Carbon tax vs cap-and-trade (again)

@aguanomics why are carbon taxes more viable worldwide?

— John C. Whitehead (@johnwhitehead81) August 17, 2015

And we went back and forth a bit from there. Recognizing that the twitter is a lousy way to communicate, David went to the blog:

One week ago, I tweeted that the Pope (!) should push for carbon taxes instead of cap and trade. In response, John Whitehead (a busy environmental economist and blogger) said "why taxes?" The following tweet exchanges were neither satisfactory nor complete, so here's a post.

Before I get into David's post it might be useful to review where I stand on the issue. In terms of addressing climate change I think that a carbon tax and cap-and-trade are 1a and 1b policies. Given that this is almost a tie, command and control policies are a distance third. As the title suggests, my perception is that many economists feel that they need to choose their favorite policy instrument and then denigrate the other. I don't understand this sort of behavior. It is like preferring chocolate to vanilla, preferring vanilla to nothing and then arguing how much better chocolate is to vanilla. You sir, will get nothing and like it!

A long time ago I did the principles level analysis of carbon tax vs cap-and-trade and found that there is little to distinguish the two. Both can achieve the efficient level of emissions reduction. Both can generate the same amount of revenue. Both provide incentives for dynamic efficiency (i.e., firms have an incentive to cut abatement costs). There is little to distinguish between the economic outcomes. 

Now, on to the David's post. After a review of both policies David provides three reasons to prefer carbon taxes:

Carbon taxes are:

1. Easy to assess (charged at source/point of entry)
2. Predictable and adjustable
3. Sources of revenue to the national treasury (or refunds to citizens)

Considering just the economics (which is what we as economists should be mostly doing), a carbon cap is also predictable and adjustable. Price floors and ceilings can be used to make the market price less uncertain. Cap-and-trade with auctioned permits (e.g., RGGI) can generate just as much revenue as a carbon tax. 

Then David asks and answers:

So why do so many politicians like cap and trade over carbon taxes? They can:

1. Claim big reductions based on (imaginary) baselines that have been capped.
2. Give permits to favored industries (attracting corruption).
3. Say that industry is doing something without spending money.

Carbon taxes are harder to manipulate or dodge.

So, quickly we have moved away from economic theory and into politics (sigh). These three seem to flow from the assumption that a cap-and-trade policy will undoubtedly be characterized by the issuance a large number of too many free permits. The flip side is that a carbon tax is likely to be set too low. I could easily assert that carbon taxes are easy to manipulate or dodge. Politicians could give carbon tax breaks to favored industries (attracting corruption). Is there anything in the historical record to suggest otherwise? All of these are political problems and not problems with incentive-based policy, per se.

Another Q&A with David:

But what about driving international improvements in efficiency, etc? Well, I think that theoretical promise has failed due to (1) terrible accounting for permits (e.g., failure of the "clean development mechanism") as well as (2) lots of anger over sending money abroad to get few useful results.

I guess the Kyoto Protocol had some problems, eh? My guess is that a carbon tax would not be immune from implementation problems (but I may be naive).

And David's conclusion:

Thus, I have doubled down in my support for carbon taxes (many prior posts) because they can be...

• Imposed within nations
• Used to fund national projects (or given back to citizens)
• Increased when other countries put them into place
• Easily integrated into business and personal decisions affecting emissions

Except for the third bullet, which I don't understand, these are all so true. And yet, I'm doubling down in my support for cap-and-trade (along with a carbon tax) because they can be:

• Imposed within nations
• Auction revenue can be used to fund national projects (or given back to citizens)
• Easily integrated into business and personal decisions affecting emissions

I'm also doubling down on my assertion that economists are too quick to fall into the carbon tax vs cap-and-trade trap. I think that most of economists prefer either incentive-based policy to the command-and-control or no policy status quo. 

Here is David's "bottom line":

Let's get real. Carbon taxes can reduce emissions, cheaply ($0.40/gallon!), under real political constraints.

I'm left thoroughly unconvinced that a carbon tax is so far superior on economic grounds that economists should strongly favor it. I'm also unconvinced that cap-and-trade is uniquely prone to implementation problems and uniquely ripe for corruption. My bottom line:

Let's get real. Cap-and-trade can also reduce emissions, cheaply, under real political constraints.

There are currently on-going policy experiments that provide evidence to support both bottom lines.