Did environmentalists get played on cap and trade?

Although it’s not his regular beat, Kevin Drum blogs sensibly about carbon policy from time to time. Recently, though, in an otherwise agreeable post about the fecklessness of opponents of climate change legislation, Drum offers up a narrative that is both fairly commonplace and also riddled with misconceptions:

> It also goes to show how fleeting conservative support for “market-oriented solutions” like cap-and trade is. A lot of the liberal enthusiasm for cap-and-trade over the past decade has been based on the idea that it might be more acceptable to conservatives than a straight tax, but obviously that hasn’t turned out to be the case. Basically, they just don’t want to do anything, full stop.

I get the point of this story. It’s supposed to demonstrate the bad faith of opponents of climate change legislation. “We gave you what you asked for, and this is the thanks we get?” While I’d hardly argue the general point, there are a couple of problems with the narrative.

First, a nitpick: a carbon tax and a cap-and-trade system are both “market-oriented solutions” to climate change. Occasionally carbon taxers like to pretend otherwise, in the hope that “market” has become an even dirtier word than “tax.” But, technically speaking, this bit of revisionism doesn’t wash. A carbon tax puts a price on carbon directly and lets market participants decide whether they’d rather pay the tax or reduce emissions. A cap and trade system puts a limit on the total amount of carbon and lets market participants decide whether they’d rather bid for carbon permits or reduce emissions. If these systems sound similar in principle, it’s because, broadly speaking, they are. They’re both market-oriented (or, alternatively, price-oriented) ways of reducing pollution.

More problematically, this narrative implies that liberals came around to a fundamentally conservative policy approach primarily as a sop to their political opponents. But carbon pricing isn’t a defensive crouch on the part of environmentalists — *it’s the substantively correct position.* The interest group known as “people who don’t want to roast the planet” came around to market-oriented environmental policies because they’re the best shot we have at curbing carbon emissions. Obviously I’m eliding a considerable diversity of opinion here, but the fact is both liberals and conservatives who support carbon pricing do so on the merits.

Next up, there’s the subtext that environmentalists secretly prefer a carbon tax, but they made a pact sometime in the ’90s to back the horse they thought could win. In reality, a large majority of people from whichever end of the political spectrum couldn’t begin to explain how either a carbon tax or cap-and-trade system works, much less parse the differences between the two. Of the significantly smaller group that is fluent in the details, you can find good-faith partisans of all sorts of different policies.

Finally, it bears mentioning that the central conceit of the narrative — cap and trade is more politically acceptable than a straight carbon tax — happens to be true. I’m pretty sure no one ever said cap and trade would unite all interest groups for a rousing chorus of kumbaya. After all, most of the organized opposition to climate change legislation isn’t ideological in nature. The issue, as ever, boils down to money. Any meaningful restrictions on emissions — carbon tax, cap and trade, command and control, whatever — are going to push costs onto polluters, and are therefore going to encounter considerable resistance. But a carbon tax never had a snowball’s chance of passage, and here we are in 2009, with climate legislation looking more likely by the minute.

None of this is to suggest that opponents of action aren’t feckless or opportunistic or whatever. But it’s hardly the case that environmentalists got played on this issue.

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adam

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  1. Anonymous - April 28, 2009

    Adam,
    A carbon tax is NOT a market oriented solution. You must misunderstand the term “market-oriented”. Market implies buying and selling. Cap-and-Trade allows participants to buy and sell pollution credits. There is no buying and selling a carbon tax–there is just a paying of the tax.
    They are both non-market solutions to the pollution problem by the very fact that they are government imposed…one provides flexibility to market participants–in terms of how and when they reduce carbon emission (C&T). A carbon tax implies zero flexibility.

  2. Alpha_Dragon - April 29, 2009

    They are both non-market solutions to the pollution problem by the very fact that they are government imposed…
    Exactly why is it impossible for the government to create or impose a market solution?
    It is an undeniable reality that the government is an entity that is a part of and affects our economy by putting people to work, buying and selling products and taxing/regulating when necessary. So why is anything they do by definition considered a non-market solution?

  3. Chad - April 29, 2009

    I have to disagree with anonymous. First, there is no substantial difference in economic theory between a cap and a tax. If appropriately sized, they will lead to the EXACT SAME REDUCTIONS. The only question is which policy has fewer overhead costs, and that is the tax, which has almost none.
    Anonymous also seems to misunderstand what a “market-BASED solution” means. Here is a refresher
    http://www.rff.org/rff/Documents/RFF-Resources-151-Marketapproaches.pdf
    Both a cap and a tax are market-based, as the government does not determine HOW to achieve its goals, but rather only changes the policies that private actors must obey such that they, in total, achieve the goals.

  4. Thor Christensen - April 29, 2009

    I disagree with both Anonymous and Alpha Dragon – they are both market forces, and government IS a part of the Market. Both of them labor under the illusion that there would be a market (an exchange of goods) without Government, a bit of miscommunication that has been propagated by the right – but without the underlying structure of Government there would be no Market. A tax, the price that we pay to exist inside the peace and safety that the structure of a government provides, is a necessary condition to living in society. I challenge both of them to provide a present day example of a Market that functions without Tax, and would encourage them to explain how people act in those markets without the safeties (not to mention such niceties as contract law) that Government provides. What they are arguing is that this Tax is somehow different than other Taxes that are imposed by Government -it isn’t. Government is finally acknowledging that climate issues are part of the Safety and Security they must provide.

  5. George - April 29, 2009

    Re Chad’s claim that a tax has almost no overhead, I would say two things:
    - In theory both C&T and Tax have almost no overhead (especially in an “upstream” C&T scenario). But in practice, and given that either system will be designed via a political process which is going to balance out many interests, the notion that a tax based approach will somehow be less encumbered is incorrect. Both systems will have monitoring, carve-outs, phase-ins, free allocations etc etc and this is where the problems lie (have you ever looked at the US Tax Code?). We should not get confused by comparing a theoretical tax with the reality-based C&T.
    - C&T creates a positive mechanism for addressing otherwise unaddressable carbon emissions. I’d like to see Carbon Tax supporters get it applied to farm methane. Or good luck taxing the emisions of an abandoned coal mine. Both of these are significant sources of emissions that have to be addressed and C&T creates a very efficient way to get at them. An apples to apples comparison of C&T and Tax would have to add into the Tax scenario all the complexities and overhead of getting at these other sources which are easily addresses with C&T.

  6. Geoff - April 29, 2009

    From my perspective the key advantage of cap & trade over a carbon tax is that it avoids the pitfalls of having an individual, committee, blue ribbon panel, or what have you set the price of carbon. On what basis? Detailed models or whimsy, I’m not sure it matters which. If government is going to set anything, it should be the amount of permissible emissions, which at least has a defensible basis in climate science. The experience of SOx and NOx trading suggests that, once the players get the hang of it, the reductions come at prices much lower than the bureaucrats would have guessed. That minimizes the inevitable burden all this will impose on the economy, which ought to be as high a priority as reducing emissions in the first place. And that’s why the debate over how to distribute the revenue from either approach is so important: the more the government disburses to favored parties, rather than returning to taxpayers, the bigger the net tax effect.

  7. Aaron - April 29, 2009

    Stating that the government should set the quantity of emissions because it “has a defensible basis in climate science” ignores the fact that good policy will only be set if we understand both the benefits and the costs of the policy. We can’t set good policy by only examining the benefits or the costs. We need to be clear that any policy we impose will have costs and benefits, not just benefits like the politicians claim, and not just costs like some detractors claim. The goal should be to choose the policy that maximizes the net benefits, and maybe reallocates some of the benefits from the winners to help the losers adapt to the changing world. Personally, I prefer a carbon tax because it is upfront about the cost and generates revenue that can be used to reduce other taxes. But fundamentally, C&T and a carbon tax ARE essentially the same from a social perspective, it’s just a matter of who gets the benefits and who pays the costs.

  8. Sal_B - April 29, 2009

    Sorry I don’t get it. Cap and Trade, Carbon Tax??? How does any of this help slow or stop global warming? The environmentalist insist that it will reduce carbon emissions. How? If you allow a company that produces almost no carbon emissions in its normal daily course of business, sell its credits to a company that produces massive carbon emissions, what have you stopped? Nothing, everything is the same except some small company now has a way to make money from another company not related in industry. Oh yeah and the government is getting its cut. None of this does anything to reduce carbon emissions, it is just a way for the government to generate revenue.
    An example; Baseball. Has salary cap stopped the Yankees for example from conducting business as they see fit and pay their players salaries they see fit. NO!! They just pay the fines and pass the cost on to the fans in the form of higher ticket costs and related costs inside the stadium.
    So the only ones being penalized by your plans for cap and trade and carbon tax are the very people who can barely afford heating fuel in the winter and summer utility bills not to mention the cost of getting to work.
    Here is a better idea. Provide free solar systems for every house hold in America, free public transportation and make all such public transportation powered by electricity produced by non carbon emission means, much cheaper to the tax payers I would be sure, and actually do something to reduce the carbon emissions themselves.

  9. George - April 29, 2009

    Re analyzing both costs & benefits, the correct context for that analysis is one where we start with the recognition that in our lives as emitters, we are imposing costs on the community at large. If an individual or company pollutes a water reservoir for example, it’s clear that 1. there costs to that activity, and 2. the polluter should bear the costs associated with cleaning it up. On this level, there is a strong consensus that the costs associated with Climate Change are far greater than the costs of mitigation. The best estimates for C&T’s economic impact project incremental costs for a gallon of gas at 20 – 50 cents. When gas prices fluctuate, we pay that to oil companies and middle eastern dictators (who don’t like us very much) without complaint. Seems to me stopping the roasting of the planet is worth that much.

  10. Bob - April 29, 2009

    Yah!… and while we are at it lets power our cars with wind mills on top!

  11. michael - April 29, 2009

    George,
    Why do you want to see farm methane taxed?

  12. George - April 29, 2009

    Well, not exactly. Under Lieberman-Warner the penalty for emitting without an allowance was $200 per ton. Has not been set (that I know of) for Waxman/Markey. Companies are fighting tooth and nail to get a price escape valve at in the $10 to $15 per ton range. No one, not even evil empires like the Yankees, will willing or by design pay $200 per ton to emit GHG.

  13. George - April 29, 2009

    Michael, I don’t want to see farm methane taxed. In fact I see that as a political impossibility…too many democratic senators from farm states.
    My point above is that under cap and trade, there is a POSITIVE incentive to capture farm methane by virtue of the fact that by doing so you can create tradable offsets. Instead of taxing farmers, you create a whole new revenue stream for them.

  14. Anonymous - April 29, 2009

    Hay can I get a cap & trade deal on my next traffic ticket for speeding? I have 2 cars in the family. If one stays parked in my yard I could double the speed limit with the other to get where I’m going faster =ing less carbon in the long run. Or is that as dangerous or not as in trading carbon in the long run? You die ether way!
    [Ha ha! Ignorance is funny!]

  15. michael - April 29, 2009

    Thanks George! Understood.
    Farming, a generalization for growing many things, does pollute in many ways beyond methane. I know I’m off topic a hair here, but perhaps another revenue stream will help farmers create a cleaner farming industry…

  16. CTF - April 29, 2009

    While I agree that both cap and trade and a carbon tax are market-based approaches, I don’t think that makes narrows the divide at all. A carbon tax (or preferably, a carbon tax shift approach) is superior on a number of levels: not only does it avoid the creation of a complicated and convoluted “subprime carbon market,” it also avoids the evasion and market manipulation inherent to cap and trade. Further, a carbon tax is more straightforward and transparent than cap and trade, incentivizes the creation of green technology, predictably reduces emissions AND returns the revenue to the people (especially attractive given these political and economic times.)

  17. Adam Stein - April 29, 2009

    “subprime carbon market”
    If anyone can define this term in an even vaguely intelligible day, I’ll send you a free TerraPass.

  18. Phoenix Woman - April 29, 2009

    Well, you see, um, erm, ah…
    Sorry. There isn’t enough coffee in the universe to make that intelligible.

  19. disdaniel - April 29, 2009

    I posted @1 By Anonymous on April 28, 2009 9:53 PM (sorry forgot to re-enter my info)
    @2 Alpha_Dragon
    “Exactly why is it impossible for the government to create or impose a market solution?”
    I don’t make up the definitions…I just try to use them correctly. See wikipedia link below. And admittedly “market oriented” is unnecessarily fuzzy.
    I interpreted Adam to be using it as a synonym for “market based”. If that assumption was incorrect my appologies.
    @3 Chad
    #1) I never said there was a substantial difference in economic theory between the cap and the tax, just that the cap route allows participants to buy and sell credits (i.e. additional flexibility in compliance).
    #2) As I admitted above “market oriented” is fuzzy terminology. Market-based is better defined, and despite your “refresher” I disagree that both a tax and a cap solution to pollution are market based. And furthermore changing “the policies that private actors must obey” is definitionally a “non-market” intervention, albeit not as abrupt as specifying precisely the “how”.
    Check out wikipedia on the topic:
    http://en.wikipedia.org/wiki/Market-based
    “A market economy is an economy based on the division of labor in which the prices of goods and services are determined in a free price system set by supply and demand.[1] This is often contrasted with a planned economy, in which a central government determines the price of goods and services using a fixed price system. Market economies are contrasted with mixed economy where the price system is not entirely free but under some government control that is not extensive enough to constitute a planned economy. In the real world, market economies do not exist in pure form, as societies and governments regulate them to varying degrees rather than allow self-regulation by market forces.”

  20. Adam Stein - April 29, 2009

    I used the term “market-oriented” because I was keying off Kevin Drum’s phrasing. But, yes, normally I would use the term market-based.
    Kind of po-ta-to/po-tah-to, though, if you ask me…

  21. Anonymous - April 29, 2009

    Subprime Carbon Market:
    The selling of overvalued Carbon Credits bundled in investment portfolio’s that create a bubble of value in carbon offset credits for companies.
    —-
    Basically people are worried that investors will buy up the credits, thinking they’re going to make money somehow on the enviroment, then end up crashing the system with their own greed. I really want that TerraPass! lol
    —-

  22. Carl - April 29, 2009

    Subprime Carbon Market:
    The selling of overvalued Carbon Credits bundled in investment portfolio’s that create a bubble of value in carbon offset credits for companies.
    —-
    Basically people are worried that investors will buy up the credits, thinking they’re going to make money somehow on the enviroment, then end up crashing the system with their own greed. I really want that TerraPass! lol
    —-

  23. michael - April 29, 2009

    Unfortunately, a free market can be seen as a free-for-all. Folks are in business to make money and the devisive paths taken to insure the stream of cash keeps on a flow’n need to be veered in a more responsible direction – however it is termed.
    There are always groups who play by the literal law/spirit of the law and those who use the law to their advantage or to the neglect of our environment. Markets have a will that is driven and sustained by profit…the string of cause and effect realtionships will be never ending

  24. Adam Stein - April 29, 2009

    I said intelligible.
    And even if this did make any sense, what does it have to do with subprime anything?

  25. Carl - April 29, 2009

    I’ll fully admit it’s not a subprime anything.
    It’s a word that was coined becuase of it’s scare factor. You hear subprime in the United States today and people cringe. They always figure it’s followed by news of economic doom.
    It still means what it means to the people who made it. It’s a created term like organicity or

  26. Carl - April 29, 2009

    As a note though, I doubt the issue would occur, after everyone is fully Obamacised (made-up word) during his speaches, he’ll “hopefully” make his cronies disallow the carbon credit market to be tied to securites and prevent the issue.

  27. dennis mchale - April 29, 2009

    Hello,
    Any cap and trade needs the co-operative will of even the ore smelter in Chile or the gold processer in South Africa. How do you police this co-operative will? Money and more money, that create talk like cap and trade diveratives. New brokage houses that create more white collar wealth. Ho-ray! In my comments to this blog in the past I’ve continued to voice the simple power of the tax at the production site, the generator. Coal, Natural Gas, Oil, Bio-fuel, Nuclear and exotics; go to the site, tax the per ton, per barrel or per cubit foot. We all use it, the tax is shared, the governments of the planet get their share and the tax overages provides for the welfare of the citizens of the planet(utopia). Yea, I know it pushs the price of the product onto the end user. So does cap and trade. Example, family farmer next to Agg Business Mega Farm gets what in cap and trade? Think about it before you rely. End game, family farmer still gets brought by the Agg Business Mega Farm. Doing so allows the Agg Farm to buy the offsets at the source and then own them. Mega Multi’s have such diversity with ‘fingers in so many pies’ they can buy the off sets from themselves, it’s already happing. Example a Coal power plant generator who owns a solar PVA manufacturing concern or a Water Multi that produces hyro-electric or a petro producer that owns a tidal wave energy equipment manufacturing firm. Old Albert said it: “nothing happens until something moves”, so tax what makes it move.
    Thanks for reading, dm

  28. Drew - April 30, 2009

    Sure, I’ll take a crack…
    “The market for collateralized carbon credits from sellers with a higher-than-normal risk of not actually delivering the promised offset. Haliburton, for one.”
    Of course, since “subprime” is a term that refers to interest rates it’s probably not that appropriate here, but I can’t resist a good jab at Dick Cheney.
    Speaking broadly, I’m also not too concerned about the role of investors. I’m enough of a cynic to feel that progress is what happens when people realize they can make money off something, so really, who cares if speculative investors pushes the price of offsets up a bit? That will make the reduction of greenhouse emissions and the creation of new offsets from untapped sources (see George’s comment re: farm methane) that much more cost-effective.

  29. Adam Stein - April 30, 2009

    You’ve put your finger on one of the main reasons the whole “sub-prime carbon” thing makes no sense. It doesn’t matter, in any cosmic sense, if an offset project fails to deliver credits. It’s not as though the emissions reductions somehow enter the cap-and-trade system before they’re generated, and then when they fail to materialize in real life, the integrity of the cap is undermined. Rather, such offsets simply never exist, and no one needs concern themselves with them. The seller might experience a financial loss, but this isn’t anything to cry over.

  30. Drew - April 30, 2009

    Thanks for the reply, Adam. I actually disagree; maybe this isn’t the best financial environment to start discounting counterparty risk, but let me pose two rhetorical questions. One, how is failing to deliver a promised offset any different from failing to, say, repay a loan at maturity? And two, if the answer is “it isn’t, really,” then why should they be treated any differently?
    I’m just thinking that as soon as such and such a company’s credit rating gets knocked down from AA to BBB over analyst concerns (not even actual failure; merely just concern) that they may not be able to deliver paid-for carbon offsets, then people are going to start paying attention in a hurry.
    I mean, we don’t have to reinvent the wheel here – these are all concerns that are already dealt with on a daily basis on most commodity exchanges, so simply applying existing solutions should build us a pretty robust carbon marketplace. FWIW I’m not taking a stand on cap-and-trade vs. a straight tax since I don’t think I understand the relative merits well enough to make that kind of a call, but I certainly don’t see any reason why a cap-and-trade system couldn’t work.

  31. Adam Stein - April 30, 2009

    Two reasons, both important:
    The first is that offsets aren’t promised. You only pay for what’s delivered. In this regard, they’re like any other product: microchips, beanie babies, whatever. If you arrange to buy oranges from a farmer at $0.25 per fruit, and then an unexpected frost wipes out half his crop, this isn’t a financial crisis. You just pay for what he delivers. This is entirely unlike making a loan to someone for a million dollars, and then only getting $500,000 back.
    The second is that scale matters a lot here. The mere existence of subprime loans and bad mortgages isn’t necessarily a problem. The problem arises when a financial bubble causes those assets to be valued in the trillions of dollars, and then that bubble bursts, wiping out critical financial institutions. There is no comparable situation in the carbon markets, and for various technical reasons, I’m pretty certain there never will be.

  32. michael - April 30, 2009

    …except the price of oranges goes up…

  33. Drew - April 30, 2009

    Hmm. This may just be a knowledge gap on my part then – I assumed a carbon offset would function more like a forward contract, wherein two parties enter into an agreement where one will agree to purchase an offset for a given amount of carbon at a given date for a given price, and then the other will reduce or capture that volume of carbon over the period. If for some reason the counterparty has not produced the needed offset in time, then the onus falls to them to fill the remainder any way they can or risk defaulting on the agreement – to use your analogy, this would be akin to a farmer promising to deliver 500,000 oranges at a price of $.25 a fruit, then neglecting his orchard (or something else within his control) and losing half his crop. He has 250,000 oranges of his own, and suddenly has the unenviable choice to either default on the agreement or source an additional 250,000 oranges at current market rates. In short, unless there’s a glut in the orange supply anyway (or in our case too high a ceiling), he’s likely to get hosed.
    Anyway, I haven’t had nearly enough coffee to be talking through this. :)

  34. Anonymous - April 30, 2009

    from what i understand from c&t a company that produces less carbon emissions than the limit, they are then issued credits. those credits are then issued/sold to companies that exceed the limit. in which there is no “loan” or promised amount but just what is already “on the table” available to those companies from the ones that are below the cap. so there is no bubble effect.