New York City mayor Michael Bloomberg just gave a bombshell speech here in Seattle calling for a federal carbon tax. (Full text of the speech is here, scroll down.)
First off, way to go Bloomberg! In fact, Sightline’s Anna Fahey has written about Bloomberg’s awesome framing. But now, with my researcher’s hat on, I think it’s worth clarifying a few things.
While many of Bloomberg’s arguments in favor of a carbon tax were spot-on, he made some very selective criticisms of cap & trade programs—criticisms that seem targeted at only the worst way of doing it. As far as I can tell, Bloomberg completely ignored the right way to do cap & trade, which starts with auctioning the credits, not giving them away for free.
So as a service for wonky readers, here’s a little primer that I whipped up this morning:
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CARBON TAXES—A good first step that could be implemented soon. Taxes have two big advantages: 1) they raise revenue to invest in greenhouse gas reductions, or cushion consumer impacts, or both; and 2) they provide price certainty. But they have a couple of big disadvantages: 1) They can’t guarantee specific levels of reduction. So to reduce ghgs by the appropriate amount, policymakers would need to continually tinker with the tax rate; and 2) tax increases are thought to be radioactive.
GRANDFATHERED CAP & TRADE—This is what Europe has done and what Bloomberg seems to be objecting to. It’s also the worst system for dealing with global warming. Grandfathering hands out free carbon credits to polluters based on their historic emissions. And because the credits are fungible—they have a cash value—they end up conferring a windfall profit based on past pollution.
Worse, grandfathering does nothing to cushion consumers from price increases. Just as giving Exxon free tickets to the World Series wouldn’t mean that Exxon would pass out free tickets to consumers. In the very same way, giving Exxon free carbon credits doesn’t mean that Exxon would pass out free carbon to consumers. Instead, Exxon would either sell the credits for their cash value, or raise the consumer price of energy to cover the price of the credit they could have sold. (Hat tip for example to Peter Barnes.) The result? Consumers pay more while energy companies chalk up another windfall.
AUCTIONED CAP & TRADE—This is the best system, but Bloomberg’s remarks seemed to ignore this possibility entirely.
In this system, instead of passing out credits for free, the government would hold regularly scheduled auctions. The big advantages are: 1) The cap puts a firm limit on pollution and drives emissions down over time; 2) It raises revenue that can be used to invest in ghg reductions, or cushion consumer impacts, or both; 3) It activates the power of the market to seek out the cheapest and most efficient reductions first, and to prioritize; and 4) It tips the playing field away from big historic polluters and toward leaner and cleaner competitors.
One of the potential drawbacks of this system is that it has emissions certainty, but price uncertainty. (It’s the inverse problem of the carbon tax.) So there is some risk of price volatility. There are, however, a number of good ways to reduce volatility (such as banking, borrowing, trading system linkages, and so on). These tend to be treated as technical details of the auction system, but they’re actually pretty fascinating. And, yes, I’ll be writing about them at a later date.
Then, there’s a whole separate issue about upstream and downstream regulation. Bloomberg made hash out of this too, but I’ll ignore it for now. (My short version: upstream is better and simpler.)
Look, I hate to criticize Bloomberg just at the moment when he’s stepped up with astonishing political courage and vision. He deserves big applause. But it’s also important to get things right—and “straw man” objections to cap & trade won’t help solve our climate problems.
Hang on a minute, there’s an entity which is way out front on this: voluntary cap & trade, with auctioning (they just annonced a reverse auction for carbon credits for the House of Representatives purchase of carbon credits to offset their operations emissions) The Chicago Climate Exchange (CCX). WHY is the CCX the best kept secret and/or the most ignored entity doing TODAY what is taking legislative bodies years to study?
Bloomberg’s key message was “let’s cut through the politics and do what’s necessary.” Gotta love that.But I’m with Eric on the policy design. Bloomberg says cap and trade is like taking 3 left turns when carbon taxes are 1 right turn to the same destination. That’s true only if your destination is a carbon price. But our real desination is a carbon QUANTITY—namely, the level that prevents us from toasting the planet. If that’s our goal, the cap is the key—the straight shot—and the tax is like three left turns with a lot of potential detours and cul-de-sacs.How would we even know the level of tax to set? We’d have to back it out from the emissions goal we’re trying to achieve. Getting the price right is a tool. Getting the quantity right is the job. I’m more comfortable letting the market figure out the price while letting science guide the quantity. Carbon taxes and trading may both be part of the answer. But either way, we need responsible, science-based limits on global warming pollution. Taxes and emissions trading are ways to get the economy pulling toward those limits. But reducing emissions to safe levels is the imperative, and the legal starting point for both policy designs.
There is no scientific consensus of what carbon-emission damage is done and therefore it is difficult to set a price or a cap on allowed emissions. It is clear that the price should be greater than zero, which is the present price. A fixed cap tends to provide an incentive to maximize the emissions within the limit set by the cap rather than provide an incentive for further reductions. This is clear from the effect of caps on automobile fuel consumption where further improvements come only from threats of future tightening legislation. A total national cap on emissions does not suffer from this shortcoming but suffers from the lack of scientific consensus.Let’s take a different tack (and restrict ourselves to USA for simplicity of argument; the international aspects will be considered later) and start with fairness. The environment belongs to us all and if someone degrades it he should pay to every man, woman and child what they think is fair compensation. The payments would be made at the source, be it the coal mine, the oil well or the oil unloading dock. The distribution of the payments can take different forms, but some form of shares to every person is a possibility. They could then sell these shares to those needing to pay at the source for whatever they think they are worth. A brokerage system for this trade would rapidly develop. The several hundred dollars per month these sales would provide a family would give strong incentives to reduce carbon-emitting energy consumption or offset the costs of continuing business as usual in an environment of higher prices for energy and goods.There is of course a cap implied in the number of shares issued and the carbon equivalent of each share. Starting with a cap equal to current emissions, the strong incentives would initiate a rapid decline in emissions. By keeping the cap at the prevailing emissions at any time, the reductions would be sustained but there would be no disruptions in the economy or the lives of individuals. Delays due to the inability of society to adjust instantly, such as time for building nuclear power stations or better public transportation, would be automatically taken into account.The incentives to reduction of carbon emissions would take many forms. Several kinds of alternative energy would become competitive, without subsidies, as would more energy-efficient forms of transportation. A boon to the economy would be the emergence of alternative-energy companies with a strong market and a new ability of US industry for energy-efficient production of goods.The essence of successful reform is the creation of strong incentives!