https://www.env-econ.net/2013/01/can-republicans-warm-up-to-a-carbon-tax-nationaljournalcom.html

According to the National Journal:

A number of the nation’s leading conservative economists, who as a rule do not like taxes, are touting some benefits to a federal carbon tax. That group includes Gregory Mankiw, a former Romney adviser and George W. Bush-era chairman of the Council of Economic Advisors; Douglas Holtz-Eakin, Sen. John McCain’s 2008 chief economic adviser; and Art Laffer, progenitor of Reagan’s treasured Laffer Curve.

Such a tax could raise an estimated $1.5 trillion over 10 years and help wean the country from carbon-intensive fuels. And with Congress set for a season of budget fights and a possible effort to overhaul the tax code, the carbon tax is likely to reenter the conversation about getting America’s fiscal house in order. …

So, why do some conservative economists who normally oppose new taxation support a carbon tax? Because a carbon tax, like any Pigovian tax, taxes something we want less of. And when you tax something, you get less of it. Even for the remaining cohort of climate-change deniers, Mankiw lists a slew of other downsides to carbon emissions in his Pigovian manifesto.

… most taxes, especially at the federal level, tax things we want more of: labor, investment, business activity.

Depending on how broadly or narrowly you define economic growth, these taxes either arguably or definitely hurt growth.

But a Pigovian tax creates economic growth by allowing markets to allocate resources more efficiently. …

Liberal economists tend to like a carbon tax, too, but usually differ with conservative economists over what to do with the revenue. They’re more likely to see the revenue as an opportunity to extend government services, subsidize alternative energy, or, in the current economic environment, pursue some other form of stimulus. 

Conservative economists are more likely to advocate using the revenue to lower rates on other taxes, give everyone a tax rebate, or pay down the deficit. It’s these latter uses that are likely to dominate the discussion of a carbon tax in the coming months.

If I’d prefer revenue be used to pay down the deficit, relative to lowering other taxes or subsidizing alternative energy, does that mean I’m a conservative economist? Yikes.

https://www.env-econ.net/2017/02/larry-summers-likes-republicans-carbon-tax-proposal.html

Ideas should be judged by their quality, not their pedigree. I am not usually a fan of Republican tax policy proposals or environmental initiatives. But I strongly support the proposal put forward Wednesday by Republicans George Shultz, James Baker, Martin Feldstein, Hank Paulson, Greg Mankiw and others for a substantial carbon tax in the United States to address global climate change. Their proposal that the carbon tax be coupled with a mechanism for rebates to consumers, a rollback of command-and-control regulation, and a border adjustment mechanism is also sound.

The United States has a moral and a prudential obligation to lead on global climate change. There would be no clearer sign of our commitment than the introduction of a substantial carbon tax. Our adoption of a carbon tax would encourage others to follow. The border adjustment mechanism would be a further inducement since foreign countries would presumably prefer their carbon emitters pay them than pay us. And because a carbon tax is easy to change it would enable us to be responsive to new developments in the science of global climate change.

Some of my friends may not completely agree, but I think the replacement of command-and-control regulation with a carbon tax is a positive step. It will reduce uncertainty and thereby encourage investment. Raising carbon prices has the virtue of discouraging all types of carbon use, be it from power production or transportation, from changing fuels or reducing energy use. It is therefore likely an efficient way to reduce emissions. Of course the devil is in the details and, as the authors point out, the tax has to be set high enough to reduce emissions at least as much as any repealed regulations.

I also think that the proposal for a lump sum rebate that gives an equal amount to all citizens is a very sound one. Since a person with a $2 million income gets no more than a person with a $20,000 income, it is highly progressive. It reminds me of Alaska’s approach of sharing oil revenue equally with all citizens. I think that the approach of not adjusting the income tax but instead declaring a social dividend also will operate to give people a stake in environmental protection because whenever the carbon tax is raised, people will get a larger and highly visible rebate.

It is hard to know how the Trump administration, which has flirted with climate denialism and has been less than embracing of traditional Republicans, will react to today’s proposal. I do know that they could change the way they are perceived in many parts of the world and by many well-intentioned Americans if they tried to run with it. It is also hard to know how Democrats will react. I hope they will seize on prominent Republican endorsement to take the largest steps on global climate change in our history and at the same time to achieve the most universal social benefit.

https://economics.harvard.edu/files/faculty/40_Smart%20Taxes.pdf

https://www.env-econ.net/2011/08/a-reading-for-the-pigou-club.html

https://www.env-econ.net/2014/08/measuring-the-early-effects-of-a-carbon-tax-comparing-three-policies-across-income-groups-common-resources.html

https://www.env-econ.net/2013/03/common-resources-on-chinas-carbon-tax-plan.html

Xinhua reported recently that China will introduce a carbon tax. The actual announcement by Jia Chen from the Ministry of Finance buried the mention of the new carbon tax within a broader set of tax reform goals. Other reforms mentioned included the use of taxes to promote innovation and the development of small- and medium-sized businesses. This is not China’s first signal that it may introduce market-based mechanisms to control its carbon intensity. For months now, it has developed pilot programs testing localized emissions trading systems.

A carbon tax in China is a great idea, for three reasons.

First, a carbon tax will decrease carbon dioxide emissions. China is the world’s top emitter of greenhouse gases; its emissions are also growing at a breathtaking rate. So a carbon tax in China would be wonderful news for climate change.

Second, a carbon tax will help with air and water pollution, two major problems in China. This is because the activities which are most carbon-intensive, like coal burning and heavy industry, are also very polluting. Forcing industry to consider the cost of their carbon emissions will also have the effect of shifting them away from emitting other noxious products generated along with carbon.

Finally, a carbon tax is the lowest cost way to accomplish carbon reductions. Given the pressing need for China to continue its economic development, a carbon tax is the best instrument that can be deployed

https://www.env-econ.net/2008/03/sociologists-ni.html

Why would a carbon tax work but a gas tax won’t? Is it because business firms respond to higher taxes but households don’t? This is stinkin’ thinkin’ because business firms will try to pass all of the carbon tax onto households. For the carbon tax to work, households must rebel against the higher prices by buying less of the carbon intensive goods. In so doing, they’ll force firms to eat part of the carbon tax. Reference: see the public finance chapter of your introductory economics textbook.

In my model, a higher gas tax ($1/gallon) would raise gas prices. This would cause people to alter their behavior in various ways:

1. drive less
2. purchase more fuel efficient vehicles
3. move closer to work
4. update: slow down

https://www.env-econ.net/2016/07/canada-to-implement-national-carbon-price-thehill.html

Empirical and simulation models suggest that the [British Columbia carbon] tax has reduced emissions in the province by 5–15%. At the same time, models show that the tax has had negligible effects on aggregate economic performance, though certain emissions-intensive sectors have faced challenges. Studies differ on the effects of the policy on income distribution but agree that they are relatively small. Finally, polling data show that the public initially opposed the tax but now generally supports it.

https://www.env-econ.net/2010/02/how-about-carbon-tax-or-permit-revenue.html

Mankiw si preoccupa dell’insostenibilità del debito rispetto alla crescita del lungo termine, spiega perché la vat è un’imposta non neutra ma non parla della carbon tax. 

https://www.env-econ.net/2017/02/republicans-hope-for-climate-change-action.html

An Escalating Carbon Tax: Starting the tax at $40 a ton, with an understanding it would eventually have to be raised to $50 or more to have the desired impact on consumption and emissions. At $40 a ton, the group estimates its carbon tax would raise $300 billion annually. At $40, the tax would add an estimated 36 cents per gallon to gas prices.

*Carbon Dividends: All revenue from the new tax would be rebated back to American taxpayers. The plan calls for the Social Security Administration to administer the plan and estimates the typical family of four would receive $2,000 a year. Conservative critics of the carbon tax, including the Koch brothers organizations, have criticized carbon tax proposals as unfair to working families. The dividend idea in the new plan is designed to address that and to keep the proposal neutral from a government revenue perspective.

*Border Adjustment Fee: High carbon imports would be subject to a tariff adjustment similar to the proposal House Republicans are considering as part of their broader tax reform proposal.

*Regulatory Rollout: The plan calls for the repeal of the Obama administration’s Clean Power Plan and a host of other Environmental Protection Agency regulations aimed at reducing carbon emissions. To make this politically palatable, the authors call for an initial carbon tax rate high enough to guarantee emissions reductions that exceed those forced by current regulations.

via www.cnn.com

The New York Times editorial authored by Martin Feldstein, Ted Halstead and Greg Mankiw begins like this: 

CRAZY as it may sound, this is the perfect time to enact a sensible policy to address the dangerous threat of climate change. Before you call us nuts, hear us out. …

https://www.env-econ.net/2006/06/sachs_on_pricin.html

Sachs: non ci sono modi credibili di attaccare il cambiamento climatico senza alzare il costo delle emissioni di anidride carbonica. 

Marvin ROmanow: Se non cambi il prezzo di una cmmodity non aspettarti che il pattern di uso cambi.

There are many ways to tax carbon, said Romanow, and the trick is to do it in a way that doesn’t target a single industry, producer or province. “I think industry … would have very limited objections to stuff that’s applied across all sectors that produce carbon dioxide.”

https://www.env-econ.net/2016/01/proof-that-a-price-on-carbon-works-the-new-york-times.html

From the New York Times editorial page:

Lawmakers who oppose taking action to lower greenhouse gas emissions by putting a price on carbon often argue that doing so would hurt businesses and consumers. But the energy policies adopted by some American states and Canadian provinces demonstrate that those arguments are simply unfounded.

Around the world, nearly 40 nations, including the 28-member European Union, and many smaller jurisdictions are engaged in some form of carbon pricing. In this hemisphere, British Columbia, Quebec, California and nine Northeastern states have raised the cost of burning fossil fuels without damaging the economy. Alberta, Canada’s biggest oil and gas producer, and Ontario have said they will adopt similar policies.

Carbon pricing comes in two forms: a direct tax on emissions or a cap on emissions. British Columbia, for instance, has levied a tax on emissions from fuels like gasoline, natural gas and heating oil. California and Quebec, which are working together, place a ceiling on overall emissions and allow utilities, manufacturing plants, fuel distributors and others to buy and sell permits that entitle them to emit greenhouse gases. Like the cap itself, the number of permits decline over time, becoming more expensive.

Many economists regard carbon taxes as the simpler and more elegant solution, and cap-and-trade systems like the one that failed in the United States Congress as complex and hard to explain. But both systems effectively raise the price of using fossil fuels, which encourages utilities and other producers to generate more energy from low-carbon sources like solar, wind and nuclear power.

British Columbia, which is home to 4.7 million people, has placed the highest price on emissions in North America, taxing a ton of carbon emitted at 30 Canadian dollars, or about $21. By comparison, emission permits in California and Quebec are trading at about $13 a ton. And permits sold for $7.50 a ton in a December auction in the Northeastern trading system known as the Regional Greenhouse Gas Initiative. That system covers emissions from power plants in nine states that include Connecticut, New York and Massachusetts.

British Columbia started taxing emissions in 2008. One big appeal of its system is that it is essentially revenue-neutral. People pay more for energy (the price of gasoline is up by about 17 cents a gallon) but pay less in personal income and corporate taxes. And low-income and rural residents get special tax credits. The tax has raised about $4.3 billion while other taxes have been cut by about $5 billion. Researchers have found that the tax helped cut emissions but has had no negative impact on the province’s growth rate, which has been about the same or slightly faster than the country as a whole in recent years.

Meanwhile, jurisdictions using the cap-and-trade approach like California, the nine Northeastern states and Quebec are investing the revenue generated by auctioning emission permits in mass transit, energy efficiency, renewable energy and other strategies to reduce carbon emissions. Some of the revenue is also dedicated to helping low-income families cope with higher energy costs.

In Alberta, a new government announced in November that it would impose a tax of 30 Canadian dollars on most greenhouse gas emissions by the start of 2018. The province’s leaders also said they would phase out the use of coal power plants and impose caps on carbon and methane emissions from Alberta’s oil and gas industry.

These actions deserve applause. But their real value may lie in providing a template for the rest of the world. Broad participation is essential to keeping warming below a point of no return; as a practical matter, it is also essential to keep companies from moving their operations to nations that do not impose a cost on carbon emissions.

In that context, China’s announcement last year that it would set up a national cap-and-trade system was hugely encouraging — the world’s largest emitter agreeing to tax itself to help solve a problem that, only a few years ago, it barely acknowledged. Yet Congress has refused to act even as it becomes clear that putting a price on greenhouse gas emissions is the most direct and cost-effective way to address climate change.

https://www.env-econ.net/2018/06/new-group-with-conservative-credentials-plans-push-for-a-carbon-tax.html

Let the demogoguery begin: 

Proponents of a market-oriented plan to fight climate change by taxing greenhouse gas emissions and giving the revenue to American taxpayers are starting a campaign to run advertisements as early as this fall and introduce legislation in Congress as early as next year.

The plan’s supporters have formed a group called Americans for Carbon Dividends that will lobby for the proposal. The group plans its first event on Wednesday and includes a number of well-known members, including Trent Lott, the former Senate Republican leader from Mississippi, and Janet L. Yellen, who led the Federal Reserve under President Barack Obama.

The initiative has already won endorsements from some environmental groups, like the Nature Conservancy and Conservation International; fossil fuel giants like Exxon Mobil, Shell and BP; and major companies in renewable and nuclear energy and consumer goods.

“It’s something that may command bipartisan consensus,” Ms. Yellen said in an interview, calling the proposal “a very exciting prospect.” Taxing carbon dioxide emissions to reduce energy use, she added, is “absolutely standard textbook economics.”

The proposal would set an initial tax of $40 per ton of carbon dioxide produced and would increase the price over time. That would raise the cost of a gallon of gas by approximately 38 cents, the group says, with similar effects on household heating and other energy use. That could, in turn, encourage people and businesses to become more energy efficient and curb their use of fossil fuels.

To offset the higher prices, the tax revenue would be returned to consumers as a “carbon dividend.” The group estimates that the dividend would give a family of four about $2,000 in the first year.

The group says the plan could reduce United States emissions even further than the Obama administration pledged under the Paris climate accord.

 

But the leaders of the group are not holding their breath. The notion that the current fractious Congress could pass a bill based on the proposal is not within their fondest expectations. Instead, their strategy is to build public support for the plan while working toward a legislative proposal that could be introduced after the midterm elections, when a new Congress might be more friendly to environmental legislation. …

https://www.env-econ.net/2018/01/quote-of-the-day-revenue-neutral-carbon-tax.html

Glenn Hubbard: “If we had a $40/ton carbon tax, that would raise 1.5 trillion dollars.” 

https://www.env-econ.net/2016/02/there-will-be-negative-economic-effects-if-the-government-burns-carbon-tax-revenue.html

https://www.env-econ.net/2015/09/to-comply-with-the-clean-power-plan-states-should-tax-carbon-brookings-institution.html

Adele Morris and Evan Weber:

Since the release of the final rule, much attention has been given to how states can trade emissions allowances across borders to reach goals jointly, allowing more abatement where costs are lowest. The requirements for these complicated schemes occupy hundreds of pages of the rule, while EPA devotes only one sentence (in the preamble) to the potentially equally cost-minimizing carbon tax approach. The agency clearly prefers cap-and-trade over other options, as evidenced by the detail in the rule and EPA’s accompanying proposed federal plan for states who do not submit an acceptable (or any) implementation plan.

However, another factor accounts for EPA’s apparent short shrift for a tax approach: the concept is remarkably simple to understand—one-sentence simple—and just as easy to administer. By gradually increasing the cost of emitting greenhouse gases from coal- and natural gas-fired power plants by charging a per-ton fee for the CO2 emissions the plants already monitor, states could both reduce electricity demand from fossil fuel sources and level the playing field for zero-emissions alternatives like wind and solar. States already know how to implement such a tax; every state already taxes fuels such as gasoline, diesel, and natural gas. A state would just need to show, by modeling (the kind EPA already does), that its proposed carbon tax trajectory will hit its Clean Power Plan target and be prepared to adjust it or take other actions if emissions are off course.

https://www.env-econ.net/2013/04/if-carbon-taxes-are-so-great-stand-up-economist.html

Yoram Bauman:

A good question on Friday from a student at Westminster College:

If revenue-neutral carbon taxes are such a great idea, why has only British Columbia adopted this policy?

I gave what I thought was a decent answer in class, but wanted to put some more thoughts down in writing:

1) People prefer the devil they know to the devil they don’t. …

2) People don’t (yet) accept that climate change is a serious problem. …

3) Economists think about the world differently than “normal people”. …

4) There will be winners and losers. …

Go read the Standupeconomist.com to get the details.

Me? I think that carbon taxes are a great way to raise government revenue too (especially with a large and growing government debt). So, why hasn’t anyone adopted this idea? As far as I can tell there are no good reasons. Here are some bad reasons:

1. Because people like to spend borrowed money
2. Because people would rather not repay borrowed money
3. Some politicians have convinced the public that a tax is a bad thing
4. Some politicians have convinced the public that everyone other than oneself is on the government dole and those government benefits should be cut

http://standupeconomist.com/if-carbon-taxes-are-so-great/

If revenue-neutral carbon taxes are such a great idea, why has only British Columbia adopted this policy?

I gave what I thought was a decent answer in class, but wanted to put some more thoughts down in writing:

1) People prefer the devil they know to the devil they don’t.

More specifically, people seem to prefer whatever tax system they have now, however lousy it may be, to possible alternatives. A good example here concerns Washington and Oregon, which both instituted income taxes in the 1930s. Washington’s income tax was found to be in violation of the state constitution, so the state adopted a sales tax instead. To this day Washington has a sales tax but no income tax, and voters would almost certainly reject an effort to replace the sales tax with an income tax. Across the state line, Oregon has an income tax but no sales tax, and voters there would almost certainly reject an effort to replace the income tax with a sales tax. Go figure.

I think that one part of the explanation here is that tax reform proposals seem to automatically engage people’s cynicism and mistrust of government, so they’re inclined to think the worst. In the case of revenue-neutral carbon taxes (i.e., raising taxes on fossil fuels but lowering existing taxes on income, sales, etc) the worst-case thinking is “You’re going to raise tax fossil fuel taxes but you’re NOT going to lower existing taxes.” This is a very difficult argument to counter, although B.C. has tried, e.g., by stipulating that the finance minister loses her salary if the tax is not revenue-neutral.

2) People don’t (yet) accept that climate change is a serious problem.

Tax reform is a big deal, and you’ve got to have a good reason to get behind it. Many people don’t feel that urgency right now.

When my older brother and I were kids, one of our household chores was hanging up the laundry. So we would go to the laundry room in our apartment building and proceed to snap towels at each other and otherwise goof around. And then eventually my brother would announce that it was “No f***ing around time”, at which point we would get down to business. The analogy, of course, is that Americans are still goofing around when it comes to climate change. At some point they may recognize that it is “No f***ing around time”, at which point they’ll be more willing to consider significant changes like environmental tax reform.

Put points #1 and #2 together and you see that people are inclined to stick with the status quo in part because they think we can just keep doing what we’ve been doing. But we can’t. The real choice is between changing our tax system and changing our climate. The status quo is not an option.

3) Economists think about the world differently than “normal people”.

When economists think about taxes, they mostly focus on efficiency and things like deadweight loss, or what was once described as plucking the goose to get the greatest amount of feathers with the least amount of hissing. When “normal people” think about taxes, they mostly focus on equity and fairness. And, as above, cynicism and mistrust of government play a major role.

Similarly, when economists think about environmental issues, they naturally think about using market-based instruments like carbon taxes or cap-and-trade systems. When “normal people” think about environmental issues, they mostly think about regulatory policies (like fuel-economy standards) or government-funded R&D into clean energy.

Finally, when economists think about policy, they often focus on pragmatic consequences and use a cost/benefit framework. In contrast, “normal people” often focus on left-versus-right ideology. (This contrast is the basis for one of my jokes, namely that economists are the kind of people who are against the death penalty because it’s too expensive.) Unfortunately, environmental tax reform exists in a kind of ideological no-man’s-land: when I make the case for using capitalism to tackle climate change, the stereotypical responses from the left and right, respectively, are “Capitalism? We don’t believe in capitalism!” and “Climate change? We don’t believe in climate change!”

4) There will be winners and losers.

Environmental tax reform will generate gains that are bigger than the losses, but there will be losses and they will disproportionately affect certain people and certain economic sectors. This was addressed in the equity part of #3 above, but it’s worth emphasizing that some people will lose their jobs and some industries will shrink. Those changes are inevitable if we want to tackle climate change, and in the big picture they will be offset by new jobs and growing industries in other economic sectors. There are ways to try to minimize these losses, e.g., by providing offsets for low-income households (as in B.C.) or by targeting certain tax reductions for energy-intensive industries (as in our proposal for Washington State). But in the end the theoretical ideal—a policy that makes everyone better off and makes nobody worse off—is unattainable; in the real world there will be winners and losers.

Of course, it’s worth remembering that climate change will produce winners and losers, too, and the odds are that the losses will outweigh the gains. This takes us back to #2 above, that people don’t (yet) acknowledge that climate change is a serious problem. If and when they do, perhaps they will be willing to take the difficult steps that will be necessary to deal with it.

1. A fisheries analogy

A similar Tragedy of the Commons situation often exists with overfishing (e.g., with cod in New England), and the political challenges are often even more stark. The obvious solution to overfishing is to limit fishing and allow stocks to recover, and economists would recommend use economic instruments like a tax on fishing or a cap-and-trade system (which is known in the fisheries world as an ITQ system of Individual Tradable Quotas). But these policy recommendations almost always encounter resistance from the fishing community itself, the complaint being that you’re taking a struggling industry and kicking it while it’s down. The four issues identified above can be clearly seen: People are skeptical of changing the system they currently have (it’s worked for generations!), they don’t always believe that the problem is serious (maybe the fish are just having a bad year and will be back next year!), they think differently than economists (you’re kicking us when we’re down, and that’s not fair!), and there are winners and losers (what about the older skippers who just want to fish for another year or two and then retire?).

https://www.env-econ.net/2013/03/a-carbon-tax-in-a-congressional-budget-proposal.html

We can no longer afford to ignore our responsibility to future generations to address climate change before it is irreversible. The Back to Work Budget would impose on polluters a $25 per ton price on carbon dioxide (increasing at 5.6% a year), rebating 25% of all revenues as refundable credits to protect low income families. The Energy Information Administration found that a similar proposal would result in carbon emissions reductions of 26% below 2005 levels by 2020. This would go a long way toward setting the United States on a path to avoid increasingly extreme and destructive weather, particularly when combined with air pollution controls measures under the Clean Air Act and enhanced energy efficiency. 

The Economic Policy Institute says that:

Net of this rebate, carbon pricing would raise over $1.1 trillion of revenue over FY2014–2023.

What’s not to like?

https://www.env-econ.net/2017/01/the-paris-agreement-under-trump-and-the-merits-of-an-economy-wide-carbon-tax.html

https://www.washingtonexaminer.com/600-companies-plead-with-trump-to-uphold-paris-agreement

https://energyfactor.exxonmobil.com/corporate-citizenship-sustainability/exxonmobil-and-the-carbon-tax/

https://www.env-econ.net/2016/07/were-going-to-need-more-tax-revenue-heres-how-to-raise-it.html

Jared Bernstein:

Broadly speaking, two things matter when it comes to the tax system: First, as just noted, the system needs to raise enough revenues to cover the fiscal obligations and economic challenges we face. Second, our tax system should reduce, not exacerbate, market-driven inequality. Those with the highest incomes should face the highest tax rates, and the public tax collection infrastructure should protect the code’s progressivity by blocking tax avoidance and prosecuting tax evasion. …

Thus, we need to raise more revenues in a way that is progressive and reduces tax avoidance and evasion. What changes might be made that are consistent with these criteria? While most tax increases should be directed at the top, it’s a mistake to limit tax hikes to the very wealthy. …

With that said, here’s what I’d recommend to progressively raise more revenue, both on the individual and business side of the tax code. My goal is not to be exhaustive—there are many good ideas I don’t explore, some of which are contained in the recent Obama budget—but to set forth more of a modular framework (as opposed to all-out “tax reform,” a recipe for an endless, fruitless, muddled debate) and provide numerous examples of the type of ideas that fit neatly into it. …

8. A tax on carbon. This one is obvious and essential. Yes, it would raise taxes on non-rich people (and many such taxes include a rebate to lower-income people who spend more of their income on energy). But it’s a defensible tax increase.

The Obama administration recently proposed a $10-per-barrel tax on oil, which raises $319 billion over ten years. Especially given how cheap oil has recently become, I appreciate their motivation, but I’d rather raise the federal gas tax. This tax is how we fund both highway infrastructure and the federal contribution to public transit, and it has been stuck at 18.4 cents a gallon in nominal terms since 1993. Meanwhile, the costs of maintenance have gone up, as has vehicle mileage, so no wonder the Highway Trust Fund is always broke. We and our politicians have conspired to create a magical world where we can maintain our roads and bridges and support our urban mass transit without paying for it.

A tax on fossil fuels is essential partly because they’re socially underpriced. Here, the National Cooperative Refinery Association oil refinery is silhouetted against the setting sun in McPherson, Kansas.

Moreover, and this is of course the other huge reason we need to raise the tax liability on fossil fuels: They’re socially underpriced. This is an opportunity to tax a seriously threatening negative externality, breaking the curse of magical thinking on transportation infrastructure, and raise needed revenues. There’s even been a touch of bipartisan support for the idea. (That’s why I’d go for this over the oil surcharge.) One such plan raises the gas tax by 12 cents a gallon over two years (6 cents per year) and then indexes it to inflation. That would raise $180 billion over ten years.

https://www.env-econ.net/2017/12/who-knew-revenue-neutral-corporate-tax-cuts.html

With a carbon tax or cap-and-trade:

In 2015, the U.S. Environmental Protection Agency issued the Clean Power Plan under which each state can set a mass-based target to meet its assigned electric power sector carbon dioxide emission reductions. If it proceeds, states can design policies to meet those requirements and also raise revenue via a carbon tax or cap-and-trade program with auctioned permits. We calculate each state’s potential revenue and demonstrate its significance. In 13 states, carbon revenue could replace all of corporate tax revenue. In addition, we collect budget projections from six key states to determine if and how carbon revenue can substantially reduce deficits. While such revenue is not free money, we discuss its advantages over use of distortionary taxation. Finally, we consider distributional aspects and potential external fiscal effects on federal revenue.

via onlinelibrary.wiley.com

That’s the abstract from: Don Fullerton and Daniel H. Karney. “Potential State Level Revenue under the Clean Power Plan,” Contemporary Economic Policy Volume 36, Issue 1, 149–166.

https://www.env-econ.net/2015/09/senate-democrats-to-unveil-aggressive-climate-change-bill-the-new-york-times.html

Translation:

• “require electric utilities to increase energy efficiency” = command and control
• “extend tax credits” = subsidy
• “make it cheaper for consumers” = subsidy
• “increase spending on research” = subsidy

The combination is surely to be more costly, i.e., less efficient, than carbon pricing (i.e., a carbon tax or cap and trade)

https://www.env-econ.net/2007/10/some-basic-econ.html

Quebec province slapped the country’s first carbon tax on energy firms on Monday, as Canadian business leaders urged “environmental taxation” to rein in greenhouse-gas emissions.

The tax, proposed more than a year ago, is expected to raise C$200 million ($202 million) a year to fund the province’s plans to reduce emissions.

Basic enironmental econ lesson–the tax will reduce emissions.  If set properly, the tax can result in the efficient level of emissions.  So why are the revenues being used to “fund the province’s plans to reduce emissions”?  Is the tax set below the desirable level and more reductions are needed?  If so, then why not set the tax higher and then use the revenues for other stuff–like reducing inefficient labor taxes?

Read on for more Env-Econ 101… 

It [the tax] includes a per-litre levy of 0.8 Canadian cent for gasoline, 0.9 Canadian cent for diesel fuel, 0.96 Canadian cent for light heating oil, and C$8 a tonne for coal.

It wasn’t immediately known whether the oil companies, including Petro-Canada (PCA.TO: Quote, Profile , Research) and Imperial Oil (IMO.TO: Quote, Profile , Research), would pass along the cost to consumers.

Almost all output/production taxes get passed on to consumers.  The question is:  how much of the tax will be passed on?  It depends on how sensitive consumers are to price changes (we call this the elasticity of demand).  If consumers are very sensitive to price changes (elastic demand) then the companies will absorb the tax.  Passing it on to consumers will result in a big drop in revenues (sales)–bigger than the drop from absorbing the tax.  But, if consumers are not very sensitive to price changes(inelastic demand) then companies can pass the tax on to consumers with little effect on the bottom line.  So ask yourself–are consumers sensitive to price changes for energy?  If not, then yes, companies will pass the tax through to the consumer.  Who’s fault is that?

Separately, the Canadian Council of Chief Executives said Canada should become “an energy and environmental superpower,” and suggested higher energy prices to help cut emissions, the Globe and Mail newspaper reported on Monday.

Companies calling for taxes?! Hmmmm…why might that be?  My guess is that the companies know carbon policy is coming and taxes–for the reason I outlines above among others–will have the least impact on their profits. 

Since 1990, greenhouse-gas emissions in Canada, a net exporter of energy, have risen more than in any other leading industrialized country, data submitted by the Group of Eight rich nations to the U.N.’s Climate Change Secretariat shows.

And they call us greedy.  I always knew there was something fishy about those Canadians, eh?

Quebec has pledged to meet its targets under the Kyoto Protocol on climate change.

Unfortunately, Kyoto will be obsolete next year.

Canada has signed on to the agreement, which calls for a 6-percent cut in emissions from 1990 levels by 2012, but Prime Minister Stephen Harper has said that target is impossible to achieve.

Instead, the minority Conservative government aims to cut emissions from greenhouse gases — the key contributor to climate change — by 20 percent from current levels by 2020.

Anyone know how a 6% cut from 1990 levels compares to a 20% cut from today’s levels?ù

https://www.env-econ.net/2013/05/a-carbon-trading-system-worth-saving-nytimescom.html

NY Times:

The European Union became a pioneer in tackling climate change by starting the first major cap-and-trade system designed to reduce carbon-dioxide emissions by putting a price on them. But analysts are increasingly worried that technical mistakes, Europe’s prolonged recession and the failure of policy makers to strengthen the system is undermining its effectiveness.

Like all such systems, Europe’s program caps the overall emissions that power plants, steel mills and other industries can put into atmosphere. The cap, which is regulated through permits, declines every year, forcing businesses to become more efficient or buy permits from another firm or on the open market.

Recently, the price of permits has collapsed to less than 4 euros (around $5.25) per ton of carbon, down from nearly 30 euros in 2008. This is troubling because the low price discourages emitters investing in climate-friendly technologies and fuels. …

In addition to its trading scheme, Europe has made real progress in dealing with climate change through policies encouraging energy efficiency and renewable sources of power like wind and solar. But nothing would do more to drive down emissions than putting a meaningful price on them, either through a carbon tax or through a cap-and-trade system. Europe’s job is to put that system on a sounder footing to make sure it doesn’t undo the real progress it has made.

I like the way the editorial ends, with a carbon tax and cap-and-trade as substitutes with plusses and minuses. And actually, a quick review of the regulating prices vs. quantities literature suggests that hybrid approaches might be preferred (e.g., cap-and-trade with a trigger price). It is only the naive who think a carbon tax would magically avoid implementation problems. And note, permit auctions can generate government revenue. 

https://www.env-econ.net/2009/03/cap-and-auction.html

Somewhere I saw cap-and-trade referred to as cap-and-auction (can’t find the link and don’t want to look)… as if the trading were a bad thing (I’m not sure if this has been proposed but I’m knee jerk reacting) .

More or less, cap-and-trade would achieve CO2 reductions efficiently (i.e., at least cost) if permits are allocated as giveaways (say, as a percentage of historical output) or with auctions. Under giveaways the low cost abaters have an incentive to sell their permits to the high abaters. The trading feature acts as the abatement cost information elicitation device. The knock on giveaways are the windfall profits that accrue to polluters.

Under an carbon permit auction firms have incentives to bid in line with their abatement costs and permits would go to the high cost abaters (who would be free to emit CO2). The low cost abaters would lose out on permits and reduce their CO2. The final allocation of permits should be about the same and firm/industry abatement costs are ultimately revealed. The knock on auctions is political — more resistance from polluters.

Auctions would reduce the additional efficiency generated by trading if permits are passed out but the trading feature should not be replaced. Gains from trade post-auction could be had by unexpected technological innovations and other surprises. Without the trading feature the dynamic efficiency aspect, i.e., firms trying hard to find ways to cut abatement costs, of incentive-based policy could be lost.

https://www.env-econ.net/2009/12/from-greg-mankiws-blogclub-member-ted-gayer-makes-five-points1–either-a-carbon-tax-or-a-cap-and-trade-program-will-result.html

From Greg Mankiw’s Blog:

Club Member Ted Gayer makes five points:

1. Either a carbon tax or a cap-and-trade program will result in substantially lower economic costs than command-and-control regulations that mandate technologies, fuels, or energy efficiency standards.
2. Given the uncertainty of the future costs of climate policy, a carbon tax is more economically efficient than cap-and-trade.
3. Carbon allowances in a cap-and-trade program would be susceptible to price volatility. Price volatility causes economic disruptions and complicates investment decisions. It also could lead to political pressure on Congress to repeal or substantially loosen the cap.
4. A carbon tax, in which the revenues are used to offset economically harmful taxes or to pay down our deficit, would substantially lower the cost of climate policy compared to a cap-and-trade program that gives away allowances for free.
5. The currently proposed climate bills rely heavily on offsets to reduce the overall costs of cap-and-trade. Given the substantial potential value of offsets, there is a very real concern that offset integrity will not be maintained. This would result in a weakening of the cap, undermining its environmental benefits.

Continue reading here.

I agree with all points except for a couple of not-so-minor things (or don’t disagree since I don’t work with the minutiae of these models). I don’t agree with:

• The last sentence of #3. At least, I don’t agree the implicit assumption that a carbon tax is immune to political pressure (e.g., this post from Tim).
• The comparison in #4. The relevant comparison is with a carbon tax and cap-and-trade with an auction of permits that raise revenue.

In fairness to Dr. Gayer, I haven’t read his four page testimony (I’m in a SSC meeting and better not [I’m taking a blogging break as the fisheries scientists debate stock assessment]) so these are really comments on Dr. Mankiw’s highlighting of Dr. Gayer’s testimony.

However, here is Dr. Gayer’s conclusion:

I acknowledge that my arguments in favor of a carbon tax over cap-and-trade are made easier in that I am comparing my ideal hypothetical carbon tax to the actual cap-and-trade programs either passed by the House or proposed in the Senate. Indeed, a cap-and-trade program that included a safety valve and that auctioned allowances would achieve many of the economic advantages of a carbon tax.

I wouldn’t dump my girlfriend because she is not quite my ideal hypothetical girlfriend. That is a sign of romantic immaturity (e.g., Beautiful Girls). In the cap-and-trade vs carbon tax debate it is a sign that you really, really like a carbon tax. I continue to fail to see why the proposed cap-and-trade should be compared to the ideal carbon tax.

*The post title works just as well with “boy” substituted for “girl.” It was a bit clunky to write girl/boy or girl (boy) so I simplified.

https://www.env-econ.net/2008/10/bizarre-no-toug.html

Joe Romm’s analysis over at climateprogress.org is mostly spot on — and if a post starts like this, you already know what comes next. This time he responds to a $10,000 contest organized by EDF (yep, my employer) that asks for submissions to help explain: “What is a carbon cap and how will it cure our oil addiction?“

Romm calls it a “bizzare” contest “to explain something that isn’t true,” since “it is all but inconceivable that a carbon cap will solve our oil addiction.” Well, not so fast.

A cap alone will not cure all ills, but it goes a long way towards solving the problem. Let’s look at the numbers.

MIT’s analysis of the Climate Security Act using their EPPA model says that net crude oil imports would be 22% lower by 2015 under CSA than without. These savings rise to 31% by 2020, 41% by 2025, and 66% by 2030. (Savings decrease in the next years due to some modeling assumptions around other countries taking on caps, but are up to 62% again by 2050.) Sure, that’s technically not “solving the problem” entirely. However, solving two thirds of it isn’t all that bad in my book.

But that’s not all. Rising prices alone aren’t going to solve the transport issue: 97% of our vehicles run on oil. Changing that requires more than increasing the price, as examples from Europe and many economic studies show. That’s where additional direct mandates like higher CAFE standards come in, much like as Romm suggests.

It’s also where the cap can show its full potential. Depending on how many of the carbon allowances are auctioned (as opposed to given away for free), a cap will also generate large sums of money. Part of that could be used to jump-start our transition to a greener transportation sector that’s less dependent on fossil fuels. It’s tough to put a number on this. Yet it wouldn’t be too surprising if a combination of these measures could take care of the remaining third of the problem.

These arguments also show why the ad competition is a good idea. It’s tough to translate economic modeling results into an accessible language without sounding overly wonkish, let alone describing the potentials for these additional measures.

So, any idea for a memorable image? It would indeed be neat to come up with something that mirrors the “This is your brain. This is your brain on drugs” campaign.

https://www.env-econ.net/2007/05/cbo_on_the_dist.html

https://www.env-econ.net/2016/07/why-are-carbon-prices-so-low.html

This preference for using prescriptive policies –rather than market mechanisms- to coordinate abatement helps explain why carbon prices are so low.   Some simple graphs summarize the basics behind this cause and effect.

In the cartoon graph below, each colored block represents a different abatement activity (e.g. coal-to-gas fuel switching, renewable energy investments,  energy  efficiency improvements, etc.). Think Sesame Street meets the McKinsey curve. The width of the block measures achievable emissions reductions. The height of the blocks measures the cost per ton of emissions reduced.

In this cartoon cap-and-trade story, suppose baseline emissions are 200 and policy makers are seeking a 25% reduction. If we rely entirely on a permit market to get us there, we’d allocate 150 permits and let the market figure out where the 50 units of abatement will come from. An efficient market would drive investment in  the lowest cost options:  A  + B + 1/2 C. The total abatement cost incurred to meet the target would be  (20 x $10) + (20 x $20) + (10X$50) = $1100. The market clearing price (and the marginal abatement cost/ton) would be $50.

Now imagine that, in addition to the permit market, complimentary measures are introduced to mandate deployment of options D  and E.  These mandates take us 80% of the way towards meeting the emissions target.  The role of the carbon market has been seriously diminished –  we need only  10 more units of abatement to hit the target.

Under this scenario, the carbon market will incentivize investment in 10 units of A. The permit price drops to $10.  The total cost of meeting the emissions  target rises to  10 x $10 + 20 x $100 + 20 x $150 = $5100. And we wring our hands about low carbon prices and broken carbon markets.

Of course, this cartoon picture omits lots of real-world complexities (see this important EI paper for a more detailed analysis of California’s abatement supply and allowance demand). But it illustrates two real-world considerations. First, when complementary measures mandate relatively expensive abatement options, the carbon price we observe in the market will not reflect the marginal cost of reducing emissions. Second, a reliance on complementary measures to reduce emissions can significantly drive up the costs of hitting a given emissions target.

In California and in Europe, there is growing evidence that low allowance prices in the carbon market belie much higher abatement costs associated with complimentary policies.  For example, this paper estimates that the California Solar Initiative delivered emissions reductions at a cost of $130 – $196 per metric ton of CO2.  California’s  LCFS credit price (which reflects the marginal incentive to reduce a ton of MCO2e)  is currently averaging around $120 per metric ton CO2. In Europe, researchers estimate that the implicit costs of renewable energy targets per metric ton of CO2 are on the order of hundreds of euros for solar (and wind in some locations).

https://www.mckinsey.com/business-functions/sustainability/our-insights/greenhouse-gas-abatement-cost-curves

https://energyathaas.wordpress.com/2016/06/20/time-to-unleash-the-carbon-market/

https://www.env-econ.net/2009/10/if-at-first-you-dont-succeed-.html

Mankiw points out that taxes distort economic behavior (no economist wants any part of that). Using a straightforward model he describes a policy to mitigate the distortion in the product market (the negative externality of climate change) without making the labor market distortion worse. However, since climate policy makes the carbon-intensive goods and services more expensive, the purchasing power of income falls. As a result people will want to work less and the labor market distortion worsens. Hence, climate policy must raise revenue significant enough  (i.e., revenue recycling) is necessary to avoid the worsening of the labor market distortion.

I have no quibble with this analysis. My worry is the potential confusion that Mankiw creates amongst noneconomists. He is working towards the most efficient* policy and is opposed to anything less than that (hence, the advice to Obama to veto whatever climate bill might come out of Congress). This is an honorable Milton Friedman-esque position. But noneconomists might not understand the difference unless the “most efficient policy” goal is explicitly stated in a way that noneconomists will understand it (but it isn’t, as far as I can tell).

Many people in the general public, including some economists (e.g., myself**), would be happy with climate policy that is more efficient than the status quo (albeit, not the most efficient). For example, suppose the most efficient policy, a carbon tax with revenue recycling, generates net benefits of $100. Another efficient policy might generate might generate $90 (cap-and-trade with full auction) or $50 (cap-and-trade without full auction). Any of these are better than the status quo and even better than regulatory alternatives that might generate negative net benefits. 

*Note: I’m using a definition of efficient as additional benefits exceed additional costs. The most efficient policy is one where the net benefits are maximized. 

**Note: It is rare that a democratic process that allows non-efficiency goals into the mix will generate maximum net benefits.

https://www.env-econ.net/2009/09/is-mankiw-being-completely-above-board.html

The title to this post is inspired by Tim’s email from the stats department at tOSU but it fits Mankiw’s  baffling August 9th attempt at making Siamese twins out of climate policy and tax cuts (A missed opportunity on climate change).

Here is the twinning of a carbon tax and tax cuts:

The textbook solution for dealing with negative externalities is to use the tax system to align private incentives with social costs and benefits. Suppose the government imposed a tax on carbon-based products and used the proceeds to cut other taxes.

Here is Mankiw’s twinning of cap-and-trade auction revenues and income tax cuts:

The auction price of an emission right is effectively a tax on carbon. The revenue raised by the auction gives the government the resources to cut other taxes that distort behavior, like income or payroll taxes.

The twinning is dead wrong. Here is how Mankiw the textbook writer puts it (pp 213-214, fourth edition of the Micro split):

… the government can internalize the externality by taxing activities that have negative externalities …

… Thus, while corrective taxes raise revenue for the government, they also enhance economic efficiency.

A carbon tax or cap-and-trade increases efficiency. Both can raise revenue for the government. The government can do a number of things with the additional revenue but none of these things are required to make correcting negative externalities efficient.

In fairness to Mankiw he makes his efficiency point here:

How much does [zero auction revenue] matter? For the purpose of efficiently allocating the carbon rights, it doesn’t. Even if these rights are handed out on political rather than economic grounds, the “trade” part of “cap and trade” will take care of the rest. Those companies with the most need to emit carbon will buy carbon allowances on newly formed exchanges. Those without such pressing needs will sell whatever allowances they are given and enjoy the profits that resulted from Congress’s largess.

Thank you for that clear explanation (as good as your excellent textbook). But, 

The problem arises in how the climate policy interacts with the overall tax system. As the president pointed out, a cap-and-trade system is like a carbon tax. The price of carbon allowances will eventually be passed on to consumers in the form of higher prices for carbon-intensive products. But if most of those allowances are handed out rather than auctioned, the government won’t have the resources to cut other taxes and offset that price increase. The result is an increase in the effective tax rates facing most Americans, leading to lower real take-home wages, reduced work incentives and depressed economic activity.

The macroeconomic problem is that some taxes are too high, distorting economic activity. The macro problem should be decoupled from climate policy as soon as possible. Please?

Here is Mankiw’s conclusion:

As for me, I hope the president refuses to sign a bill that fails to auction most of the allowances. Some might say a veto would make the best the enemy of the good. But sometimes good is not good enough.

In other words, Mankiw hopes that the president vetos a bill that generates more benefits and costs in the hopes that someday we get a bill that generates even more benefits than costs. Me? I think climate policy with economic incentives built in is “good enough.” This would be an important movement in the right direction for environmental policy.

https://www.nytimes.com/2009/08/09/business/economy/09view.html?_r=2&ref=business

https://www.env-econ.net/2007/05/an_latimes_edit.html

Carbon tax vs cap-and-trade

An LATimes editorial on climate change economics has four sections:

1. Scary problem
2. Carbon tax vs cap-and-trade
3. The European market got all screwed up (and then we’re back to #2)
4. We’ll never have a carbon tax

In section #1, the opinion person tries to get our attention by saying that CA’s beaches will be gone soon. This doesn’t help.

In section #2, after arguing rightly that The Terminator’s pursuit of cap-and-trade is better than technological and other standards, the opinion person declares that a carbon tax is better than both:

And yet for all its benefits, cap-and-trade still isn’t the most effective or efficient approach. That distinction goes to Method No. 3: a carbon tax. While cap-and-trade creates opportunities for cheating, leads to unpredictable fluctuations in energy prices and does nothing to offset high power costs for consumers, carbon taxes can be structured to sidestep all those problems while providing a more reliable market incentive to produce clean-energy technology.

There are three points in this paragraph and each of them can be disputed.

First, what government policy does not create opportunities for cheating? Has anyone other than me ever heard of someone NOT paying their taxes?

Second, a safety valve can help avoid crazy fluctuations in energy prices.

Third, [begin rant here] the only way that a tax on carbon would not be passed on to consumers in the form of higher prices is if demand is perfectly elastic (i.e., flat). This means that consumers have perfect substitutes elsewhere and as soon as firms try to raise price they flee. Firms can’t raise price as a result. Does this sound like energy markets to you? Can I repeat? Any government policy that addresses climate change will result in higher prices and/or taxes for consumers. There is a cost. There is no free lunch. I’ve read this myth several times recently. Who is the source? Anger. Rage. I want to brain him!

In section #3, the opinion person(s) states that the European cap-and-trade experiment hasn’t worked and might never work because of a weak overlord (no EU-EPA) and lobbyists. This experience is then incorrectly transferred to the United States and a huge allocation option with cap-and-trade is ignored: auctioning of permits. For the most excellent analysis of cap-and-trade allocation schemes see the CBO’s.

In section #4, the opinion person(s) correctly state that a carbon tax is difficult politically and, again, incorrectly states that it is friendlier to consumers.

Let me be clear, I’m a fan of economic incentives. I would be delighted with implementation of a carbon tax or cap-and-trade to deal with climate change. Yet, I don’t see either as wildly superior to the other. Whenever someone advocates one as wildly superior to the other I grow suspicious (i.e., where’s my wallet). You should too.

Hat tip: Silent Bob.

https://www.env-econ.net/2007/01/stavins_on_the_.html

https://www.env-econ.net/2007/05/cbo_on_the_dist.html

https://www.env-econ.net/2009/09/carbon-taxes-vs-caps-one-more-time.html

Guest post from Jim Roumasset:

As Paul Krugman says, bad ideas are like New York cockroaches; you can flush them down, but they keep coming back. This is nowhere more the case than in the debate on carbon taxes vs. tradable permits. Taxes are better we are told because they generate more revenue. In contrast, cap and trade is said to be better because its primary purpose is to control pollution, whereas the primary purpose of emission taxes is to raise revenue. I’m afraid that these propositions cloud the waters.

In order to understand the difference between different policies (or institutions), it’s often best to start with what’s the same (Coase). In the world of perfect competition, controlling quantity with price (Pigouvian taxation) is exactly equivalent to controlling price with quantity via transferable and auctioned permits. This remains true even if there is uncertainty about marginal damage costs but not about the marginal benefits of emissions (Weitzman, 1974). For this reason, the typical environmental econ textbook emphasizes the case of uncertainty about marginal benefits, holding the marginal damage cost function fixed. The result of this exercise is that taxes cause less excess-burden than tradable permits so long as the marginal damage cost function is relatively flat, compared to the marginal benefit function. This is probably true for global warming because this year’s emissions have a relatively small effect on the total stock of carbon and future effects are discounted. (I don’t know if this is why Nordhaus favors taxes or whether he gives some other reason.)

The equivalence perspective is also useful for understanding the implications of taxes vs. permits for revenue. In the world of certainty, there are none! Again, a specific tax on all emissions is equivalent to auctioning the permits. Same price, same quantity, same revenue. Suppose instead that the 85% of the permits are given away “free,” ala Waxman-Markey.  Can we emulate that with a tax? Yes! For simplicity, suppose that each producer gets exactly 85% of its efficient pollution quantity for free. The same thing can be accomplished with a block-rate tax schedule with the first 85% of emissions untaxed. (The more cap-and-trade entitlements are manipulated by lobbies, the harder it will be to imitate the scheme by taxes, but the principle remains the same.) That is, cap and trade can be designed to match the revenue-raising implications of carbon taxes and vice versa. (Again, uncertainty about emission benefits throws this proposition off.)

So much for blackboard economics. In the real world we have uncertainty about both costs and benefits. Clearly it is possible to design hybrid schemes that are superior to either taxes or permits, but I don’t think we have strong results about the optimal hybrid scheme.

https://www.env-econ.net/2009/09/um-dont-hate-the-player-hate-the-game.html

https://www.env-econ.net/2007/05/an_latimes_edit.html

An LATimes editorial on climate change economics has four sections:

1. Scary problem
2. Carbon tax vs cap-and-trade
3. The European market got all screwed up (and then we’re back to #2)
4. We’ll never have a carbon tax

In section #1, the opinion person tries to get our attention by saying that CA’s beaches will be gone soon. This doesn’t help.

In section #2, after arguing rightly that The Terminator’s pursuit of cap-and-trade is better than technological and other standards, the opinion person declares that a carbon tax is better than both:

And yet for all its benefits, cap-and-trade still isn’t the most effective or efficient approach. That distinction goes to Method No. 3: a carbon tax. While cap-and-trade creates opportunities for cheating, leads to unpredictable fluctuations in energy prices and does nothing to offset high power costs for consumers, carbon taxes can be structured to sidestep all those problems while providing a more reliable market incentive to produce clean-energy technology.

There are three points in this paragraph and each of them can be disputed.

First, what government policy does not create opportunities for cheating? Has anyone other than me ever heard of someone NOT paying their taxes?

Second, a safety valve can help avoid crazy fluctuations in energy prices.

Third, [begin rant here] the only way that a tax on carbon would not be passed on to consumers in the form of higher prices is if demand is perfectly elastic (i.e., flat). This means that consumers have perfect substitutes elsewhere and as soon as firms try to raise price they flee. Firms can’t raise price as a result. Does this sound like energy markets to you? Can I repeat? Any government policy that addresses climate change will result in higher prices and/or taxes for consumers. There is a cost. There is no free lunch. I’ve read this myth several times recently. Who is the source? Anger. Rage. I want to brain him!

In section #3, the opinion person(s) states that the European cap-and-trade experiment hasn’t worked and might never work because of a weak overlord (no EU-EPA) and lobbyists. This experience is then incorrectly transferred to the United States and a huge allocation option with cap-and-trade is ignored: auctioning of permits. For the most excellent analysis of cap-and-trade allocation schemes see the CBO’s.

In section #4, the opinion person(s) correctly state that a carbon tax is difficult politically and, again, incorrectly states that it is friendlier to consumers.

Let me be clear, I’m a fan of economic incentives. I would be delighted with implementation of a carbon tax or cap-and-trade to deal with climate change. Yet, I don’t see either as wildly superior to the other. Whenever someone advocates one as wildly superior to the other I grow suspicious (i.e., where’s my wallet). You should too.

Hat tip: Silent Bob.

https://www.env-econ.net/2007/11/cbo-and-cap-and.html

https://www.env-econ.net/2008/10/here-we-go-agai.html

From the inbox (from Dr. Alan Dove, high school friend, freelance science writer and Columbia U. PhD in microbiology–smart dude):

Tim:

Hope all is well with you. I’ve been enjoying the blog, and was interested to see that you favor a cap-and-trade system. This subject actually came up in my own work recently, so I wanted to run something past you. While covering a meeting in Mexico City a few weeks ago, I heard Robert Engle give a neat talk about risk analysis and climate change.

Among other ideas, he suggested a carbon tax, but with a twist. In order to make it politically palatable, he said, why not take the vast revenue from such a tax, divert a small percentage into a soverign wealth fund for Social Security, and simply give the rest back to the taxpayers, in the form of an equal payment to every citizen. Driving your SUV each way to work, you’d pay the tax at the pump (and in your monthly electric bill and so on), and then you’d get some of it back at the end of the year.

If you rode a bike or bought a smaller car, you’d pay less at the pump, but still get the same check back. The kickback makes the tax somewhat less burdensome to the poor, and most voters would probably support a plan that sends them a “bonus” each year. Putting the revenue back into consumers’ hands might also help feed a market for alternative energy, in a technology-neutral way. Meanwhile, the tax would fund a solution to a looming Social Security catastrophe. This would amount to turning two huge future risks (climate change and pension collapse) into a set of mutual solutions. It would also address the fundamental problem politicians face in responding to long-term risk, which is that the risk happens long after the next election cycle.

So here’s what I’m wondering. Could a cap-and-trade program also provide a secondary revenue stream to fix some other big future risk? If not, is there some other political tradeoff that could be used to make cap-and-trade more attractive than a carbon tax with a payback mechanism?

My response after the jump.

Hey Alan,

Thanks for the message (mind if I use your question as a blog post?).

I know I’ve come out in the past as an advocate of cap and trade over a tax, but really I see pros and cons with each. Your question gets at the heart of an interesting debate, but for non-economic reasons: How do we make either policy palatable to the public (and their representatives). This is a separate issue from whether either policy achieves the desired economic result–a reduction in carbon emissions to the socially optimal level at lowest cost to society.

In Engle’s proposal, the tax is a standard tax on external damages. Tax the damaging party at the marginal cost to society and in the end you get the optimal level of carbon and correspondingly the optimal level of damages at least cost. But the tax creates a ‘windfall’ for the government. What should the government do with that revenue?

From an economic efficiency point of view there is only one thing the government shouldn’t do: pay the victim an amount proportionate to the individual damages incurred. A proportionate reimbursement will increase the incentive for the victim to incur more damages. A classic moral hazard problem. The example I use in class is a polluting factory paying local residents for pollution damages depending on how close to the factory they live. The closer you live the higher your payment. What incentive does that create? Move closer and get paid more. So people move closer than they would if the payment were to be decoupled from damages.

Beyond that, we have to go from positive to normative analysis. For the efficiency reasoning above, most economists (and I’m probably speaking out of turn for some) would advocate redistributing the tax revenues as Engle suggests–a lump sum payment independent of the damages. The incentive properties of the tax remain: drive more, emit more, pay more, and the lump-sum redistribution makes people who value ‘fairness’ happy. As you mention, such a transfer might make the tax less regressive if income is positively correlated with carbon emissions.

As to the second part of the question, can cap and trade be similarly redesigned to make it politically palatable? Maybe. Full auction of all permits with the government keeping all revenues sets up the same situation as the tax. Redistribute the windfall in a lump-sum fashion and you don’t create the moral hazard. So yes it’s possible for a cap and trade system to mimic the properties of a lump -sum tax revenue transfer. But how likely is it that a full auction cap and trade system will ever be implemented? Slim, in my view.

To be politically palatable almost any implemented cap and trade system will have to include some free permits allocated to current emitters (similar to the EPA’s Acid Rain/Sulfur Dioxide Program). How will they be distributed? If history is any indication, it would be proportional to past output of whatever is producing the emissions. In the sulfur dioxide case, permits are allocated as a prorated portion of past electricity production (KWH’s). I would guess something similar would have to happen with carbon permits for a cap and trade system to pass. The government may still auction some permits to cover administrative costs of the program, but I’m guessing that not all permits would be auctioned. This would mean that the ‘windfall’ to the government would be smaller under cap and trade than a direct carbon tax.

Hope that helps.

https://www.env-econ.net/2016/08/more-angst-about-californias-cap-and-trade-program.html

https://www.env-econ.net/2015/10/this-conservative-economist-makes-the-case-for-a-carbon-tax-grist.html

I quit reading the Grist a long time ago because they don’t heart (“hate” is a very strong word) economists. But, they might be falling in love with one of them:

10. Gregory Mankiw is, if not a household name, a dorm-room one. His Principles of Economics textbook is the standard for most college intro-to-econ courses, with more than a million copies sold. A professor at Harvard, Mankiw teaches the university’s most popular undergraduate course, Econ. 10.

He’s also well known in Republican circles. President George W. Bush named him chair of the Council of Economic Advisers in 2003, and in 2006, Mitt Romney brought on Mankiw as an economic adviser, a role the economist played throughout Romney’s 2012 presidential bid.

But though he calls himself a conservative — “I want limited government,” he explains — Mankiw advocates a carbon tax, a position notably at odds with all of the current GOP presidential candidates. He articulated his reasons in a recent New York Times op-ed, “The Key Role of Conservatives in Taxing Carbon.”

We called him up to get his perspective on the rift over climate change among Republicans, and his advice on how to sell a carbon tax to conservatives. …

1. Why a carbon tax and not a cap-and-trade system?
2. A carbon tax is much simpler. In cap-and-trade, one of the issues becomes: how do you allocate those permits for carbon emissions? A fully auctioned cap-and-trade system is very, very close to a carbon tax. But in practice, people who write the bills often don’t auction [all the permits] off, and [politicians] start using these permits to start paying off particular constituencies politically. That means that you’re basically pricing carbon, but you don’t have the revenue that you can use to reduce people’s taxes.

…

1. Elon Musk is an advocate of a carbon tax, with the idea that it could catalyze the cleantech industries, and possibly be a job-creation engine.
2. Again, I wouldn’t push a carbon tax as a huge job creator. Some jobs will be created, some jobs will be destroyed. Some industries will grow, some industries will shrink. I don’t think the overall economy’s going to boom.

via grist.org

There are a number of questions with a lot of great answers (e.g., regarding climate science: “I can read the consensus of scientists, so I take that as a given and go on with economics.”) I’ve excerpted only two, on familiar themes. One answer I agree with and one I don’t. 

I don’t agree on the preference for a carbon tax over cap-and-trade with the reason being that politicians will enjoy passing out free permits. This is comparing an ideal carbon tax, with no tax breaks, with a politicized cap-and-trade. I see nothing about politics to suggest that a carbon tax will be immune to enjoyment of politicians passing out tax breaks.

And I most definitely agree that a carbon tax will not create jobs

https://www.env-econ.net/2015/11/eu-emissions-trading-system-bolstered-by-move-to-allowance-auctions-resources-for-the-future.html

Dallas Burtraw and Anna Malinovskaya:

The EU Emissions Trading System (ETS) for carbon dioxide is the world’s largest greenhouse gas trading program in scope and the most important environmental market in the world. After a somewhat volatile start in 2005, the EU ETS underwent significant changes beginning with phase three, which runs from 2013 to 2020. Two major developments in particular buttressed the program and strengthened its influence: the centralization of the system under a single cap on emissions across the European Union (compared to earlier implementation at the member-state level, with national caps) and the system’s expansion to cover more nations (including three non-EU states), activities, and greenhouse gases.

The most important change, however, was a tremendous shift in the distribution of the asset value—constituting tens of billions of euros—created under the EU ETS via emissions allowances. We delve into the implications with colleagues in a recent RFF discussion paper. Before 2013, about 97 percent of emissions allowances, and thus the associated financial value, was distributed for free to incumbent firms, intended to help offset their compliance costs. But in many cases, that value was greater than the costs, leading to windfall profits. Auctions are now the default mechanism for the initial distribution of emissions allowances, making the initial and final distribution of the asset value more transparent. Since 2013, about half of the allowances are auctioned, with the asset value going to member state governments in the form of auction revenue.*

Although phase three marks an evolution likely to improve the EU ETS, challenges persist. In the past several years, the price of allowances and, consequently, the total asset value have fluctuated widely, falling dramatically at the beginning of phase three. Key reasons for the low prices include the use of international carbon credits for compliance with the EU ETS, poor projections of future industrial production, limited growth of the European economy in general, and subsidies to renewable energy. Several policy measures have been taken to stabilize the price, including “back-loading” efforts such as new rules on the use of international credits for compliance and a temporary delay in issuing some emissions allowances.

Regulators also implemented a structural change—the creation of a market stability reserve—which is expected to balance the supply and demand of emissions allowances on a regular basis. However, the introduction of a minimum price in the allowance auctions, which is a feature of the three North American trading programs, has not been embraced. Further, the most straightforward way to increase the price—to reduce the cap and thus the number of allowances available—has proven politically impossible, despite efforts in this direction.

What else has changed in phase three? In 2018, for the first time, the majority of the allowance value will be auctioned. Free allocation currently still accounts for about half of the total asset value due to concerns about the leakage of economic activity in trade-exposed industries to outside of the European Union. In phase three, harmonized system-wide rules based on product-specific emissions rate benchmarks are used to determine the allocation of emissions allowances to industry. Further, some industries deemed to be in trade-exposed sectors are included into the so-called carbon leakage list and receive their allowances for free. In addition to subsidizing industry through provisions to avoid carbon leakage, member states also have the opportunity to compensate industry for the indirect costs of compliance with the EU ETS. Yet we find little evidence that EU member states have used this opportunity to subsidize domestic industries, demonstrating an absence of strategic behavior.

The recent changes have made the EU ETS more comprehensive, transparent, and predictable. In July 2015, the European Commission presented a legislative proposal to further revise the system for the period after 2020. These future adjustments will determine whether the system will be an efficient policy instrument as it was intended to be and whether it continues contributing to important emissions reductions.

via www.rff.org

This may mitigate one of Mankiw’s favorite criticisms of cap-and-trade:

1. Why a carbon tax and not a cap-and-trade system?
2. A carbon tax is much simpler. In cap-and-trade, one of the issues becomes: how do you allocate those permits for carbon emissions? A fully auctioned cap-and-trade system is very, very close to a carbon tax. But in practice, people who write the bills often don’t auction [all the permits] off, and [politicians] start using these permits to start paying off particular constituencies politically. That means that you’re basically pricing carbon, but you don’t have the revenue that you can use to reduce people’s taxes.

Given the political process, most environmental policies are not without flaws when they are first implemented (yes, this would include the beloved carbon tax). Good environmental policy is usually the result of an evolutionary process. Economists often praise the market system for being flexible and government policy for being inflexible. Yet, here is an example of the flexibility of government (albeit, it took long enough!). The European Union seems to have a sincere policy goal of cutting carbon, tried to do so with cap-and-trade, made some mistakes and is now trying to fix those mistakes.

https://www.env-econ.net/2007/09/carbon-tax-vs-1.html

read my own required reading. First, I read Mankiw’s Economic View piece advocating a global carbon tax.

Mankiw (me):

• A tax would reduce carbon and mitigate climate change (yep, and so would cap-and-trade)
• A tax would raise revenue that can be used to reduce income taxes (in fact, the “double dividend” of a Pigovian tax is more general, the increased government revenue could be used for lots of things, such as covering the deficit instead of using social security taxes for that purpose.)
• A tax would be easier to negotiate internationally than cap-and-trade (maybe so, but I’d say the negotiations are significantly difficult that the difference in difficulty is minor; also, implementation of a carbon tax in the U.S. seems near impossible with the strong opposition from business)

As always in this debate, I’m blown away by the way economists pit a carbon tax against cap-and-trade as if it were an academic exercise (in graduate school it was the great macro debate “money matters, no it doesn’t”). The contrasts in the two approaches are presented as stark but this isn’t so. A carbon cap-and-trade system with an auction and safety value is similar to a carbon tax. It raises revenue and etc. Economists state this similarity and then ignore it and revert back to stating that a carbon tax is a much superior policy*.

Suppose we economists push for cap-and-trade in the power sector** with an initial giveaway of permits and a gradual ratcheting up of auctions? Since we are playing for keeps with Congress seemingly ready to implement cap-and-trade, playing the name game, i.e., gradually moving from cap-and-trade to a carbon tax might be one way to make all economists happy and actually get some sort of sensible climate legislation passed sometime soon.

Second, I read the WSJ piece. I found a balanced comparison of the economic issues with a clear statement that most of the differences in the two proposals are about distribution and not efficiency.

*The only really good reason to favor a carbon tax is the idea that regulating prices (i.e., taxes) works better with uncertain benefits.

**An increased gas tax, er, carbon tax on transportation, covers the other big carbon sector.

https://www.env-econ.net/2007/08/mankiw-the-popu.html

In today’s Washington Post, congressman John Dingell pushes for a carbon tax. He ends by suggesting, however, that cap-and-trade is politically more feasible.

He may be right, but it is a frustrating conclusion. Economists recognize that a cap-and-trade system is equivalent to a tax on carbon emissions with the tax revenue rebated to existing carbon emitters, such as energy companies. That is,

Cap-and-trade = Carbon tax + Corporate welfare.

If the public understood this theorem, the carbon tax alternative, with revenues rebated to households through lower payroll or income taxes, would attract a lot more interest.

There are good ways to do the comparative economic analysis of carbon taxes vs cap-and-trade and there are bad ways. Comparing a cap-and-trade giveway to corporate welfare is a bad way (especially since this is not the only allocation method for permits).

If there are efficiency arguments to suggest that carbon taxes are preferred to cap-and-trade (other than revenue neutral reductions in distortionary taxes, which are not a given anyway, since these are two different policies with two different politics), and there are, then I’m ready to listen. If you are resorting to populist rhetoric, I’m not.

I’m beginning to think that I should switch intro textbooks.

https://gregmankiw.blogspot.com/2007/08/fundamental-theorem-of-carbon-taxation.html

In today’s Washington Post, congressman John Dingell pushes for a carbon tax. He ends by suggesting, however, that cap-and-trade is politically more feasible.

He may be right, but it is a frustrating conclusion. Economists recognize that a cap-and-trade system is equivalent to a tax on carbon emissions with the tax revenue rebated to existing carbon emitters, such as energy companies. That is,

Cap-and-trade = Carbon tax + Corporate welfare.

If the public understood this theorem, the carbon tax alternative, with revenues rebated to households through lower payroll or income taxes, would attract a lot more interest.

https://www.env-econ.net/2018/06/the-climes-they-are-a-changin.html

https://www.env-econ.net/2018/06/climate-change-is-the-car-alarm-of-the-2010s.html

https://www.env-econ.net/2018/08/just-like-coase-drew-it-up.html

https://www.env-econ.net/2018/12/the-aea-did-something-and-im-not-going-to-complain-about-it.html

https://www.env-econ.net/2019/01/from-the-wapo-us-greenhouse-gas-emissions-spiked-in-2018-us-carbon-dioxide-emissions-rose-an-estimated-34-percen.html

The headline is likely an overstatement. Did emissions spike? Emissions in 2018 are still below the pre-Great Recession peak and below several years since the decline began (again, due to the Great Recession). There may be some sort of cyclical pattern here too. In other words, there have been three “spikes” since the peak. The most recent may be related to the 2018 tax cut. As that wears off we might get closer to the Copenhagen Accord target in 2019 and a recession in 2020 might really nail it.