AEI Slams Cap, Touts Tax

06/4/2007 by Charles Komanoff

The American Enterprise Institute has a concise new (June 2007) report comparing carbon caps with carbon taxes for combating climate change. AEI's clear verdict: "carbon-centered tax reform -- not GHG [greenhouse gases] emission trading -- is the superior policy option."

Coming from a powerful right-of-center D.C. think tank, this resounding endorsement of carbon taxing will likely carry big political weight.

It'll be a few days before CTC fully digests the AEI report. In the meantime, here are some excerpts. (Note: all text that follows is taken directly from the AEI report, except where noted with brackets.)

On SO2 Trading as a Model for CO₂ Cap-and-Trade

There has been significant volatility in [SO2] emission permit prices, ranging from a low of $66 per ton in 1997 to $860 per ton in 2006... Over the last three years, SO2 permit prices have risen 80 percent a year, despite the EPA's authority to auction additional permits as a "safety valve" to smooth out this severe price volatility.

Several other aspects of the SO2-trading program are of doubtful applicability to GHGs. First, SO2 trading was only applied to a single sector: ... coal-fired power plants ... a comprehensive GHG emissions-trading program will have to apply across many sectors beyond electric utilities, vastly complicating a trading system.

Second ... reducing SO2 emissions did not require any constraint on end-use energy production or consumption. Coal-fired power plants had many low-cost options to reduce SO2 emissions without reducing electricity production. CO₂ is different: it is the product of complete fuel combustion. There is no "low-CO₂ coal," and the equivalent of SO2 scrubbers does not yet exist in economical form. [A]ny serious reduction in CO₂ emissions will require a suppression of fuel combustion. This is going to mean lower energy consumption and higher prices, at least in the intermediate term.

Even though confined to a segment of a single sector of energy use, the SO2 emissions-trading regime was far from simple. There were complicated allocation formulas to distribute the initial emissions permits. [Even so,] establishing allowances and accounting systems for GHG emissions across industries is going to be vastly more difficult and highly politicized.

Volatility 

The favored solution to these problems is to over-allocate the number of initial permits both to ease the cost and to encourage the rapid start-up of a market for trades. This was the course the European Union took with its Emissions Trading System (ETS), and it has very nearly led to the collapse of the system. Because emissions permits were over-allocated, the price of emissions permits plummeted, and little -- if any -- emissions reductions have taken place because of the ETS. The over-allocation of initial permits merely postpones both emissions cuts and the economic pain involved. Economist Robert J. Shapiro notes:

As a result of all of these factors and deficiencies, the ETS is failing to reduce European CO₂ emissions. [T]he European Environmental Agency has projected that the EU is likely to achieve no more than one-quarter of its Kyoto-targeted reductions by 2012, and much of those "reductions" will simply reflect credits purchased from Russia or non-Annex-I countries [developing countries], with no net environmental benefits.

As economist William Nordhaus observes:

We have preliminary indications that European trading prices for CO₂ are highly volatile, fluctuating in a band and [changing] +/- 50 percent over the last year. More extensive evidence comes from the history of the U.S. sulfur-emissions trading program. SO2 trading prices have varied from a low of $70 per ton in 1996 to $1500 per ton in late 2005. SO2 allowances have a monthly volatility of 10 percent and an annual volatility of 43 percent over the last decade.

Nordhaus points out the ramifications of such volatility, observing that "[s]uch rapid fluctuations would be extremely undesirable, particularly for an input (carbon) whose aggregate costs might be as great as petroleum in the coming decades," and that "experience suggests that a regime of strict quantity limits might become extremely unpopular with market participants and economic policymakers if carbon price variability caused significant changes in inflation rates, energy prices, and import and export values."

Nordhaus is not alone in this concern about price volatility. Shapiro similarly observes:

Under a cap-and-trade program strict enough to affect climate change, this increased volatility in all energy prices will affect business investment and consumption, especially in major CO₂ producing economies such as the United States, Germany, Britain, China and other major developing countries.

Cap Reform Unlikely

It is possible that the defects of previous emissions-trading programs could be overcome with more careful design and extended to an international level, though this would require an extraordinary feat of diplomacy and substantial refinements of international law. Even if such improvement could be accomplished, it would not provide assurance against the prospect that the cost of such a system might erode the competitiveness of the U.S. economy against developing nations that do not join the system.

Advantages of a Carbon Tax 

Most economists believe a carbon tax (a tax on the quantity of CO₂ emitted when using energy) would be a superior policy alternative to an emissions-trading regime. In fact, the irony is that there is a broad consensus in favor of a carbon tax everywhere except on Capitol Hill, where the "T word" is anathema. Former vice president Al Gore supports the concept, as does James Connaughton, head of the White House Council on Environmental Quality during the George W. Bush administration. Lester Brown of the Earth Policy Institute supports such an initiative, but so does Paul Anderson, the CEO of Duke Energy. Crossing the two disciplines most relevant to the discussion of climate policy--science and economics--both NASA scientist James Hansen and Harvard University economist N. Gregory Mankiw give the thumbs up to a carbon tax swap. [Note: pro-tax statements by all six individuals are collected here.]

There are many reasons for preferring a revenue-neutral carbon tax regime (in which taxes are placed on the carbon emissions of fuel use, with revenues used to reduce other taxes) to emissions trading.

[The AEI report goes on to catalog the advantages of carbon taxing, under these nine headings:]

• Effectiveness and Efficiency
• Incentive Creation
• Less Corruption
• Elimination of Superfluous Regulations
• Price-Stabilization 
• Adjustability and Certainty
• Preexisting Collection Mechanisms
• Keeping Revenue In-Country 
• Mitigation of General Economic Damages
  

[The AEI report, which was authored by Kenneth P. Green, Steven F. Hayward, and Kevin A. Hassett, ends as follows:]

A cap-and-trade approach to controlling GHG emissions would be highly problematic. A lack of international binding authority would render enforcement nearly impossible, while the incentives for cheating would be extremely high. The upfront costs of creating institutions to administer trading are significant and likely to produce entrenched bureaucracies that clamor for ever-tighter controls on carbon emissions. Permit holders will see value in further tightening of caps, but will resist efforts outside the cap-and-trade system that might devalue their new carbon currency. Higher energy costs resulting from trading would lead to economic slowdown, but as revenues would flow into for-profit coffers (domestically or internationally), revenues would be unavailable for offsetting either the economic slowdown or the impacts of higher energy prices on low-income earners.

A program of carbon-centered tax reform, by contrast, lacks most of the negative attributes of cap-and-trade, and could convey significant benefits unrelated to GHG reductions or avoidance of potential climate harms, making this a no-regrets policy. A tax swap would create economy-wide incentives for energy efficiency and lower-carbon energy, and by raising the price of energy would also reduce energy use. At the same time, revenues generated would allow the mitigation of the economic impact of higher energy prices, both on the general economy and on the lower-income earners who might be disproportionately affected by such a change. Carbon taxes would be more difficult to avoid, and existing institutions quite adept at tax collection could step up immediately. Revenues would remain in-country, removing international incentives for cheating or insincere participation in carbon-reduction programs. Most of these effects would remain beneficial even if science should determine that reducing GHG emissions has only a negligible effect on mitigating global warming.

A modest carbon tax of $15 per ton of CO₂ emitted would result in an 11 percent decline in CO₂ emissions, while raising non-coal-based energy forms modestly. Coal-based energy prices would be affected more strongly, which is to be expected in any plan genuinely intended to reduce GHG emissions. A number of possible mechanisms are available to refund the revenues raised by this tax. On net, these tools could significantly reduce the economic costs of the tax and quite possibly provide economic benefits.

For these reasons, we conclude that if aggressive actions are to be taken to control GHG emissions, carbon-centered tax reform--not GHG emission trading--is the superior policy option.

A Convenient Tax — Issue #2

06/4/2007 by Charles Komanoff

Welcome to the second issue of A Convenient Tax, the Carbon Tax Center's newsletter, summarizing our progress in April and May. (For Issue #1, click here.)

The big carbon-tax developments this spring have been (i) the first overt expressions of Congressional support for a carbon tax, (ii) a torrent of criticism of the competing "cap-and-trade" approach by editorial writers and other opinion leaders, and (iii) a significant increase in CTC's visibility on the national stage.

Congressional Support for a Carbon Tax

Two milestones were reached in the national political arena in April.

First, California Democrat Fortney "Pete" Stark, the second-most senior member of the House Ways & Means Committee, introduced the first carbon-tax bill in Congress in a generation. The Save Our Climate Act, filed on April 26 and co-sponsored by Rep. Jim McDermott (D-Wash.), would impose a $10 per ton (of carbon) charge on coal, petroleum and natural gas when the fuel is either extracted or imported. The charge would increase by $10 every year until U.S. carbon dioxide emissions have dropped 80 percent from 1990.

Prior to introducing the Save Our Climate Act, Rep. Stark's staff reached out to CTC for guidance on carbon tax administrative and technical issues, as well as the optimal tax level, While the tax rate in the bill is several times less than what CTC is urging, we support it as an essential first step in the long legislative process, especially since the ramped-up tax in future years would tip millions of future carbon-critical decisions in land use, manufacturing and household purchasing toward carbon-conserving alternatives.

How quickly the Stark bill receives a hearing will depend on both the national political climate and the interest shown by other Ways & Means members. CTC has met with staff for other Committee members, as well as for Reps. McDermott and Stark, to review fine points and to convey the message that support for carbon taxing is growing in the grass roots.

In the other political milestone, Sen. Chris Dodd has built a strong carbon tax plank into his presidential election platform. Sen. Dodd, a Democrat who has represented Connecticut in the Senate since 1980, is making a Corporate Carbon Tax the centerpiece of his plan to eliminate 80% of U.S. greenhouse gas emissions by 2050.

"I don't know how we can possibly talk about honestly getting to the [carbon] number we need to get to if you're going to just dance around [the tax]," Dodd said as he campaigned in New Hampshire in April. "Price is the last real barrier." Sen. Dodd has forthrightly put a carbon tax on the home page of his campaign Web site. In fact, on May 31 Sen. Dodd released a new television ad to run in Iowa and New Hampshire that promotes what he refers to as "a courageous corporate carbon tax to transform American industry." CTC regards the senator's corporate carbon tax as a lead-in to a universal carbon tax that can propagate incentives for carbon reductions throughout our economy.

Editorial Writers Back Tax, Take Whacks at Cap-and-Trade

When we two (Charles & Dan) resolved last fall to form the Carbon Tax Center, we looked forward to tangling with anti-tax ideologues on the Right and advocates of state intervention on the Left, not to mention Flat-Earthers who deny climate change altogether. We never anticipated that we would be debating with our friends and allies in the environmental community, but that became inevitable when, just before we launched announced the CTC, four large environmental organizations teamed up with major corporations to back carbon cap-and-trade regimes through the U.S. Climate Action Partnership.

CTC has no quarrel with the notion of tradeable emission allowances. In fact we credit the sulfur dioxide permit program enacted as part of the 1990 Clean Air Act Amendments with helping drive down acid rain emissions from power generation. But the scale and complexity of the carbon problem positively dwarf those of sulfur. (Block That Metaphor Department? We have likened the disparity to the difference between a French mud hut and the Palace of Versailles, in an article in Gristmill; and to the difference between a Mozart sonata and a Wagnerian opera, in an invited post on the on-line Portfolio magazine.) Our fear is that with so many billions at stake, any carbon cap-and-trade program will necessarily be beset by crippling delays, inside-dealing and favoritism run wild. The result will be to disgust and disillusion the American public so that it turns against putting a price on carbon emissions altogether.

On this score, CTC finds itself in fine company. In just the past two months, outspoken criticisms of carbon cap-and-trade proposals have been published in Reason magazine, the Financial Times (U.K.), the Los Angeles Times, and the New York Times Science Section "TierneyLab" blog, to name just a handful. Of critical importance, each piece has been effusive in its support of a carbon tax. As we were posting this newsletter, the right-of-center American Enterprise Institute weighed in with an extraordinarily cogent report comparing a carbon tax with cap-and-trade that unambiguously backs carbon taxing as "the superior policy option."

These testimonials are collected on our Supporters and Tax vs. Cap pages. The L.A. Times editorial is especially noteworthy. The sole editorial in the May 28 (Sunday) edition, the 1,600-word Time To Tax Carbon made as resounding a case for a carbon tax — both in preference to cap-and-trade and for its capacity to stimulate carbon-reducing investment and innovation — as we've seen. Here's one passage:

A carbon tax simply imposes a tax for polluting based on the amount emitted, thus encouraging polluters to clean up and entrepreneurs to come up with alternatives. The tax is constant and predictable. It doesn't require the creation of a new energy trading market, and it can be collected by existing state and federal agencies. It's straightforward and much harder to manipulate by special interests than the politicized process of allocating carbon credits.

Reading manifestos like this, it's hard to resist the feeling that a shift is underway from cap-and-trade to a carbon tax. Indeed, a few days after the L.A. Times ran its editorial, an editor at a popular environmental blog wrote to say:

It's been a slow process of education for me… What brought me around to my pro-tax position is, ironically, my libertarian streak. The essential libertarian insight is that complexity and bureaucracy are invitations to corruption. Big business will try their best to game the system. We know that. Politicians will be subject to lobbying and financial support. We know that. So the best route is the one that minimizes complexity and bureaucracy.

Since the biggest rap against a carbon tax has been its lack of popular support, "conversions" to the carbon tax camp such as that above could have a snowball effect, as each new adherent makes success more plausible. Part of our job at the Carbon Tax Center is to help the world see how rapidly the snowball is growing. We hope to have more to report in future newsletters.

CTC's Visibility Continues to Grow

• CTC co-director Dan Rosenblum appeared on the Newshour with Jim Lehrer — a substantive interview enabling Dan to make the case for a carbon tax to an aware nationwide audience. Click here to see the interview.
• Articles by CTC co-director Charles Komanoff in Gristmill, Common Dreams, and Conde Nast's Portfolio.com, along with quotes in the New York Times and the Detroit Free Press.
• We surpassed Wikipedia to become the leading site on Google for those searching "carbon tax." CTC's Web site, www.carbontax.org continues to receive almost 1,000 visits each week from across the USA as well as Canada, Europe, Asia and Australia.

Other CTC Highlights from April and May:

We are continuing to provide technical and logistical support to advocates organizing for state-level carbon taxes in Colorado, Washington State, New York State and California. We have greatly improved our state-level spreadsheet model for estimating the CO₂ reductions and revenue generation from different levels of carbon taxes. The model now allows for time lags in demand response, and it reflects supply-side incentives (toward lower-carbon fuels and power generation) as well as demand-side conservation. We hope to "grow" the model to the national level and post it on our Web site soon.

Going Forward

The next two years will be the crucial period during which competing policies to reduce carbon emissions will be examined for their effectiveness, cost and political viability. CTC's strategic goals focus on shaping that debate and properly framing the issues by:

• Working with environmental organizations and other allies to solidify support for the concept of "putting a price on carbon."
• Educating opinion leaders, grassroots organizations and decision-makers that while cap-and-trade is also a vehicle to put a price on carbon, carbon taxes are far superior because they provide a more predictable and less volatile price and are transparent, immediate, universal and equitable.

We anticipate engaging in these activities during 2007-2008:

• Continuing to develop intellectual ammunition on key issues including revenue recycling, tax equity, "co-benefits" of a carbon tax (e.g., for national security), and the potential "bang" for each carbon tax "buck."
• Providing technical assistance to opinion leaders, grassroots organizations and decision-makers, including responding to requests for technical information from political campaigns.
• Assisting local and state-level carbon tax initiatives.
• Spearheading a sign-on statement by economists and other experts calling a tax on carbon emissions more effective, transparent and equitable than a carbon cap-and-trade regime.
• Working with a broad coalition of interest groups (labor, environmental, economic justice, national security, etc.) to support carbon taxes through a national sign-on statement and other actions.

It's clear that CTC is proving its effectiveness every day. But we can't continue to play our essential role without your financial help. We heartily thank those of you who have already donated to CTC. We ask carbon tax supporters who are not yet CTC contributors to become so today.

You can contribute to CTC in three ways, of which two are tax-deductible:

• Tax-deductible:
  Write a check or money order to ELPC (Environmental Law & Policy Center), writing Carbon Tax Center in the memo line; mail it to ELPC at 35 East Wacker Drive, Suite 1300, Chicago, IL 60601. ELPC is CTC's fiscal sponsor.
• Tax-deductible :
  Make an on-line contribution via Groundspring by clicking on the DONATE NOW box on our website, www.carbontax.org.
• Not deductible:
  Write a check or money order to Carbon Tax Center and send it to our New York City mailing address: CTC, 636 Broadway, Room 602, New York, NY 10012.

Just as a carbon tax now will send climate-appropriate price signals to businesses and individuals and help lock in low-carbon investment for the long haul, your financial support today will enable CTC to build on our current successes and chart a growth trajectory. Please be as generous as you can, and please donate today. Thank you.

Sincerely,

Charles Komanoff
Daniel W. Rosenblum