the emission rights. The auction is conducted

in an efficient and transparent manner, and the clearing price is, say, $10

per ton of carbon. In fact, the market is so efficient that in the secondary

market for emissions rights, the price stays at exactly $10 per ton for the

entire year.

Now consider that instead of implementing the cap-and-trade system, the government

simply imposed a $10-a-ton carbon tax at the beginning of the year. Can we say

with any certainty that under this scenario, total carbon emissions would fall

to C?

It seems to me that the arguments made by the pro-carbon-tax crowd always assume

that the answer to this question is yes, while my real-world intuition is that

the answer to this question is no. My feeling is that under the carbon tax,

government revenue would be greater than under the auctioned cap-and-trade system,

as businesses continued to emit carbon and pay the tax on their emissions. Yes,

the higher price would encourage a reduction in those emissions, but a price

incentive is surely no match for a hard cap when it comes to something as sticky

as energy consumption.

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