I’ve finally been provoked into writing this post. Though actually it is going to be about something slightly different, or at least I’m going to go through a long rambling diversion, inspired by Idiocy on carbon permits by Timmy.
But since I’m also rather conscious that many of my posts are (when looked back over the period of a couple of years) utterly incomprehensible due to lack of context, I’m going to do some context.
If you look at the problem of Global Warming from an Economics point of view, then it is a perfectly standard problem, that of uncosted Externalities. Which is to say, emitting CO2 is free, but has a cost in terms of climate change. The standard Economics answer is to tax it (in some way) to Internalise this cost.
It is worth pointing out (another parenthesis, I’ll escape to my main point eventually) that we don’t apply this approach to all things. For example, in the UK, exceeding the speed limit (and getting caught) is penalised by a fine, which deters the poor people, and by having points docked off your license, which deters everyone, since 4 speedings is enough to lose your license for a while. Which is to say, is isn’t Discouraged, it is Forbidden. Another example is killing people: killing people is Bad, but we don’t deter that by imposing massive fines, we lock you up. So even rich folk can’t do it. My sense, from reading various bits of Green literature, is that they think emitting CO2 should be of this “forbidden” nature, and shouldn’t merely be something that you pay to do in order to pay for the externalities. That is a point of view, certainly, but for the purposes of this post, I’m going to ignore it and consider the std.Economics approach. End of parenthesis 1.
So, if we’re going to “tax” CO2 (note that I’m carefully putting quotes around tax, because we might want to do carbon permits) then we need to decide how to sting people, and how much we should charge them. How much to sting them is quite a difficult problem, because it depends on a variety of things which we know moderately well (climate sensitivity, for example), things we’re less sure of (what the airborne fraction will be in the future), and things we’re even less sure of (how much ecosystem damage might occur, and how much it should be costed at. Even attempting to cost ecosystem damage winds some people up, and there is a helpful example from the Grauniad just now. That is representative of the “ecosystem damage should be forbidden, not penalised” school of thought, which as I’ve said I’m going to ignore for this post. If that winds you up, complain, and we can have another post on that) and then there are the things that we know extremely well, but different people disagree on what the value is that we know (discount rate, where we have Lord Stern versus the world). There are a couple of solutions to this difficult problem: the one I’d favour is to not worry about it too much. Set your costs at a reasonable best-guess level; or even start by setting them deliberately low, and then ramp them up as clarity arrives, or it becomes clear that people can tolerate them.
Another diversion: carbon costs can in principle be largely revenue neutral, in that you can (and should) offset them by reducing other taxes (there is still an effect because you’re shifting taxes around the economy and penalising high-CO2-use, but I’ll ignore that for now). People dislike carbon “tax” because it has the word tax in, and they don’t trust the government to do this in a revenue-neutral way. So, a good way to start is at a low level, and establish trust that other taxes will indeed be cut. Ends.
OK, so just for now I’m not very interested in how much to charge people, but the question of how to charge them is interesting. And the two principle candidates are carbon permits and carbon taxes. Carbon taxes are easy: you just tax carbon emissions, probably by taxing fuel and ‘lectric and stuff. Carbon permits are where you make a rule that in order to emit CO2 you need a permit, and you force people to buy permits (or, in the less reputable schemes, you give away a set number of permits) and then people can trade them.
Carbon permits are complex, permit a parasitic trading class, and allow pointless political interference. Carbon taxes are simple and provide little opportunities for parasites. So naturally our political class prefers… yes, you’ve guessed it, the bad system. However, I don’t really want to rant about that either, I want to finally get to my main point, which (to give credit where it is due, came from Timmy, though I think he would say that from his point of view, it is merely the bleedin’ obvious). And that point is…
There is a fundamental difference between carbon taxes and permits. For the permits, you do your science ahead of time and you work out how much CO2 you want to emit, and you issue permits to this level. Anyone wanting to emit CO2 (well, I say anyone, I mean anyone covered by the scheme) then needs a permit to do so. That means you know the maximum amount of CO2 that can be emitted. The idea is that companies that still need to emit CO2 are forced to buy permits, which they will do from people, presumably, who have managed to reduce their own emissions at a cost less than that of the permit they are selling; or who for some other reason have excess permits (like, for example, our idiot EU-wide governments handed out permits like confetti). But never mind: what it means to the bureaucracy that manages the permits is that the price of the permits has become irrelevant. Which is why the Grauniad is silly. When you’ve set the number of permits, you’ve done your job. If you find yourself saying “the price of carbon permits is too low” then you’ve failed to understand the permit system. Of course, to decide how much CO2 should be emitted is tricky. I don’t even know what levels the current EU permit system is designed to produce, and quite possibly they don’t either.
To make a carbon tax work, on the other hand, you need to decide how much damage the CO2 is going to cause, and you then penalise emitters at this rate. This too is tricky, but is does allow the normal market conditions to operate, rather than requiring explicit government intervention, which I think is a good thing. In theory, it is what the Stern report has allowed us to work out. You still need to do pretty well the same science as you needed to do to set permit levels, but what you don’t have to do is the complex step of deciding what CO2 levels the government wants to see. It provides a softer (you can start with an under-estimate of the cost, to ease people in, for example; and it still works), but more continuous pressure. With permits, if you accidentally set the limits too tight for any one year, then (if anyone takes the limits seriously) you risk some of your industry grinding to a halt, unable to find any free permits. Or, conversely, if there is an economic slowdown, suddenly permits become effectively valueless, because there are excess permits no-one wants to burn, and the Grauniad becomes sad.
Conclusion: carbon tax good. Carbon permits bad.
[Note: this post got updated, overwritten, and originally published with the wrong date, thereby pushing it below the visible level. Now pushed to the top again]
[Update: there is another interesting example, again courtesy of Timmy, or what happens when you try to set your limits by another process: just deciding on limits, and then sort of giving various institutions quotas. First off, those targets aren’t very important to the institutions, so they ignore them. And secondly you encourage a whole pile of clip-board tickers to go around measuring them. Compare that to a simple carbon tax: in that case, fuel prices just go up, so your institutions actually care, and no external pressure is needed.]
[Update: and another thing: with carbon taxes, you don’t have to wait for international agreement. You can just do it, in a manner revenue neutral within your own economy. CF points out in the comments that you may need to pay attention to imports, though]
* Timmy, Chasing Rainbows – credit where it is due, Timmy is the source for my understanding of the central point of this post
* Hansen on cap-n-trade vs carbon tax – Me in 2009
* Atmoz joins the campaign.
* A carbon tax is meant to hurt a little, but we have a choice: we can change – New Anthropocene.
* Australia’s carbon tax
* Timmy in El Rego
* Hot Topic: the case for a carbon tax “There is no policy instrument that is more transparent and administratively simple than a carbon tax.” Unfortunately its overtness tells against it politically because voters, politicians and emitting industries see the price very clearly and can calculate what they think it might cost them. But in Shi-Ling Hsu’s view environmental measures that purport to be painless are either misleading or set to accomplish nothing.”
* November 08, 2011: Australia Carbon Tax is Passed
* Larry Summers Calls For A Carbon Tax Now That Oil Prices Have Fallen – Timmy, Jan 2015.
* How Not to Pass a Carbon Tax – GREG MANKIW, August 2015.