Study Recommends Carbon Tax over "Cap and Trade"

As we’ve noted, Wall Street firms have been investing in various means of profiting from likely future regulation of carbon emissions, particularly carbon trading. A study by Dr. Robert Shapiro, undersecretary of Commerce in the Clinton Administration (which we found thanks to Greg Mankiw’s blog), concludes that carbon taxes would be more effective than emissions caps and tradeable permits. The executive summary (full report here), finds many reasons for preferring carbon taxes, including better incentives (the worst sinners are taxed most, and the resulting increase in energy prices would encourage conservation), less opportunity for manipulation and evasion, lower price volatility (note that would be more favorable for investment in carbon reduction technologies) lower administration costs. The most telling factoid is that the EU, which implemented a carbon trading scheme, called the European Emissions Trading Scheme, produced an increase, rather than the desired reduction, in carbon output in 2005, and is projected to achieve at most 1/4 of the targeted greenhouse gas emission reductions called for by the Kyoto accords.

An obvious benefit of carbon taxes is that they will generate government revenue. Shaprio thinks that might make emission reduction more palatable to third world countries. He does not also mention that they’d be useful for the US. The government needs to find ways to undo the profligacy of the Bush Administration cutting taxes during a war.

These findings aren’t surprising. As we’ve said before, trading markets have to have very specific conditions in place to deliver good outcomes, and even liquid markets are subject to manipulation. A market like the proposed carbon trading market has elements that would permit manipulation, namely, lack of disclosure of bids and offers (think the market-makers are going to open their order books? Not unless required to), thin trading (which makes it relatively easy to game prices) and inexperienced, sporadic counterparties (many of the utilities and corporate buyers and sellers won’t participate often enough to know how to get a good price and will be at the mercy of the trading firms).

But say “tax” to any red-blooded Republican, no matter how solid the case, and you will get howls of protest. It will be interesting to see what kind of play, if any, this report gets in the mainstream media.

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