How to Reduce Greenhouse Gas Emissions in a World of Corporate Pork

Daniel Hall unwraps a rarely-heard yet very powerful argument in favor of cap-and-trade over carbon taxes. Essentially, coporate pork in a cap-and-trade system (free emissions allowances) is much less harmful than corporate pork in a carbon-tax system (lower taxes, or tax exemptions). Why?

Because one system (cap-and-trade with free allowances) equalizes the marginal cost of emissions, while the other (carbon taxes with exemptions) does not.

Once you establish a cap-and-trade system, every regulated entity within that system will have an identical incentive to reduce emissions. The incentive will be the market price for allowances. And this incentive will be the same for all firms regardless of how allowances are initially distributed. Even if firms get allowances for free, they will still face an opportunity cost for emissions.

If you establish a carbon tax system with different tax rates for different sectors, however, firms will face varying incentives to reduce emissions. This will end up making some firms or sectors work much harder to reduce emissions (those with the higher tax rates) and others work less hard. This will have (at least) two unfortunate effects: one is that society will get less bang for its buck now — fewer emissions reductions for the money it spends than it could have done if marginal tax rates were equal. The second problem is that over time the existence of differing marginal tax rates will tend to push economic activities into sectors with low tax rates and away from those with high tax rates.

This is similar, but not identical, to the argument I was making yesterday. Basically: assume imperfect government and an exasperatingly craven legislature. Then ask yourself what the world will, in practice, look like under each of the two alternatives. The cap-and-trade world is the better one.

(Via Avent)

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