A Few Bits on Cap and Trade

June 4th, 2008

Posted by: Roger Pielke, Jr.

The U.S. Senate is debating a cap and trade bill this week and next. Anyone wanting a look at the debate can find it on CSPAN-2.

Meantime here are a few minor related items:

I reviewed Earth: The Sequel by Fred Krupp and Miriam Horn of the Environmental Defense Fund. Unfortunately, the book adds little to understanding of or debate on cap and trade. My review can be found at Nature Reports: Climate Change here.

Monday’s Denver Post has a column by David Harsanyi (opposing the cap and trade bill) in which he quotes from an analysis I did of the effectiveness of the Clean Development Mechanism (CDM) of the Kyoto Protocol for reducing carbon dioxide emissions. Unfortunately he confuses my analysis of the effect of the CDM with an assessment of the entire Protocol. For that analysis he would have wanted to look at a 1998 paper by Tom Wigley, and make a few adjustments based on actual participation and performance of Kyoto. The amount of delay in emissions from all of Kyoto would be measured in months not days.

4 Responses to “A Few Bits on Cap and Trade”

  1. Chip Knappenberger Says:


    FWIW, I ran through a rough calculation for Mr. Harsanyi (the details of which I posted as a comment to his article), and came up with Kyoto savings of about two month’s worth of emissions.

    So you are right on.


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  3. Roger C NY Says:

    I have been very involved in cap and trade programs for SO2 and NOX and with the proposed programs for CO2. One key point is that the proposed CO2 program is not the same as the very successful SO2 and NOX programs because the government wants to auction off a significant portion of the allowances and use the proceeds for what it thinks should be done. So it is not cap and trade, it is cap and auction.

    There are other important differences. SO2 and NOX modeling is more refined from the standpoint that you can estimate specific environmental impacts and therefore, determine a cap that can be justified by specific environmental impacts. SO2 and NOX can also be directly controlled and it turns out that you can get more cost-effective reductions at some facilities than others. So the cap is set for a specific environmental objective and the market drives over-control at the cost-effective facilities and trading to the other facilities. On the other hand, the CO2 cap is subject to more than a little debate and there are no cost effective control technologies for CO2. Ultimately, then the cap and trade CO2 proposal is supposed to set a price for carbon.

    I am convinced directly setting the price of carbone is a better “free market” response. I found the analysis by William Nordhaus to be the clincher to me (http://nordhaus.econ.yale.edu/dice_mss_072407_all.pdf).

    I am afraid we will spend the next few years arguing who gets what out of the cap and trade pie when the real purpose is to set a price for carbon. It would be far better to simply set the price of carbon with a tax that replaces other taxes.

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  5. SeekerBlog.com Says:

    Roger C — I agree. And further delays will probably prove costly. I would expect focus group evaluations of a revenue-neutral carbon tax to be very positive — at least where the tax swap is for payroll taxes [e.g. Gilbert E. Metcalf, "A Proposal for a U.S. Carbon Tax Swap - An Equitable Tax Reform to Address Global Climate Change"].


    Maybe not so well-received if the swap proposed was for the collection of savings-penalty taxes [the "rich man taxes" like dividends, capital gains].

    “The saying in Washington is anytime there’s a new program, the lawyers are the ones who get rich first,” says Charles A. Patrizia, a Paul, Hastings, Janofsky & Walker attorney who’s spent three decades inside the Beltway.

    …If and when the U.S. government imposes carbon emissions restrictions, says Jones Day’s Holden, the amount of legal work generated by those regulations will be significant.

    “The transactional side is going to be huge; the regulatory side, the litigation side is quite big; there’s patent, intellectual property; the international law side,” he says. “

    It’s hard to find an area of law that isn’t going to be impacted by a regulatory program that not only affects every manufacturing facility, but … [affects] all the products that go into what is manufactured.”

    The U.S. political system strongly favors rent-seeking, especially brand-new rent-seeking opportunities. I.e., fresh pork. If you are a Beltway lawyer or union official, here are some things to hate about implanting an economic carbon price signal by means of a revenue-neutral carbon tax:

    1. Since all the tax revenue is directly returned to U.S. citizens [say via payroll tax cuts] there is no new never-ending stream of cash to be administered and pilfered.

    2. Because the carbon tax can be administered by one page of new law and a small laptop computer program, there are no new million square feet Federal Office Buildings to construct and to staff. Therefore no new construction industry union dues payers to fund the salaries and first-class air travel of the execs of the National Federation of Federal Employees or the American Federation of Government Employees, AFL-CIO, or the …

    3. Because of the simplicity of the carbon tax there are no sweet new special privileges or rents to be allocated to political supporters. E.g., free or low cost “emissions credits” to be issued to coal-based utilities to cover their “historical emissions”. An example of a powerful rent-seeking lobby is the U.S. Climate Action Partnership, whose mission is to nuture cap-and-trade legislation in order to grant each company [or industry] special advantages. Naturally, their PR arm is totally against revenue-neutral carbon taxes.


    4. Because of the simplicity of the carbon tax there is no new consulting industry created which would generate millions of hours of legal and accounting work.

    Every energy policy economist [that I know of] strongly favors a carbon tax structure over “cap-and-trade” schemes. Such “price type” mechanisms are much more effective and efficient than “quantity type” schemes like cap-and-trade. E.g., see William Nordhaus [PDF].






    Steve Darden

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  7. SeekerBlog.com Says:

    A few more thoughts on the dangers and costs of the “Cap and tax” schemes. Yes, I understand that in a perfect world it is theoretically possible to get the same pure economic effects via either policy. But in the real political world I’m convinced the results will be totally different.

    We need certainty of future costs to achieve fast, sound investment decisions. A revenue-neutral carbon tax scheme can be implemented with nearly zero administrative cost — existing tax collection and auditing channels are almost all that is required to implement a new tax schedule. The price mechanism allows each investor to confidently plan for her future cost of emissions. The carbon tax option gives us [e.g., the utility investor] certainty of future costs [until the tax rate is changed], transparency, and low transaction costs associated with the carbon pricing.

    The opposite of certain is what we get with the quantity mechanism of cap-and-trade. The investor faces a volatile, uncertain profile of future emissions costs. The ETS experience has demonstrated great volatility. Volatility is the enemy of what we urgently need — that is fast decisions to stop building dirty coal power generation, substituting the larger capital investments required for low- or zero- carbon plants.

    The cap and trade scheme creates a new administrative monster that will be impossible to kill off once it gets going. I anticipate something like the Dept of Agriculture times 10. Do not forget that cap and trade hinges on measuring and auditing reported quantities of emissions. Cap and trade will create a rich growth medium for rent seeking — which leads inevitably to corruption of staggering proportions. We know how effectively “Oil for Food” corrupted the UN.

    A carbon tax swap needs no costly measure & audit function. There could be an audit function to verify that a plant did not consume more than the 100,000 bbls oil that were reported. Other than that it is simple table lookup to compute the tax due. For a study of the costly, messy world of trading permits and offsets see this new April 2008 working paper [PDF] is by reliable sources Michael Wara and David Victor.


    Excerpt from Wara & Victor:

    This article reviews the actual experience in the world’s largest offset market—the Kyoto Protocol Clean Development Mechanism (CDM)—and finds an urgent need for reform. Well- designed offsets markets can play a role in engaging developing countries and encouraging sound investment in low-cost strategies for controlling emissions. However, in practice, much of the current CDM market does not reflect actual reductions in emissions, and that trend is poised to get worse. Nor are CDM-like offsets likely to be effective cost control mechanisms.

    This is excellent work — and compelling results. I hope that all the politicians pushing “son of Kyoto” deals will read it and think carefully about what they are proposing.

    A key requirement of any scheme is that it be adaptive. It boggles my mind to consider how to design a cap and trade scheme to be adjustable as our understanding improves.

    In Nature, 8 May 2008: among the 4 letters responding to the Nature PWG commentary is this letter from Richels, Tol and Yohe. This letter makes the point on the adaptive requirement better than I have:

    In their Commentary ‘Dangerous assumptions’ (Nature 452, 531–531; 2008), Pielke et al. show that the 2000 Special Report on Emissions Scenarios (SRES) reflects unrealistic progress on both the supply and demand sides of the energy sector. These unduly optimistic baselines cause serious underestimation of the costs of policy-induced mitigation required to achieve a given stabilization level.

    This is well known among experts but perhaps not to the public, which may explain why some politicians overstate the impact of their (plans for) climate policy, and why others argue incorrectly that ‘available’ off-the-shelf technologies can reduce emissions at very little or no cost.

    The numbers presented by Pielke et al. are revealing, but they divert attention from a more serious problem underlying the SRES approach to calculating mitigation costs: a failure to incorporate the dynamic nature of the decision problem into climate-policy analysis. Until we can keep adjusting the analysis by continually incorporating uncertainty, correction and learning, we shall continue to offer policy-makers an incomplete guide to decision-making.

    The focus of policy analysis should not be on what to do over the next 100 years, but on what to do today in the face of many important long-term uncertainties. The minute details of any particular scenario for 2100 are then not that important. This can be achieved through an iterative risk management approach in which uncertain long-term goals are used to develop short-term emission targets. As new information arises, emission scenarios, long-term goals and short-term targets are adjusted as necessary. Analyses would be conducted periodically (every 5–10 years), making it easier to distinguish autonomous trends from policy-induced developments — a major concern of Pielke and colleagues. If actual emissions are carefully monitored and analysed, the true efficacy and costs of past policies would be revealed and estimates of the impact of future policy interventions would be less uncertain.

    Such an approach would incorporate recent actions by developed and developing countries. In an ‘act then learn’ framework, climate policy is altered in response to how businesses change their behavior in reaction to existing climate policies and in anticipation of future ones. This differs from SRES-like analyses, which ignore the dynamic nature of the decision process and opportunities for mid-course corrections as they compare scenarios without policy with global, century-long plans.

    Cheers, Steve Darden