Taxing Carbon - Part 4

A few days ago I took Jeffrey Sachs to task for a post he wrote supporting a carbon tax in preference to cap-and-trade.  Over the weekend he sent me a response.  I'll probably have a reply later today, but in the meantime, here's Sachs:Kevin Drum is certainly right that a cap-and-trade system potentially can look a lot more like a carbon tax than actual cap-and-trade systems have done in the past.  My worries are about the reality of such systems, not the theory.  Both the Waxman-Markey draft bill and the actual experience of the European Union Emissions Trading System (EU ETS) give me concern for the reasons that I mentioned.  While a tax can be levied at a few upstream points, the EU ETS involves around 12,000 enterprises and the draft Waxman-Markey bill would apparently involve several thousand US sites as well (essentially all industrial units which emit more than 25,000 tons of carbon dioxide equivalent greenhouse gases). We would create for essentially no reason a highly expensive, Wall-Street-based system of permit trading and enterprise compliance that could be substituted by an easy-to-implement upstream tax.  Mr. Drum correctly notes that the Waxman-Markey proposal is both upstream and downstream.  I do indeed like the upstream part. The fact, however, that it is also a downstream system, which is the administratively cumbersome part that would be avoided by an upstream carbon tax.

As for the lack of price predictability, the price fluctuations of the EU ETS are notorious.  Emissions prices actually collapsed for Phase I permits at the end of that phase (2007), and recently emission permit prices have declined from more than 30 euros per ton in 2008 to less than 15 euros this year.  Some European economists are arguing for a floor price in the EU ETS, which indeed would make it much more like a tax.  I disagree with Mr. Drum that we should see the trading system as a helpful macro stabilizer and therefore like the fact that the price on carbon emissions has collapsed. We need a stable carbon price into the future to give the right incentives for a new generation of low-emissions technology development and adoption, and should use other economic instruments for cyclical policies.

I agree with Mr. Drum that an emissions system can cover most of the economy like an upstream tax, but in practice the EU ETS covers only around 50 percent of the economy.  The Waxman-Markey bill aims for much more, so perhaps I'm too pessimistic on that count and Mr. Drum is correct, but we'll see once the negotiations proceed further.  As for revenues and for revenue transparency, I still believe that a tax is the right way to go. I am not very confident about the fairness of backroom haggling over emissions rights now underway in Washington, or which has characterized the EU ETS.  I think that the tax approach can be more direct and visible, and less vulnerable to unfair insider dealing.

Finally, I would like to remind Mr. Drum and his readers that I stated clearly in my brief Yale article cited by Mr. Drum that either a tax or a cap-and-trade system is far superior to the status quo.  We are arguing about matters that are less than essential.  If Congress actually adopts a cap-and-trade system, that would be a huge advance. In fact, putting a market price on carbon emissions (through either a tax or permit system) is just one modest part of a truly comprehensive and effective carbon mitigation strategy, that must involve standards, R&D, demonstration projects, and many other kinds of incentives and public policies.

Sachs is, among other things, Director of the Earth Institute at Columbia University and author of The End of Poverty: Economic Possibilities for Our Time.