Cap and Trade (Auctioned) is Not the Same as Carbon Tax

For those interested, I thought I’d briefly expand on my comments published in a very comprehensive article written by Bob Caylor of the Fort Wayne News-Sentinel. 

Cap-and-Trade is indeed more politically feasible to carbon taxation, as has been discussed before on this blog: not the smallest of reasons being that a carbon tax is a more “in your face” way of going about environmental policy. 

But many, including Pigou Club founder and macro blogger Greg Mankiw, attempt to explain cap-and-trade as being essentially the same as a carbon tax (for a more detailed and easy-to-follow understanding of auctioned cap-and-trade and carbon tax similarities, go here), only with corporate welfare (in the case where carbon permits are freely given) or at least with added regulation and beuracracy (regardless of whether permits are given or auctioned by government).

But, despite the tax hike-lovers statements, auctioned cap-and-trade not only is not the same thing as a carbon tax in name – it is not only not the same politically, or psychologically and to the consumer – it is also not at all the same economically/environmentally. 

Why?  Well price stability is a major economic goal, and while it’s true a cap-and-trade system would affect price volatility, at least it would do so within the confines of a market - one that can and hopefully would stabalize over time.  A tax leaves price volatility up to government – which could be scary (unless the so called “optimal” price, or timeline of gradual tax increases,  is set and left there a long time.   

More importantly, I’m not the first person to point this out I’m sure, but cap-and-trade gives company’s incentives directly to find better and new technologies, and depending on the cap phase-in, can provide an incentive to reduce overall energy usage!  Carbon (consumption) taxes, to the extent that it mostly causes  a shift from carbon based consumption to something maybe just as bad – has a much less beneficial effect. 

An extension of this difference is that cap-and-trade systems are not necessitated on / limited to controlling one type of pollution!  The system of permits can be set up to function as a general emissions cap on input compliments (maybe setting 1 “unit” sulfur dioxide = 1 “unit” carbon …).  Even if the government wanted to keep the cap systems separate by pollution type, once the system had time to work out kinks, it would surely be a better system than having a tax on carbon, a tax on sulfur, a tax on mercury… all it different levels … all that could be changed on a whim resulting in extreme volatility and messing with market expectations.    Some states are even considering cap and trade beyond just talking about “carbon” as if it were the only pollutant on Earth.

More and more, emissions of these pollutants are something (given our technology) we can accurately measure to some degree.  Measuring social cost (and setting up an “optimal”) tax is not something we can easily set up.   All this means the likelihood of setting up a carbon tax system that wouldn’t need a lot of tinkering with is unlikely.