Let's Do Something About Climate Change - But Let's Get it Right

10 Reasons Why a Tax Shift is Better than Cap and Trade

By Wyatt Boyd, The Earth Institute at Columbia University

1) Command and Control versus Market Forces. A cap dictates emissions levels and creates price uncertainty. With a safety valve provision (the government will release as many permits as it takes to get below a price ceiling) it completely loses the so-called “guarantee” of emissions reductions. Then it’s just like a tax, except more expensive because of the administrative and regulatory costs. A carbon tax gives price certainty and allows the market to do what it does best – allocate resources given complete price information. In the SO2 market, permits reached prices excess of $1,000 - do you think a cap and trade system will be accepted without a safety valve? Yet with it you can imagine a scenario where firms and states are paying for permits with absolutely no real value (they're above the cap) which is also unacceptable, and expensive.

2) A cap and trade system is a tax hike, while a carbon tax, ironically, is not. With a revenue-neutral carbon tax, money could be returned to taxpayers in two basic ways. Either a check could be cut and mailed to every taxpayer, similar to the petroleum fund in Alaska, or the amount raised in carbon could be offset in payroll and income tax rates. Either way the money will go back to the people and the overall tax burden will not increase. Does Liebermann-Warner have a provision to return money to the taxpayers? No. It will create scarcity in the carbon market, thus price increases that all Americans will have to face – with absolutely no relief.

3) Windfall Profits. Initially in Liebermann-Warner, over 70% of the carbon credits are handed out, for free, to applicable firms. Assigning private property rights to a current public good and then handing them out has a name – windfall profits. A cap and trade system will essentially give the largest and most polluting firms billions of dollars in new assets and value on their balance sheets. This creates distortions in the market and perverse incentives for companies to support a cap and trade system. And then when they do auction off the allowances, the Treasury keeps about $5 trillion of the $6.7 trilloin generated over the lifetime of the Act. It should be revenue neutral, like a tax shift would be.

4) Traders Bonanza. A cap and trade system would mean a huge new overnight business for traders and brokerages all over the world. As the traders say, volatility is valuable. It allows arbitrage and profits. A huge push for Liebermann-Warner has nothing to do with the environment, national security, or the economy – but solely the ability for traders to make a healthy percentage profit on each and every carbon credit trade. If that sounds expensive it’s because it is. As Mayor Bloomberg (who knows something about Wall Street as he only built its backbone, or terminal) said about the costs of cap and trade versus taxes, “if anything, they will be higher under cap-and-trade, because middlemen will be making money off the trades.”

Additionally, oil executives have recently testified that the “true”, supply-demand determined, price of oil today is about $60 per barrel. This makes sense considering Saudi Arabia alone has 1.8 million barrels a day in spare capacity and U.S. refineries are only operating at 85% capacity. There are over 2,000 federally approved drilling permits in the U.S. representing over 30 milion acres of land that are currently undeveloped. It is not because of scarcity that prices today are in uncharted territory. A full half or more of current prices result rather from speculation and irrational exuberance. When one long position pays off, it can create a stampede of similar positions and upward price spirals that further incent a long (call) position – a bubble. Do we want such speculation to extend to all carbon-based sources via a cap and trade system? Ironically, rising gas prices make a revenue neutral carbon tax less popular, when in fact it is the system most likely to control price surges that occur on the futures market and provide greater ultimate price containment.


5) Price Threshold. Carbon has a real (currently external) cost, and there is a critical cost needed to provide incentives for large-scale deployment of technologies like solar or carbon capture and storage. According to Sir Nicholas Stern, the IPCC and the International Foundation for Science, it’s around $30/ton of CO2. Setting a cap and having price volatility provides great uncertainty as to whether this price point will be reached. For instance, the Chicago Climate Exchange, the biggest cap system today in the world, prices carbon now at about $4/ton – not even close to providing the necessary level of incentives to combat climate change. There is a “tipping point” for renewables and new technologies to be deployed at scale and it demands the price certainty only a tax shift can give.

6) Efficiency. A tax shift from income and labor onto carbon produces a more efficient outcome via reducing climate change emissions and increasing productivity. Providing more incentives for good things (like income) and less for bad things (like greenhouse gases) results in more of the good and less of the bad, which is better for everyone. Mayor Bloomberg summarized it well in a recent carbon tax endorsement speech that can be found at http://cityroom.blogs.nytimes.com/2007/11/02/bloomberg-calls-for-tax-on-carbon-emissions/



7) Non-Partisan Congressional Budget Office Findings. The CBO’s recent report “Policy Options for Reducing CO2 Emissions” (http://www.cbo.gov/ftpdocs/89xx/doc8934/toc.htm) concludes a carbon tax is up to 5 times as efficient as a fixed cap system, writing: “A tax on emissions would be the most efficient incentive-based option for reducing emissions and could be relatively easy to implement.” This is largely because a tax lets firms smooth out their investments in clean technologies over time, rather than being legally forced to do it in mandated timeframes courtesy of a cap system.

8) Politically Possible. British Columbia is going to implement a tax shift from business and personal income to carbon starting in July. French President Sarkozy has endorsed a revenue neutral tax, saying "We need to profoundly revise all of our taxes...to tax pollution more, including fossil fuels, and to tax labour less." This is politically doable. (http://afp.google.com/article/ALeqM5gx9Wyuo7XJiydxsqseJmVdX3-MoQ)

9) Regulation and Litigation Nightmare. If Liebermann-Warner is passed it will take years for the EPA to draft regulation and settle an avalanche of suits from firms seeking exemption. Given the EPA’s current denial of California’s emissions waver under the Clean Air Act, I don’t have to tell you how arduous it can be to get any agency to enforce the law – even if it’s clearly in their purview. A shift in the tax code would be a very simple and unambiguous piece of legislation and could be implemented years before a cap and trade program even cleared the courts. Where does the government have more competency than in tax policy?

10) The Dean of Climate Change has spoken. In the words of Former vice-President Al Gore in his Nobel speech: “And most important of all, we need to put a price on carbon – with a CO2 tax that is then rebated back to the people, progressively, according to the laws of each nation, in ways that shift the burden of taxation from employment to pollution. This is by far the most effective and simplest way to accelerate solutions to this crisis.”