Taxing Carbon - Part 2

Surely it's simpler, and equally effective, to tax the carbon-bearing fuels at
their source, i.e. find the coal mines and tax their sales, find the oil refineries
and tax various grades of fuel output based on carbon content.

After all, anyone who buys coal is going to burn it eventually, and all the
carbon is going to end up as CO2 (bad), CO (worse), or particulate emissions
(bad for health if not for climate).

Brilliant posts - it really bears worth repeating that to combat a physical problem (climate change) the thing one must focus like a laser on is the physical cause (CO2). If it were true that a tax would be much better than actually capping CO2 emissions, then it'd be a different story - but a tax will not necessarily do that and it will be open to more political manipulation as its connection to the underlying physical mechanism will always be more opaque.

In many technical ways a tax is better. Most obviously is a known future cost, which is really beneficial for business planning. With a cap&trade system, you have a high degree of uncertainty about future costs. Also, if we make better than expected technological progress on no/low carbon solutions, previously negotiated caps will be too high -and you will have a huge fight getting them re-negotiated.

But, I thought the environmental community had agreed not to make best/better the enemy of the good. Thats why it was agreed to go for cap&trade, which is presumed to be more politically saleable.

Kevin, you seem to have taken a lot of interest in this subject. Some areas I would like to see discussed and possibly answered include:

1. Why won't producers of CO2 just move production to a country that does not have any limits on carbon gas emissions? Won't this have a negative effect on our economy while not have any effect on global emissions.

2. Would not a cap and trade have an entrenching bias toward existing polluters? How would a cap and trade permit be accounted for both at the tax and financial accounting level.

3. Concurrently, wouldn't a cap and trade make it very expensive for start-ups, particularly many years down the road when the emission levels have been greatly reduced.

4. Isn't a cap and trade somewhat unfair to companies that already have taken steps to reduce their carbon emissions?

5. Should the point of charging be at the wellhead (upstream) or at the ultimate producer of the carbon emissions? If upstream, how do you encourage conservation and emission reduction?

6. Who should the cap and trade and/or the carbon tax apply to. Big industrial users, homeowners, retailers, vehicle drivers, etc.

Any discussion of these areas would be greatly appreciated or reference to another site where these areas have been covered.

RE: "Take power plants, for example. First you have to have technology in place to monitor carbon emissions from each plant,"

As Cranky noted earlier, CO2 emissions from power plants have been measured and reported since the early 1990s.

Continuous Emissions Monitors (CEMs) record SO2, NOx and CO2 from all power plants regulated under Title IV of the Clean Air Act (Acid Rain Program)

Emissions data is available here http://camddataandmaps.epa.gov/gdm/index.cfm?fuseaction=emissions.wizard

See also http://www.epa.gov/captrade

Hi Brad,

Here are some responses as best as I can figure them to your questions.

1. Producers have little ability to move around from jurisdiction to jurisdiction as they have an overwhelming incentive to establish facilities at or near the extraction point. The coal producers of West Virginia can't move to China or even Mexico, because the coal is in WV, and the electicity plants that burn the coal obviously can't move either. What could happen on the margin is that heavy industries that consume great amounts of energy might move to more lax jurisdictions, but given the trend towards outsourcing manufacturing to Asia, this wouldn't represent much of a hit to the US.

2-4. Cap-and-trade punishes heavy polluters and rewards those that have been more responsible in this regard. A carbon tax would hit everyone; the heaviest polluters would pay the most, and the best-in-class performers would pay the least. But everyone would pay, and be absolutely worse off, while the best-in-class performers would gain a relative advantage. Conversely, a cap-and-trade plan would allow best-in-class performers to make money by trading permits they don't need to polluters for money. It results in much more progressive revenue collection then the tax. A cap-and-trade plan intended to tax CO2 output to the same extent as a carbon tax would produce a higher marginal cost of CO2 than the equivalent revenue-generating tax, and would thus be a stronger driver on emissions reductions than the tax. Permits are granted every year, so start-ups wouldn't need to rely on the secondary market to get their allotment. Further to that, start-ups are not encumbered by an embedded base that they need to continue to derive value from, and are thus in a better position to start their business in an environmentally sound manner that would mitigate the need for permits.

5-6. Cap-and-trade would apply to any big emitter. The extraction companies emit a lot of CO2 in their extraction and initial refining processes, while the large users of energy emit even more CO2 when they consume the extracted fuel. Cap-and-trade in the EU encompasses medium and large users and producers of energy; even Oxford Uiversity is covered as it has a power plant in excess of 5 MW (I believe that was the threshold for coverage for Phase 1 but I'm not exactly sure). The costs of cap-and-trade would then be passed down from these medium to large producers and users to their customers just as a tax would be, thereby encouraging reductions in consumption.

A straight tax on fossil fuels would provide no differentiation between the business practices that bring a fuel to market. Fossil fuel extactors that are worst-in-class as far as emissions production/unit of fuel extracted would have their fuel taxed at the same price as the best-in-class operator producing the same grade of fuel. There would be no pressure brought to bear on these companies to clean up their own practices as their output would be valued and taxed identically to that of the most responsible producers. How would the tax have to be structured to influence the practices of extractors, not just consumers?

To start, I agree that any decent cap-and-trade or carbon-tax policy is preferable to nothing. But there are some advantages of a carbon tax over cap-and-trade that I haven't seen discussed yet.

1. Global climate change is an EXTREMELY long-term issue. 5-10 years is very short-term, medium term is measured in decades, and the long term policy horizon is as much as a century or more.
2. The most important economic and environmental difference between a carbon tax and cap and trade is whether you want stability and predictability in the carbon price or in the current rate of emissions. Yes, for a given level of GDP and with accurate estimates of the elasticity of carbon emissions to GDP and to carbon prices one can design a cap and trade policy with nearly the same effects as a carbon tax (or vice-versa). But we're talking about a policy that will be in place for multiple years.
3. Because GCC is such a long-term phenomenon, the most important thing to do in the short to medium term is to develop (and reduce the costs of) less carbon-intensive energy technologies. The next most important thing to do is to make our long-lived capital investments (e.g. power plants, buildings) as low in carbon-intensity as technically and economically feasible.
4. As an earlier commenter has already noted, the private sector generally does more to develop and install new technologies when the private economic benefits are stable and predictable -- i.e. under a carbon tax. (For comparison, think about the negative effects that large swings in gasoline prices have had on development and sale of high MPG vehicles in the U.S.)
5. Again because GCC is a long-term problem, short-term variations in the level of carbon emissions (within the range of plausible scenarios) are not nearly as important as getting the long-run trend headed in the right direction. So cap-and trade's advantage of certainty about the level of emissions in any given year is not so significant.
6. Some comments here and at the related post yesterday have suggested the cyclical variation of a carbon price under cap-and-trade is beneficial as an automatic macroeconomic stabilizer. But there are many other automatic stabilizers available. The social opportunity costs of developing and installing low-carbon technologies are lower when the economy is in a recession. So if anything, a countercyclical price on carbon would be more desirable
7. Yes, either policy will be gamed in the political process -- exemptions, grandfathered allocations, credits and reduced rates, etc. But the equity and social cost implications could be quite different. When an emission permit is granted rather than auctioned, that's a windfall to the business receiving the permit. They won't use the permit to keep their prices down for consumers because they can always sell it. If they don't sell it, their price must be high enough so that they make at least as much by producing more as they would have earned by selling the permit. On the other hand, if some industry succeeds in getting special treatment under a carbon tax (e.g. a lower rate) they can't sell that. Therefore the tax reduction reduces the firm's opportunity cost of production in a way that a permit grant doesn't. Depending on how competitive the industry is, some of the tax reduction passes through to lower consumer prices. (Permit auction or carbon tax revenues can both go towards reducing other taxes (e.g. payroll), funding research on carbon-reducing technologies, or any other purpose our political representatives select.)

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