High. Low. It’s all good.

A newly published study (pdf) from the University of New South Wales and the University of California at Merced concludes that when compared to a carbon tax, a relatively unrestrained cap-and-trade system is economically advantageous.

My first thought was that this is no news at all. The economic advantage of cap and trade – enabling capital to flow to the least expensive emission reductions first and to ensure capital flows to the least expensive options overall – is the primary driver behind market-based regulatory systems. It’s the raison d’être. Where’s the news?

But this study examines a different question, making its conclusion interesting and indeed a bit surprising.

The study sought to determine which regulatory system (cap and trade vs. carbon tax) would be more likely to inspire regulated emitters to invest in new, cleaner technology so as to reduce their regulatory burden. A sensible line of logic, if you’d asked me yesterday, would have been: the system which is more expensive for emitters, whichever one that is, will create the more powerful incentives to invest in clean technologies to reduce those costs. And, as I said just a couple sentences ago, cap-and-trade is more cost effective because it allows emitters to reduce pollution outside their boundaries, delaying or even obviating the need for in-plant investment. So, ipso facto, a carbon tax is probably the more effective regulatory tool if you want emitters to invest in clean technologies.

The study concludes otherwise.

Using modeling techniques that are both sophisticated and pretty simple (if you ignore the equations), the researchers explore the fact that people behave differently when faced with situations which are economically volatile, compared to situations which are economically stable. Taxes create relatively stable, predictable economic outcomes. Cap and trade systems create relatively unstable, difficult-to-predict economic outcomes for any particular emitter because carbon prices are more volatile than tax levels (the study uses the European Union’s Emissions Trading Scheme for its data).

When investment behavior is modeled in these two scenarios, the authors show that emitters are more likely to invest in carbon-reducing technology sooner, and at lower overall carbon price levels, when a cap and trade system is in place as compared to a carbon tax. Further, they assert that efforts to moderate price volatility via policy tools may be counterproductive (they suggest lump-sum rebates to protect industries as needed, may be preferable to carbon price controls).

Fascinating stuff. An optimistic me hopes that this research helps inform the public policy debate. A pessimistic me reminds myself that there isn’t a a public policy debate about climate change just now, productive or otherwise. Sigh.

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erin