Poorly informed critiques
A group of climate activists have just produced an entertaining animated short called “The Story of Cap & Trade.” Although the film is correct to worry about market manipulation and the transaction costs of those we now love to hate on Wall Street (some of which seem to believe they create value in the economy equal or greater than their inflated salaries), it misses the point on policy.
Emissions trading is more complex than the film’s makers present. I could discuss at length the numerous liberties taken with the truth in the film, but it is more important to focus on the grown up arguments.
1) Political reality: Cap and trade has the potential to pass the US Congress. A carbon tax does not. It’s that simple; no amount of cute animation films is going to change that.
2) Fraud: While it is something we need to be vigilant about, we are not new to emissions trading. We have been doing it nationally in the United States for more than a decade without massive abuse or fraud, and instances of fraud in the EU ETS have been minimal to date and are being addressed.
3) Offsets: While offsets are a challenging environmental commodity to implement well, they are not impractical. They are worth using, despite complexity, because they offer the unique potential to reduce emission in places and sectors that are inexpensive and that otherwise would be ignored.
4) Alternatives: The filmmakers’ chosen alternative of essentially using command-and-control regulation and “carbon fees” (i.e., taxes) is by no measure superior. It is not clear we know how to regulate this many different kinds of sources with strict technology and other mandates. What we do know is that we would probably get a lot wrong and that it would take decades to get all the regulations in place. We can get an emissions trading system up and running rather quickly.
As for carbon taxes, they do have benefits, but they also have their own problems. The filmmakers complain about how allowances are allocated. But do you think that redistributing all that tax revenue would be any less political? And taxes are more difficult to monitor and enforce within an international treaty. Countries can easily evade the punitive impacts by providing other economic kickbacks to industry that negate the economic effects of the tax. Emission caps are more easily monitored and enforced within an international treaty.
Importantly, emissions trading instruments provide policy makers with some price discovery for both the current and expected cost of mitigation. This is very powerful and something that taxes will not do. With taxes you have to guess what the right tax rate is. But with emissions trading the market tells you how much it costs to reduce. Then you can adjust caps in the future accordingly.
Lastly, with taxes you have no certainty of the quantity of reductions you will achieve. This is usually something that most environmentalists are concerned about.
I could go on, but this is a long blog post already. In reality, it is not that cap and trade is always preferable to other kinds of regulation or carbon taxes. What policy is best depends on the characteristics of the emission sources and the economics involved. Different policy tools are appropriate in different circumstances. And we will need to use them all. Nothing says we can’t have both a carbon tax, with an emissions trading scheme, then regulation for some other sources, and offsets for even others. As a matter of fact, I’m pretty sure that is where we will end up when we graduate from the cartoon world to the world of grownups.