Greg Mankiw on Cap-and-Trade (NYT)

Greg Mankiw has a highly readable and quite balanced editorial in the Sunday Times about cap-and-trade.

Mankiw makes the point that the economists’ preferred solution to the problem of climate change would be a carbon tax. He notes that it allows the revenues collected from carbon emissions to be used by the government as offsets against other taxes in order to mitigate the negative economic effect of an extra tax while encouraging consumers to ramp up their efforts to limit their carbon output.

A cap-and-trade system in which the permits are auctioned provides the same opportunity, however, once you decide to pass out permits for free the scheme begins to fall apart.

From The Times:

The numbers involved are not trivial. From Congressional Budget Office estimates, one can calculate that if all the allowances were auctioned, the government could raise $989 billion in proceeds over 10 years. But in the bill as written, the auction proceeds are only $276 billion.

Mr. Obama understood these risks. When asked about a carbon tax in an interview in July 2007, he said: “I believe that, depending on how it is designed, a carbon tax accomplishes much of the same thing that a cap-and-trade program accomplishes. The danger in a cap-and-trade system is that the permits to emit greenhouse gases are given away for free as opposed to priced at auction. One of the mistakes the Europeans made in setting up a cap-and-trade system was to give too many of those permits away.”

Congress is now in the process of sending President Obama a bill that makes exactly this mistake.

How much does it matter? For the purpose of efficiently allocating the carbon rights, it doesn’t. Even if these rights are handed out on political rather than economic grounds, the “trade” part of “cap and trade” will take care of the rest. Those companies with the most need to emit carbon will buy carbon allowances on newly formed exchanges. Those without such pressing needs will sell whatever allowances they are given and enjoy the profits that resulted from Congress’s largess.

The problem arises in how the climate policy interacts with the overall tax system. As the president pointed out, a cap-and-trade system is like a carbon tax. The price of carbon allowances will eventually be passed on to consumers in the form of higher prices for carbon-intensive products. But if most of those allowances are handed out rather than auctioned, the government won’t have the resources to cut other taxes and offset that price increase. The result is an increase in the effective tax rates facing most Americans, leading to lower real take-home wages, reduced work incentives and depressed economic activity.

It appears as if cap-and-trade’s passage is problematical at best. As it’s currently drafted it is, in my opinion, a mediocre effort of addressing the problem. In good economic times it would be suspect, in these times it is simply unconscionable. Better to put it on the shelf and tackle the problem when the economy is better able to withstand the shock that the current legislation would entail or redraft it to make those tax effects more neutral.

Comments

[Leftfield:]

The idea anyway is to add another tax. Even if something else were reduced and this tax were to be "dedicated" to saving Earth, the other taxes would soon be raised and this one would go to the general fund. That's the principal idea.

Aug 09 08:01 AM

[SubsidyEye:]

Gawd, I get so tired of hearing this mantra: "If we raise revenue from a carbon tax, the government will still demand as much in taxes from other sources as it did before." Are we that helpless as to be unable to hold our Congressional representatives to a revenue-neutral shift in tax revenues?

Leftfield: would you rather we keep going as we have: subsidizing fossil fuels, and then subsidizing biofuels because we are subsidizing fossil fuels, then subsidizing electric vehicles because we are subsidizing ethanol ... ad infinitum? From where do you think those subsidies come?

Aug 09 09:29 AM

[Ferdinand E...:]

As I said in my comment before it disappeared, it is nice that someone told the President - or he found out for himself - that cap-and trade did not work in Europe. This is why Lord Browne - the former CEO of BP - said that it cap-and-trade was the wrong way to go.

Aug 09 10:20 AM

[john s. gordon:]

the danger of capntrade is that it can be gamed by certain clever people & then we have another enron on our hands.
> jack

Aug 09 11:08 AM

[A. Nony Mouse:]

This whole crazy scheme is a fraud. If Obama keeps pushing this lunatic idea, he might as well pardon Bernie Madoff. The purpose of this legislation is to allow San Francisco flakes such as nutty nancy to feel good about themselves, believing falsely, they are "saving the planet" Cap and Trade will financially destroy working Americans, the group the Dems pretend to represent and love.

Aug 09 11:13 AM

[Swiftcreek1:]

.....and the evil villian constantly mentioned in the media, the Great Satan of the modern economy, the cause of so many alarmist articles, and so much fear-mongering from the enviro crowd, the primary reason given for switching over to compact flourescents, (which, if broken in your home, virtually REQUIRE haz mat clean-up because of the mercury).....the Demon constantly mentioned as the cause of "man-made" global warming (which is unproven THEORY) is CO2.....Carbon Dioxide.....An ESSENTIAL part of the atmosphere for life to flourish on our planet.

Considered the evil villian of the whole global warming mantra, in reality, CO2 is nothing more than plant food......

and to subsidyeye above.....even a "revenue neutral" shift will still ultimately trickle down to the consumer. Businesses still need to make a profit to survive, and if their tax burden is increased they will pass those cost off to their customers. That's simple economic reality.

Also, in answer to your question.....Yes.....b... no matter who gets elected to a national office, once they get there they do pretty much whatever the hell they want. Obama won by campaigning as a centrist, he damn sure isn't governing like one.

Aug 09 02:01 PM

[Jimbo:]

Cap and trade.....bait and switch

Aug 09 02:07 PM

[Steve Russell:]

Cap and trade passed BECAUSE it can be gamed like it was in Europe.

Of course, the idea that we could wait until the economy improved is preposterous.

I'm not sure this cap and trade idiocy matters because the climate models were wrong. In everything measurable, the measurements are showing that the models were way too optimistic.

It's too late for prevention. Amelioration makes more sense now. For the US, that's making some real estate decisions re the coastal lands and helping our farmers though some major changes.

For China and India....well, they've got more serious problems.

Aug 09 05:57 PM

[A Barrel Full:]

Cap and Trade is based on the rather stupid notion that we need to set absolute limits to our CO2 emissions. (please bear with me a second).

All targets on emissions are political. All that any of the models say are that emssions should be cut. 2%, 20%, 50%, that is an arbitrary political decision. Critics of Carbon Taxes, say that it does not guarantee a particular level of emissions. Yet for the same cost, it will always end up producing a bigger reduction, because it is,
a) Simpler and easier to manage.
b) Much less easy to corrupt.
c) Predictable, enabling companies to invest with greater confidence.

But from a politician or lobbyists point of view, b) is actually a feature not a flaw.

Aug 10 07:03 AM