Carbon tax takes lead over emissions capping

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A carbon tax — based on emissions from cars, homes, power plants and corporations — is more likely to successfully lower carbon dioxide in the atmosphere than a carbon trading system.
That’s the word from the Congressional Budget Office, as well as environmental analysts. Both groups say that a carbon tax would be more efficient than emissions capping. And Dr. Walt Hecox of Colorado College believes a carbon tax would more efficiently lower carbon emissions.
“It’s what economists call a negative externality,” he said. “Taxes are assessed based on the type of fuel used and how much carbon it releases. And the tax revenue could be used to mitigate the cost to the poor, or to invest in alternative energy sources.”
Carbon trading — on a commodities market, where a cap is set and companies who emit less carbon than the cap can sell the remainder to another company — is based in the private sector, Hecox said.
Europe introduced a carbon emissions market after the 1997 Kyoto Protocol, he said, although the market has faced some big problems.
“The problem is they over-estimated the number of permits,” he said. “So the price has fallen. With a cap-trade system, there’s no revenue for the government, no real incentive to invest in other sources of energy.”
The United States has a single, voluntary carbon emissions trading system: The Chicago Climate Exchange. It is self-regulating and voluntary, but legally binding. The group requires members to reduce emissions by 6 percent below the Kyoto baseline no later than 2010.
The exchange opened in 2001, and carbon is traded, much like any other commodity. Just like any commodity, the price fluctuates. The cumulative trading volume between March 2003 and May 2006 reached 6.5 million metric tons.
The CBO researched the issue in 2005, and decided that the carbon tax would be a better effort than a cap-and-trade system.
“Neither the costs nor benefits (of reducing emissions) are known with certainty,” the CBO said in its report to Congress. “For that reason, the best policy makers can do is to choose the policy instrument that is most likely to minimize the cost of making a ‘wrong’ choice.”
Because the cost of controlling carbon is unknown, most economists believe the best idea is one that controls price, not quantity. The amount of carbon dioxide produced when a fuel is burned is a known quantity, experts say, and a price can easily be fixed to it.
“It’s going to make carbon-based energy more expensive,” said Colorado School of the Mines Professor J. Thomas McKinnon. “And it will force companies and people to be more efficient. It will level the playing field for non-carbon based fuels, give incentives for investment in wind energy or solar centric power companies. There’s a lot of room for innovation if the playing field is level.”
The CBO noted that a cap-trade system doesn’t allow for flexibility. Because the costs of reducing emissions is unknown, a cap system might not allow enough financial incentives if actual costs are much higher than anticipated costs.
“The less information policymakers have about the cost of meeting a particular emission cap, the greater the advantage offered by an emission price,” the report said. “The cost of meeting a given cap on carbon emissions is likely to be difficult to estimate for at least three reasons. First, the cost of meeting a future cap would vary significantly with the amount of growth in carbon emissions in the interim. … Second, policymakers have less information about the cost of controlling emissions than do the firms that create them. Third, the cost of meeting the future cap will depend on the technologies that are developed to reduce carbon dioxide emissions and the economic consequences of adopting those technologies — neither of which can be predicted with certainty.”
One group that is interested in leveling the playing field is the New York City-based Carbon Tax Center.
In its plan, the tax — which starts at 10 cents for a gallon of gas, and increases in 10-cent increments during a 10-year period — would be “revenue neutral,” said co-founder Charles Komanoff.
“The money could be spent in two ways: we could give it back to the taxpayer, much like they do the income from the Alaskan oil pipeline,” he said. “Or it could be used to lower Social Security payments. Our plan isn’t to put the money into alternative fuels or to subsidize an industry.”
Komanoff said the organization believes the carbon tax is “more fair, more understandable.”
“We can get it into place quicker, and it will cover all uses of carbon fuels,” he said. “It will exclude those financial types hovering at the trough.”
But Komanoff’s group isn’t the only one interested in a carbon tax. Many national and multinational companies are supporting a national carbon tax — as opposed to various state taxes and a myriad of international taxes.
“Many of these large companies think the worst thing to do is have 50 different taxes when they’re trying to do business,” Hecox said. “They know some kind of change is inevitable and they prefer a single, national tax, a multinational tax would be even better in their view.”
Pressure from businesses will lead to legislation by the end of President Bush’s current term, he said. The European Union is threatening to impose a carbon tax on American imports.
“It’s probably not legal under the WTO (World Trade Organization),” he said. “But they’re going to try it if the United States doesn’t take some steps of its own. That’s increasing the pressure to get something done sooner.”
The Congressional Budget Office says the uncertainty about climate change science — if there is a specific temperature that will trigger catastrophic damages — lends more credence to a carbon tax than a cap and trade system.
If there is uncertainty about either the existence or the level of a trigger temperature — as is currently the case — the potential advantages of an emission cap decline,” the CBO report said. “Under those circumstances, it is no longer clear whether, or at what level, to set a cap to avoid a catastrophic outcome. … A price instrument is generally superior if damages are expected to grow, but at a gradual rate of increase.”
Amy.Gillentine@csbj.com

An example of the advantage of using a tax, rather than a cap, to reduce carbon emissions

  Expected outcomes Actual outcome if final cost was 50% lower Actual outcome if final cost was 50% higher
Set a tax of $10 per ton of carbon
Marginal cost $10 $10a $10b
Emission reduction 29mtc 56mtc 19mtc
Net benefit $143M $280M $96M
Set a cap to reduce carbon emissions by 29mtc
Marginal cost $10 $5 $15
Emission reduction 29mtc 29mtc 29mtc
Net benefit $143M $215M $72M
Percentage increase in net benefit from a tax rather than a cap
  n.a. 30% 34%
Source: Congressional Budget Office.
Notes: This example arbitrarily assumes that the benefit of reducing carbon emissions is $10 per metric ton. It examines the net benefits that would result in the first year of each policy, assuming that the policy would apply only to the United States, that the initial year would be 2010, and that the policy would have been announced 10 years earlier. The cost of firms’ emission reductions (and the response to various taxes) is derived from Mark Lasky, The Economic Costs of Reducing Emissions of Greenhouse Gases: A Survey of Economic Models, CBO Technical Paper No. 2003-03 (May 2003), available at www.cbo.gov/Tech.cfm.
a. The actual marginal cost of reducing 29 million metric tons of carbon (mtc) is $5, but the tax induces reductions up to 56 million mtc, at a marginal cost of $10.
b. The actual marginal cost of reducing 29 million mtc is $15, but the tax induces fewer reductions (19 million mtc instead of 29 million mtc), up to a marginal cost of $10.