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A novel approach to tackling climate
change could satisfy economists and environmentalists alike What should America’s policy on climate change look
like? When George Bush rejected the
UN’s Kyoto Protocol as "fatally
flawed" last year, he insisted that he regarded the problem as real, and
promised a credible domestic alternative. Unfortunately, his proposal of Feb
14th does not
include either of the two things that would commend it as a serious effort:
taxes on carbon emissions, or mandatory limits on them. In principle, taxes and targets are equally efficient
ways to reduce a given pollutant, although, as The Economist has long argued, the tax approach has the advantage of
simplicity. An economy-wide carbon tax could be implemented with little of the
red tape likely to surround a regulatory approach. It would send a powerful
signal to all parts of the economy, unlike measures aimed only, say, at power
plants. However, as Bill Clinton discovered in the early 1990S, energy taxes do
not get far in Congress. That is one reason why most American environmentalists
prefer the second approach: binding targets for greenhousegas emissions.
Once, this method might have precluded the economic flexibility of a tax-namely,
that the abatement effort can vary from polluter to polluter, according to
cost. Nowadays, though, even many green groups acknowledge that such flexibility
makes sense, and that you can duplicate it in a target regime by issuing
tradable emissions permits.
Under this approach, the government would cap total
emissions and give firms allowances, by auction or grant. Since firms must pay a
price if they exceed their allowances, they have an incentive to cut emissions.
Since the permits are tradable, those with low marginal costs of abatement
will make extra cuts and sell credits to firms that find it more costly to cut
emissions. The result is a target achieved at least cost, both to
firms and to the whole economy. This is no free market fantasy: America's scheme
to trade sulphur dioxide emissions, in order to reduce acid rain, has done
better than its initial target, at less than half the anticipated cost. Various
proposals in Washington, DC, now suggest some form of "cap-and-trade"
regime for carbon. The Congressional Budget Office has produced a good review
of the leading contenders. One interesting proposal comes from Resources for the
Future (RFF), an American think-tank. The theoretical notion that price
instruments (carbon taxes) and quantity instruments (emissions targets) are
equivalent, RFF researchers argue, is true only if the costs and benefits of
reducing emissions are pretty certain. In the case of greenhouse gases, that is
not the case: estimates of both vary enormously. A rigid target runs a risk,
however small, of imposing ruinous costs. This could be true even with
cap-and-trade. This looks like another reason why a carbon tax is
better. But RFF makes the case for a hybrid: combine cap-and-trade with a
"safety valve". The environmental discipline of the rigid target would
prevail, unless the cost of meeting it rose sharply, to an agreed trigger price.
If that happened, the straitjacket would be loosened, and extra permits would be
sold until the end of the compliance period. This proposal suggests an initial
trigger of $25 per tonne of carbon (adding six cents a gallon to the price of
petrol); others would set it much higher. The key is that the level should rise
gradually over time, encouraging individuals and companies to prepare for a
low-carbon world. Most American conservatives hate this idea. They call it
a carbon tax by stealth - and since a carbon tax is a tax, it must be bad. Once
the safety valve is triggered, they are right that the system works like a
tax-but so what? (It need not be a tax rise in the aggregate, obviously: the
revenues could be used to finance income tax cuts.) Most greens, even those
sympathetic to market approaches, are equally ferocious in their opposition.
Their chief worry is that "environmental integrity" will be
compromised - that is, the emissions target might not be achieved with certainty. They are right - but, again, so what? If the cost of
achieving the target turns out to be painfully high, then popular opinion would
anyway doom their ambitions to failure. If abatement costs are high, this scheme
still delivers the green goals of a cap-and-trade scheme until the safety valve
is hit. If the costs are low (as many greens predict), the safety valve will
never actually be triggered. Economists at MIT** point out that a cap-and-trade regime
might be designed to do what the safety valve does without sacrificing fixed
targets. They point to "banking" provisions that let firms borrow or
store allowances from adjacent compliance periods as an equivalent method. The
RFF researchers reply that for greenhouse-gas banking to work well, firms must
bank lots of credits - and that raises the chances that dubious ones slip through. The RFF approach seems best. It forces politicians to say
what price society should be willing to pay to address global warming - and offers
a pragmatic way to make that cost explicit. Reprinted from The Economist February 16th
2002 *Click here to read the RFF paper **Click here to read the MIT paper |
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