Looks like today is a day for John and me to correct our idiocy from yesterday. So I'm going to take another shot at describing a Gas Allowance Market that addresses some of the criticisms frequently leveled at gas taxes. Much of what is here will duplicate and clarify my arguments from yesterday, with significant modifications to address comments and concerns raised by readers. Of course, this is still a work in progress, but I think it has some promise. I'm not giving up easily.
Warning--long post ahead.
First the premise: Greg Mankiw has been very vocal in advocating a $1 increase in the national gas tax ($.10 per year for 10 years). His campaign has gathered steam among economists and seems to have legs. So I want to ask the question: If we are going to try to solve the problem of overconsumption of gas--and consequently the problem of gas consumption externalities, emissions--is a tax the best way to go about it? So my starting point is 'some policy is going to be used,' and I want to design the economically most appropriate policy. If you want to argue that no policy is needed, that's fine but beyond the scope of the current discussion.
So here's a quick overview of the two programs. After this quick overview I will give you my argument for preferring the allowance system to the tax system. Then I will describe in more detail the gas allowance system. When you consume a gallon of gas you generate emissions (CO, CO2 and other stuff). These emissions cause harm to others. In order for the market to capture these costs they have to be imposed. Otherwise gas buyers and sellers will ignore the external costs and over-consume gas and under-price it. A gas tax is very simply a government set price on the external costs of gas consumption. Economists get together and determine the optimal price of the externality, the government charges that price on each gallon of gas and then collects the revenue and redistributes it. A gas allowance system would set a cap on the quantity of gas consumed nationwide. Then gas allowances would be distributed to the public and they can be bought and sold from each other. In order to buy a gallon of gas you have to have a corresponding gas allowance. The price of that allowance is determined by the demand and supply. Revenues from the sale of the allowances accrue to those holding excess allowances. That's the simple version of both programs. Of course the devil is in the details.
What is my beef with a gas tax? None really. In theory, a gas tax and the proposed gas allowance market are equivalent--in terms of efficiency. The gas tax is a price-system for rationing gas and an allowance system is a quantity rationing scheme. In other words, a tax scheme sets the price and lets the market determine the quantity of gas consumed--and indirectly the quantity of external costs imposed. An allowance scheme sets the quantity of gas to be consumed and then allows the market to determine the price. Under ideal conditions, the tax set by the government will be identical to the price established by the allowance market. So what are some of the concerns with a tax system:
1) What if the government--or economists- choose the wrong tax level? If the tax is set too low, we undershoot the optimal consumption level. If the tax is set too high, we overshoot. Unless the tax is set exactly equal to the marginal damages created by the last gallon of gas consumed, we will end up with an inefficient level of gas consumption and consequently an inefficient level of emissions.
2) Gas taxes have the potential to be regressive. That is, gas taxes may place a disproportionate burden on those with lower incomes. This can be solved by either introducing a graduated gas tax rate based on income, or using the tax revenue after the fact to redistribute income.
A gas allowance system addresses both of these concerns. By establishing the quantity of gas consumed, the regulatory agency directly regulates the amount of the externality. Notice that this is the same goal that the gas tax has, but we don't have to wait and see if we got the tax right. By directly determining quantity, we don't have to guess at the price that will lead to that quantity. Further, since the allowances are up for sale on the open market, if we issue too many gas allowances, 'society' can step in, buy credits and retire them. If it is worth it to Greenpeace to have less gas consumed, they can step in and buy allowances. This will increase the price and force those consuming the gas to pay the external cost. When will Greenpeace stop buying allowances? When they are no longer willing or able to, in other words, when the price of a permit exceeds the benefits of reducing the damages any further. So by establishing the ability to buy and sell emissions, an allowance market can find both the socially optimal price AND quantity of emissions.
So how will a gas emission market work? Here is my revised program:
1) Cap gas consumption at current level.
2) Hire a private company to administer the program--similar to the Chicago Climate Exchange administering the SO2 emissions trading auctions.
3) Establish an account for every U.S. citizen of minimum driving age (16 in most states, 15 in some?). Each eligible participant will receive an account number.
4) Credit each participant with a monthly allotment of emissions allowances (enumerated in gallons of gas). The total allotment is equal to the current gas cap established in 1). Any college student that has used a dining hall account, or anyone who has been to Dave and Buster's is familiar with the fill up the account and then deduct allowances system. How is the allotment determined? This is a political question, but here is a simple idea. Allocate based on the median income of the census tract of residence--prorated to ensure the total allocation meets the national cap. This alleviates the need for individual monitoring of income and it serves as a mild income redistribution. Those below the median in the census tract receive disproportionately more allowances and those above, disproportionately less. This will serve to lubricate the market since gas consumption tends to increase with income. Those above the local median will have to buy permits from those below.
5) Set up a virtual clearinghouse (similar to ebay) where participants are free to buy and sell gas credits. I predict very readily that someone will invent a system for trading allowances on site. I'm picturing a nationwide system of ATM like machines where consumers can buy and sell allowances.
6) Non-eligible gas consumers can purchase allowances on site (at the gas station) in the form of allowance credit cards. There is no need for the government to participate in this part of the program. I'm sure some entrepreneurial individuals will take advantage of the opportunity to establish a secondary market for allowances by buying allowances from those with an allotment and selling to those without. This means non-citizens can participate without being monitored. The only catch is they don't receive an allocation.
7) Every time a driver fills up, they must enter their account number or swipe their allowance credit card to be deducted the appropriate number of credits. This is in addition to paying for the gas itself.
8) Maintain the current cap for 5 years, to allow consumers to get used to the program. Then annually decrease the gas cap by 5% (or some percentage).
What are the advantages of this system? First, minimal government involvement. The government establishes the cap, a rule for allocation of allowances and a monitoring system for ensuring that gas stations have and maintain the equipment necessary to use allowances. Beyond that, there is no need for monitoring. When you buy gas, you have to have allowances. I'm sure there are technogeeks out there that can easily (and profitably) build this technology into the pump.
Second, the market will establish the cost of reducing emissions. We avoid the problem of having to set the right tax.
Third, although I'm skeptical, such a system could replace other tax schemes. Since the allowances can be used both as an efficient way to allocate gas and as a way to redistribute income, we could replace less efficient employment taxes (yeah, I know, a pipe dream).
Possible criticisms:
--What if someone tries to corner the market? I just don't see it happening. It doesn't happen in other markets, why would it here? What's the advantage? When you buy up all the allowances you artificially drive the price up. When you try to unload them, you drive the price back down. If this worked, why don't big companies buy up all the excess housing inventory currently out there to prop up the market? Or buy up all the SUV's sitting in dealer lots?
--We're used to taxes, this is too new. That's just sad. I like progress, and I think a market based system of emissions trading is significant progress. Besides, there is precedent in the Acid Rain program. I'm just taking it another step to the consumer market.
An unanswered question:
Can credits be banked/carried over year to year? I'm not sure. The economist in me says, why not? But I'm open to suggestions.
