Cap-and-trade versus a carbon tax, Part III

(If you’re not interested in technical fussing about economics, just skip this post. Here are links to Part I and Part II.)

The carbon-tax-versus-cap-and-trade post du jour comes from Lynne Kiesling, a senior lecturer in economics at Northwestern University in Chicago and senior fellow at the Reason Public Policy Institute, a free-market-oriented think tank. It’s dense, but here’s the heart of it:

The most problematic aspect of Pigouvian taxes [that is, taxes on harmful externalities like pollution] is that they rely on the assumption that the policymaker has sufficient knowledge to be able to set the optimal tax. The knowledge of the optimal level of emissions and the optimal tax rate is not, in Hayek’s phrase, given to any one mind. That is the knowledge problem. That means that the policymaker has to have information about production processes, production costs, the epidemiological and other health and consumption effects of the product, and the economic value of those epidemiological and other consumption effects. That is a heroic assumption. No one person or group of people, however well-informed and well-intentioned, can ever determine the optimal emissions or tax through a centralized process.

In other words, a carbon tax’s irreparable and fatal flaw is that we cannot begin to guess what rate we ought to set the tax at.

What’s more, this simple thing is true in two completely different ways, depending on what you want to use a carbon tax for.

  1. If you see a carbon tax as reparations for harm done, we need to be able to quantify the harm done by greenhouse gases in dollar terms. This is Kiesling’s point in the passage I quoted.
  2. If you see a carbon tax as a means to prevent harm from happening in the first place — as a way to keep carbon emissions at a level the atmosphere can safely absorb — well, we probably can’t even make an educated guess at what that tax ought to be.

In Kiesling’s estimation, this problem overwhelms all the criticisms of a cap-and-trade system (it only applies to some emitters and requires complex enforcement mechanisms and a well-designed market carbon-traders trust). It’s a point that’s hard to answer.

Commenter “dcbob” tries at Environmental Economics, and he doesn’t convince me.

His central argument appears to be that even a carbon cap, with emissions permits distributed until we reach that cap, “unavoidably impl[ies] a best-guess price” for carbon, and therefore a cap-and-trade system has the same weakness as Kiesling says a carbon tax does. A cap on carbon emissions might indeed let a clever person with a lot of information on hand calculate what the cost of a tonne of carbon “should” be, but it seems to me that’s neither here nor there — no such calculation is needed for a cap-and-trade system to work (the emissions-permit market will sort the actual price of carbon out very quickly, regardless of the “best-guess price”), but that calculation is the whole foundation of a carbon tax.

Kiesling makes a second worthwhile point, that it’s not fair to criticize carbon markets in principle for the practical failures of the European system. Lobbyists and featherbedding politicians built in all kinds of exemptions and loopholes and ultimately gave away the first round of permits for free, leading to a pathetically low price for carbon and a pretty ineffective system. The much-talked-about Los Angeles Times editorial of a few days ago pointed several fingers at the European screwups in rejecting cap-and-trade.

But, Kiesling points out, comparing a flawed example of a cap-and-trade system to the platonic ideal of a carbon tax isn’t fair. As she puts it:

I don’t understand why setting a tax rate … is substantially less prone to political manipulation than establishing a carbon permit market. Tax supporters who ground their argument in the practical public choice foundation should explain why that’s the case, or else they are committing the Nirvana fallacy.

In other words, sufficiently venal politicians could do the exact same bloody thing with a carbon tax.

Hmmm. I thought I knew what I thought, but now I’m swinging back the other way.

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One response to “Cap-and-trade versus a carbon tax, Part III

  1. Pingback: The libertarian argument for government-mandated carbon markets « The EcoLibertarian

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