I’ve been trying to read up on what are the relative merits of Cap and Trade schemes for limiting pollution versus Carbon Tax. I’ve dug up a couple of links regarding this issue but haven’t as yet had time to consider them properly.
One of these contains this as a succinct comparison.
Some say “use a carbon tax,” while others say “use cap and trade.” The advantage of the tax is that when we set it at, say, $5/ton we know this is the cost we will impose on carbon users and no more. The downside is we don’t know how much that will limit carbon. The advantage of cap and trade is that we know how much we will limit carbon, but we have little idea how much allowances will cost–the market will decide later.
Which I’m sure doesn’t get to the bottom of the subtleties of the matter. It seems to me that Cap and Trade has to be very careful in the initial implementation stage as being too lax or too tight with the cap will result in bad results. Notably what was being reported in the Economist recently (subscription only).
The ETS was set up in 2005 to cover five industries, and 13,000 factories and plants, rated as particularly dirty. They were given tradeable allowances covering their existing emissions; firms wanting to exceed those levels had to buy permission, either by purchasing allowances from other firms, or by buying permits from developing-country companies….
Three problems have emerged. The first is the consequence of handing allowances free to existing polluters (a process known as “grandfathering”). The polluters pocketed them, passing on the extra cost of production to their consumers. Moreover, once trading took off, the price of allowances rocketed to €30 ($40) a tonne. Developing countries, meanwhile, were selling permits for about half that (because they cannot yet be traded, and are regarded as riskier). So polluters have been cashing in their allowances, buying cheap CDM permits—and keeping the difference. According to a report by IPA Energy Consulting, Britain’s power companies alone have profited to the tune of around £800m ($1.5 billion) a year.
The second problem was that when the scheme started there was little information about how much pollution the 13,000 factories were emitting. The original levels claimed by member governments were not much more than guesswork, and not surprisingly were generous. Now that levels are being monitored, it turns out that Europe is not emitting as much as it thought it was. When this emerged last month, the price of carbon allowances crashed.
Third, the current phase of the ETS lasts for only three years. Nobody knows what level of allowances will then be set. Since the payback period for cleaner power-generating technology is at least five years, there is no incentive for producers to invest in cleaner technologies.
On the other hand it is true that no one knows what the effect of a carbon tax will be, as we don’t know if we have priced it correctly for the volume we want. More particularly as it will have its greatest effect in how the economy evolves rather than in instantaneous change the feed back loop of adjustment is going to be of the order of 5 years or so.
In the second link it seems that the writer is very disturbed by this aspect of a Carbon Tax. Personally I think its makes it much more transparent and if it get things moving the right way we can adjust the price up slowly to get it moving where we want it to be over time. Although I’m certainly open to being persuaded otherwise.