October 11, 2006 EMISSIONS TRADING AND CARBON TAXES - By Gar W. Lipow
In a previous post I touched lightly on problems with carbon trading , and aside from the current disaster, suggested that any system that relying heavily on emissions trading for carbon was unworkable. Reasons to oppose carbon trading include:
1) We need to ultimately reduce fossil fuel use by somewhere between 80% to 100%, not per capita, but in absolute numbers. And we need do so fairly quickly, by 2040 or 2050. That means we need a large emissions drop each and every year. No nation, and not very many individuals or firms will easily meet these targets. Simple arithmetic suggests that if our efforts are serious, there just won't be that many "excess reductions" to trade. Yes, there are billions of extremely poor people who consume no or almost no fossil fuel. But they don't constitute some magic carbon sink that will let rich Americans continue to drive nine MPG Hummers. 2) Emissions trading discourages innovation, and investment in carbon reduction. Time and money that should be spent on reducing emissions are directed towards seeking out other people's emissions to buy all over the world, or using lawyers and lobbyists to win new government issued credits rather than earning them from carbon reductions. It also creates a situation where both buyers and sellers of credits have no reason to care about whether they respresent actual savings, so long as they satisfy regulators. This encourages generating Enron style credits via creative accounting, and dishonest consultants - again at the expense of both innovation and implementation. 3) Emissions trading, to the extent it has worked at all, operated in environments with strong, well-enforced regulations, where emissions were easily detectable on a source by source basis. Sulfur trading, usually pointed to as a poster child for pollution trading, took place among fewer than 100 factories. More to the point, emissions trading has show success where little major revamping of infrastructure was required. For example, sulfur trading mostly relied on substitution of low-sulfur coal for dirtier varieties, and end of pipe technologies. Carbon reductions require an almost complete transformation of everything. We need to drastically change how we produce new buildings, and radically modify existing ones. We need to change how we grow food, how we produce goods, how transport people and freight. We need to rebuild the electric grid, and replace most of our existing electric generating plants with carbon neutral ones. Emissions trading has no record in dealing with problems of this scale - other than the recent collapse of the carbon market. 4) That emissions trading is taken as the default, and people ask what the alternatives our shows how successful ideological warfare has been in blinding people to history and evidence. Emissions trading is the new kid on the block; regulation and public works have a long honorable history of successfully achieving environmental goals. Emission trading has been tested in much more limited circumstances, by most measures with inferior results to regulation. 5) Emissions trading in things like sulfur and lead have been much less successful than the current conventional wisdom suggests. The Clean Air Act produced major reductions BEFORE any emission trading program was tried. It can be documented that at least some emissions trading programs produced slower reductions than the regulatory programs they replaced. And every successful emissions program can be compared to a regulatory program elsewhere that reduced the same emissions faster.
As mentioned in my last post, the Dag Hammarskjöld Foundation has published an impressive and beautifully written analysis of Carbon Trading. The full text is available in PDF form at no charge.
So I'm going to move on to another subject - Carbon Taxes. As I pointed out in my previous post, non-tradable (or almost non-tradable) permits could be used as a combination carbon tax and rationing system. Or you could simply institute a carbon tax, adding so much to the price of a barrel of oil, so much to a ton of coal, so much to a thousand cubic feet of gas.
Unlike emissions trading, this market approach would have an effect. But Pigovian taxes as the primary means of promoting infrastructural change is still flawed.
It has a high chance of failing to reach the goal of decarbonization in a timely fashion, though it does not guarantee failure the way carbon trading would.
One symptom of the inefficiency of a Carbon Tax is (as I said back in May-2006) that energy demand has a high inelasticity in response to price increases[1]. What this jargon means is that a large increase in the price of energy tends to produce very small increases in efficiency. So very large increases in the price of heating fuel tend to produce very small improvements in insulation levels. Note that according to the cited source, it is specifically demand reduction that suffers this problem. Substitution of one fuel for another has a fairly high elasticity; there is some sluggishness in response, but not a lot. Most studies which report high elasticity, use fuel reduction as a proxy for demand reduction. (The exceptions are from the oil crisis of the seventies, when price increases coincided with recession.)
There are all sorts of micro explanations for this - split incentives, unequal access to capital markets, unequal access to information, high transaction costs, drowning of energy price changes in the "noise" of other costs. But I think the fundamental reason is that decarbonization requires infrastructure changes and infrastructure changes are always dependent on large scale public works and subsidies.
Think of transportation - railroads (subsidized with huge grants of land stolen from American Indians), canals, public highways. Think of the U.S. highway system. Think of the airlines dependent on publicly financed airports.
Consider our existing power infrastructure. The electrical grid is spread over public rights of way, and mostly government built. Early power plants were mostly government built, later ones constructed by heavily regulated monopolies required to act in the public interest as quasi-governmental bodies. (Note that the U.S. experiment with power deregulation resulted in disasters in some states, or in not much change at all in others - with, as far as I can determine, zero improvements in service, reliability, or environmental soundness. Note also that municipal power companies throughout both the regulated and unregulated periods have continued to provide lower priced service than investor owned utilities.)
Consider water and sewage. Consider the Internet, originally developed with public funds. As happens with many public goods it was turned over to private companies once proven successful - with infrastructure in place.
Consider broadband Internet service which has been largely left to private monopolies to develop, without strict regulation or requirements. Today 10 MPS is the fastest broadband ordinary USAians can buy, and you have to be located within an area served by cable for this to be a reasonable choice; for a lot of people, DSL of 2 MPS or less is the fastest broadband alternative to dial-up modems. Meanwhile 100 MPS is the standard in many parts of the world where it is taken for granted that this kind infrastructure is a public responsibility.
Given this record, do you really want to trust the most important infrastructure change in hundreds of years, decarbonization of our society, to private developers, guided only by price signals?
Public works, regulation and subsidies are often derided as "command and control". But again and again, such "command and control" has proven the most efficient means, and often the only means to make fundamental infrastructure changes.
Carbon taxes will have their place - after infrastructure is in place, and people have real alternatives available. They are supplement to public works, regulation and subsidies - not a substitute.
[1] Dermot Gately and Hillard G. Huntington RR#: 2001-01:The Asymmetric Effects of Changes in Price and Income on Energy and Oil Demand Economic Research Reports; January 2001 p23. Tables 6 & 7.
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