Trading, Taxes, Regulation, or OPEC?

By Johnston, Jim | Regulation, Winter 2007 | Go to article overview

Trading, Taxes, Regulation, or OPEC?


Johnston, Jim, Regulation


In "Combating Global Warming" (Fall 2007), Ian Parry and William Pizer of Resources for the Future offer an extensive discussion comparing cap-and-trade with a carbon tax. They end up accepting a combination of the two systems, with a noticeable tilt toward the carbon tax that contains a lot of discretion to protect some favored industries. Along the way they admit that how the revenues are spent will be subject to a lot of political manipulations that benefit politically powerful constituents. They hope that favoritism will not occur. But we all know it is the nature of government to trade favors. Altering this behavior, to paraphrase Milton Friedman, is like teaching a cat to bark.

Their proposed revenue-neutral carbon tax based on the carbon content of energy inputs, as opposed to the carbon output, has an interesting side feature. It allows a tax credit for emissions offsets and sequestration projects. The authors claim one of the advantages of a carbon tax over cap-and-trade is that the tax can be levied on a relatively few sources of energy, which conserves on administrative costs. But if tax credits are all right for countless downstream carbon-reduction projects, why not reduce taxes for emission reductions at energy sources? After all, such reductions, if successful, will allow governments to avoid large mitigation costs of building levees and other measures. The answer, I fear, is that many of the offset projects will be in the politically powerful agriculture sector. This feature of the proposed carbon tax could be so large that, by comparison, it will make the corn-based ethanol subsidy look like chicken feed (pun intended).

In the discussion of the emissions-trading option, the authors make much of the problem of volatility in permit prices. Government functionaries will supposedly step in to iron out the price changes with safety valves like relaxing caps during energy shocks and borrowing permits from the government to be repaid later with extra reductions. Just think about that: government will be reducing risk rather than increasing it. That will be a historic first.

I remind readers of the suspension of the Regional Clean Air Incentives Market (RECLAIM) trading credits during California's 2000-2001 electricity crisis because the price of the credits got too high for the utilities. The other participants in the trading scheme were left holding bags of worthless credits that they had earned by over-reducing their emissions. Those good deeds did not go unpunished by the government. The reader might ask how such a trick could be played on investors. The answer lies deep in the details of the RECLAIM scheme (and in the Clean Air Act Amendments of 1990). Allowances and credits are denied property right status and thus the government can alter or eliminate the trading system without being subject to the requirement in the Fifth Amendment of the Constitution that compensation be given to owners of property taken by the government.

The effect of denying property-rights status is to lead emission sources to avoid the reduction trading and physically reduce emissions in the amount required, plus a little extra for emergencies. During an energy shock, the emission source could either use the extra allowances or shut down the plant and buy power from another source.

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