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Prices are not Enough

Posted on 26 February 2019 by Guest Author

This is a re-post from TripleCrisis by Frank Ackerman.  Fourth in a series on climate policy; find Part 1 here, Part 2 here, and Part 3 here.

We need a price on carbon emissions. This opinion, virtually unanimous among economists, is also shared by a growing number of advocates and policymakers. But unanimity disappears in the debate over how to price carbon: there is continuing controversy about the merits of taxes vs. cap-and-trade systems for pricing emissions, and about the role for complementary, non-price policies.

At the risk of spoiling the suspense, this blog post reaches two main conclusions: First, under either a carbon tax or a cap-and-trade system, the price level matters more than the mechanism used to reach that price. Second, under either approach, a reasonably high price is necessary but not sufficient for climate policy; other measures are needed to complement price incentives.

Why taxes and cap-and-trade systems are similar

A carbon tax raises the cost of fossil fuels directly, by taxing their carbon emissions from combustion. This is most easily done upstream, i.e. taxing the oil or gas well, coal mine, or fuel importer, who presumably passes the tax on to end users. There are only hundreds of upstream fuel producers and importers to keep track of, compared to millions of end users.

A cap-and-trade system accomplishes the same thing indirectly, by setting a cap on total allowable emissions, and issuing that many annual allowances. Companies that want to sell or use fossil fuels are required to hold allowances equal to their emissions. If the cap is low enough to make allowances a scarce resource, then the market will establish a price on allowances – in effect, a price on greenhouse gas emissions. Again, it is easier to apply allowance requirements, and thus induce carbon trading, at the upstream level rather than on millions of end users.

If the price of emissions is, for example, $50 per ton of carbon dioxide, then any firm that can reduce emissions for less than $50 a ton will do so – under either a tax or cap-and-trade system. Cutting emissions reduces tax payments, under a carbon tax; it reduces the need to buy allowances under a cap-and-trade system. The price, not the mechanism, is what matters for this incentive effect.

review of the economics literature on carbon taxes vs. cap-and-trade systems found a number of other points of similarity. Either system can be configured to achieve a desired distribution of the burden on households and industries, e.g. via free allocation of some allowances, or partial exemption from taxes. Money raised from either taxes or allowance auctions could be wholly or partially refunded to households.  Either approach can be manipulated to reduce effects on international competitiveness.

And problems raised with offsets – along the lines of credits given too casually for tree-planting – are not unique to cap and trade. A carbon tax could emerge from Congress riddled with obscure loopholes, which could be as damaging to the integrity of carbon pricing as any of the poorly written offset provisions of existing cap-and-trade systems. More positively speaking, either approach to carbon pricing can be carried out either with or without offsets and tax exemptions.

Why taxes and cap-and-trade systems are different

Compared to the numerous similarities between the two approaches, the list of differences is a shorter one. A carbon tax is easier and cheaper to administer. In theory, a carbon tax provides certainty about the price of emissions, while a cap-and-trade system provides certainty about the quantity of emissions (in practice, these certainties can be undone by too-frequent tinkering with tax rates or emissions caps).

Cap-and-trade systems have been more widely used in practice. The European Union’s Emissions Trading System (EU ETS) is the world’s largest carbon market. Others include the linked carbon market of California and several Canadian provinces, and the Regional Greenhouse Gas Initiative (RGGI) among states in the Northeast.

Numerous critics have pointed to potential flaws in cap-and-trade, such as overly generous, poorly monitored offsets. Many recent cap-and-trade systems, introduced in a conservative era, began with caps so high and prices so low that they have little effect (leaving them open to the criticism that the administrative costs are not justified by the skimpy results). The price must be high enough, and the cap must be low enough, to alter the behavior of major emitters.

The same applies, of course, to a carbon tax. Starting with a trivial level of carbon tax, in order to calm opponents of the measure, runs the risk of “proving” that a carbon price has no effect. The correct starting price under either system is the highest price that is politically acceptable; there is no hope of “getting the prices right” due to the uncertain and potentially disastrous scope of climate damages.

Perhaps the most salient difference between taxes and cap-and-trade is political rather than economic: in an era when people like to chant “no new taxes”, the prospects for any initiative seem worse if it involves a new tax. This could explain why there is so much more experience to date with cap-and-trade systems.

Beyond price incentives

Some carbon emitters, for instance in electricity generation, have multiple choices among alternative technologies. In such cases, price incentives alone are powerful, and producers can respond incrementally, retiring and replacing individual plants when appropriate. Other sectors face barriers that an individual firm cannot usually overcome on its own. Electric vehicles are not practical without an extensive recharging and repair infrastructure, which is just beginning to exist in a few parts of the country. In this case, no reasonable level of carbon price can, by itself, bring an adequate nationwide electric vehicle infrastructure into existence. Policies that build and promote electric vehicle infrastructure are valuable complements to a carbon price: they create a combined incentive to move away from gasoline.

Yet another reason for combining non-price climate policies with a carbon price is that purely price-based decision-making can be exhausting. People could calculate for themselves the fuel saved by buying a more fuel-efficient car and subtract that from the sticker price of the vehicle, but it is not an easy calculation. Federal and state fuel economy standards make the process simpler, by setting a floor underneath vehicle fuel efficiency.

When buying a major appliance, it is possible in theory to read the energy efficiency sticker on the carton, calculate your average annual use of the appliance, convert it to dollars saved per year, and see if that savings justifies purchase of a more efficient appliance. But who does all that arithmetic? Even I don’t want to do that calculation, and I have a PhD in economics and enjoy playing with numbers. My guess is that virtually no one does the calculation consistently and correctly. On the other hand, federal and state appliance efficiency standards have often set minimum levels of required efficiency, which increase over time. It’s much more fun to buy something off the shelf that meets those standards, instead of settling in for an extended data-crunching session any time you need a new fridge, air conditioner, washing machine…

In short, the carbon price is what matters, not the mechanism used to adopt that price. And whatever the price, non-price climate policies are needed as well – both to build things that no one company can do on its own, and to make energy-efficient choices accessible to all, without heroic feats of calculation.

Frank Ackerman is principal economist at Synapse Energy Economics in Cambridge, Mass., and one of the founders of Dollars & Sense, which publishes Triple Crisis. 

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Comments 1 to 15:

  1. I don't disagree with your conclusion, but the politics and optics are important. A carbon tax with and accompanying per capita carbon dividend which leverages "market forces" is a lot easier to sell and actually get done. By taxing embedded carbon in imports, you can get around one of the major objections (international competitiveness).

    Of course we also need to encourage research (we do that with public means already for many things), and redirecting direct fossil fuel subsidies provides hundreds of billions of runway for strategic public programs.

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  2. Fair comments in the main, but it comes down more to political realities.

    Clearly carbon taxes or cap and trade 'could' be applied to the climate issue and work in a technical sense, (but that you would still need other measures with both). Cap and trade was used successfully to resolve the ozone problem. Consumption taxes have worked to help get rates of tobacco smoking down and pay for the damages in my country of NZ. The climate problem is a consumption and energy substitution problem.

    However its confoundingly complicated. Carbon taxes work best short term, cap and trade long term as below:

    However this could possibly be resolved. While a carbon tax sets a price and not a limit on quantities, quantities can be monitored over time and the tax adjusted surely?.

    The issue is which is most appropriate approach for the climate problem? Perhaps it partly comes down to "political acceptability". While the article is right that people dont like taxes, they dont like cap and trade schemes either, because they are opaque and look like a form of crony capitalism that favours the corporate sector. They might not be, but the perception is there among some of the general public posting comments in the media.

    And the political difficulty of selling a carbon tax can be mitigated with a carbon fee and dividend scheme that uses different terminology and softens the blow with the dividend component. Technically cap and trade could return money to the public but It becomes a little more complex to explain to the public how it is all working.

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  3. Sorry to sound like a parrot. J W Rebels comment was not there when I pushed submit. Hes right as well.

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  4. The Energy Innovation and Carbon Dividend Act (H.R. Bill 763) is a revenue neutral carbon fee and dividend approach.  I think avoiding the word tax and giving all the "well head" fees back to the public as a monthly dividend is a good reminder about climate change and would offset some of the increased costs of fossil fuel by the suppliers. Fuel prices are going to go up regardless of what system is used to reduce emissions.  

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  5. 50 dollars a (metric?) ton at the rate of 5-20 tonnes CO2e/ha/yr for a farmer means something significant. Even a small farmer of 200 acres can earn additional ~ 25-100 thousand dollars a year sequestering carbon.

    Do that and the price of beef and organic produce will drop and end up offsetting the extra costs in fossil fuels directly, while also directly removing the Carbon from the atmosphere and sequestering it deep in the soil.

    It will also offset a great injustice that has been perpetrated on small family farmers and rural comminities since the 1970's, namely the forced instability of the small family farm forcing millions off their land and out of their homes.

    Even now only 46.1% of farmers have net positive income from farming. This would rejuvenate rural economies as well as rejuvenate degraded soils. 

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  6. Regarding Red Barons information. Soil carbon sequestration from enhanced farming systems equals 5 - 20 tonnes CO2 / hect / yr. I assume this is additional sequestration over the normal sequestration of carbon from standard farming systems.

    This number doesn't mean a lot to me, so I have tried to see what it means in terms of how much of global emissions such farming systems might sequester per year (tried a google search but nothing). Quick and very rough back of envelope calculation : Lets assume additional CO2 sequestered is 10 tonnes CO2 / hect / yr.

    Total global arable land plus open range grasslands equals approx. 3 billion hectares. Lets assume 1 billion is suitable for enhanced soil carbon sequestration so this equals 10 billion tonnes / CO2 / yr sequestered.

    Total CO2 emissions 2017 was approx. 36 billion tonnes / CO2 / yr. So 10 billions sequestered seems like significant potential.

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  7. Nigelj,.

    In Red Baron's post a few days ago here, the first  paper he cited to support his claim of 5-20 ton/ha/yr was:

    Conservation practices to mitigate and adapt to climate change

    Jorge A. Delgado, Peter M. Groffman, Mark A. Nearing, Tom Goddard, Don Reicosky, Rattan Lal, Newell R. Kitchen, Charles W. Rice, Dan Towery, and Paul Salon doi:10.2489/jswc.66.4.118A

    It can be located here.  (I had to look up the location).

    Table 1 lists many methods of enhancing cabon uptake in soils.  It has three categories: 0-2 t/ha/yr, 2-4 t/ha/yr and >4 t/ha/yr.  Only 5 of 20 methods rise to the highest amount of sequestration.  Of those 5, 4 involve removing land from cultivation and returning it to pasture or forest.  The fifth is adding biochar to the soil  which would involve enormous manufacture of biochar to implement on a widespread basis.  Improved grazing pasture management, often cited by Red Baron as 5-20 t/ha/yr, is given as 0-2 t/ha/yr.

    I do not have time to reread all of Red Baron's citations.  They do not support his wild claim of 5-20 t/ha/yr of sequestration.  I recommend you do not hang your hopes on farming being a silver bullet to solve AGW.

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  8. Corporations, NGOs and governments have been fixing climate for 30 yrs.

    Emissions went up 60%.

    That is why carbon dividends must be 100% private = 0% for corporations, NGOs and governments.

    The tax must be on the rich and paid directly to the poor.

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  9. *U.S. = #1 Exporter of Coal Gas Oil*
    In 2017 U.S. coal exports to Asia went up 61%.
    Our oil will soon run out and we need Venezuela's oil. Many will die for it.
    All the world's energy growth is in Asia India Africa, and not here.

    They want to live like us more than they care about the climate.

    *Why North America and Europe Do Not Matter Anymore*

    Electricity = 25% of total world primary energy.

    Energy Use By Nation:

    Canada = 360 Giga Joules / person

    ___ U.S. = 300 Giga Joules / person

    __ China = 120 Giga Joules / person

    ___ India = 90 Giga Joules / person

    ___ Brazil = 60 Giga Joules / person

    ___ Africa = 20 Giga Joules / person ur

    Euro-America demand is slow compared to Africa India and Asia.

    Solar + Wind = 6% of electricity production worldwide.

    Electricity production = 25% of world primary energy.

    Solar + Wind 1990 - 2018 grew to 1% of world primary energy.

    Solar/Wind 2019 = 1% of energy after 30 years of hype.

    Emissions went up 60% in 30 years.

    Food + Meat = 24% of emissions.

    World concrete = 4 billion tons / yr

    World steel = 2 billion tons / yr

    World sand = 11 - 15 billion tons / yr

    Open sand piracy is the norm over there. They just take your sand and go.

    It doesn't matter what North America and Europe does for emissions.

    World energy demand growth is in Africa and Asia. They are all young and eager.

    India's energy demand grows as much as all the energy used in Canada every 32 months.

    Indian coal is going to go up to drive the economy, even if they convert it to gas.

    China's coal has grown from 1 billion to 4 billion tons / yr in 30 yrs.

    China coal is now down to 3.5 billion tons.

    China is building 700 coal plants worldwide, not in China.

    Many of these plants convert coal to gas.

    Solar panels in Germany provide 90% of their rated power 11% of the time.

    Wind turbines in Germany provide 90% of their rated power 20% of the time.

    It doesn't matter that Denmark has the most wind turbines, they are only a few million people.

    What matters is what's happening in India and Africa not here.

    Coal and gas will still be 70% of their energy by 2040.

    There are 30 million EVs and 1.2 billion gas vehicles on earth.

    It will take 40 years to convert all the cars on earth.

    The amount of batteries Tokyo will need during future Typhoons is staggering.

    Batteries cannot be scaled up in time to make a difference to climate.

    The Paris Agreement = Emissions go up from 35 billion tons to 50 billion tons by 2040.

    The Paris Agreement will not be kept and you know it.

    Emissions must go down 50% in 10 yrs + 100% in 20 yrs for 2 C.

    Five of 13 major hothouse tipping points start below 2 C.

    Runaway mass extinction cannot be stopped or reversed.

    Krill cannot survive in many parts of the ocean without oxygen.

    All ocean life depend on Krill.

    The world wants the American lifestyle and we can't stop them.

    China is buying up U.S. chip and bio tech right now.

    The U.S. is now the number one exporter of gas, oil and coal.

    In 2017 U.S. coal exports to Asia went up 61%.

    All the U.S. will have left is its guns and fracking gear.

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  10. When you are talking about economic incentives you should also consider the incentives of those who collect the carbon taxes or whatever.  What's to prevent them from perpetuating the problem the tax is designed to solve?  If the problem goes away, so does their revenue stream.  

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  11. MS Sweet, thank's. I took the 5 - 20 tonnes number in good faith. I hadn't seen that page of discussion on soil carbon issues. Perhaps someone can clarify exactly how the 5 - 20 tonnes figure is derived? 

    Red Baron mentions it in relation to the research :"Global Cooling by Grassland Soils of the Geological Past and Near Future" on the page you linked to. I had a quick scan and the only thing I could find was that there was evidence in Australia that better grasslands management could sequester 15% of their emissions. Not a silver bullet, but not insignificant either. Of course this number only applies to Australia.

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  12. I think the author is way off the mark.  The only system likely to actually achieve the aim of reducing our carbon output is Tax and Dividend a la James Hansen

    There are a couple of vital aspects of this policy.

    1/ The tax can be small to the point of insignificance at first but built into it is an increase each year.  This can be arithmetic (1,2,3,4...) or geometric (1,2,4,8...) but the inevidability is the important part.  People will be divesting from fossil fuel long before it is an economic necessity to avoid taking a 'hair cut'.  Where will they shift their money to.  Predominately to renewable energy.

    2/ Insteas of stifling the economy and making the government the bad guys (look at Macron in France with his fuel tax.  Jeeesh!!)  money is put into the hands of the poorest who will spend it all just to keep their heads above water.  The government becomes the hero of the people.  Mony is not put into the hands of the rich which they squrrel away as happens with, for instance, Cap and Trade.  What the economists call velocity (the rate money circulates in the economy) increases instead of decreasing as with C&T.

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  13. jcfanclub - the predominant carbon prices mechanisms discussed are:

    1/ fee and dividend. You tax the carbon and return 100% of what is collected to tax payers on per capita basis. If your FF consumption is "average" then what you get back in dividend should cover the increased cost of FF. However, it creates powerful incentives to reduce FF use and thus benefit from the dividend. I cannot see how anyone could "perpetuate the problem" so as to gain from it.

    2/ ETS. Emitters have to buy carbon credits from carbon sequesterers. That certainly creates a convenient revenue scheme for those able to sequester carbon, but how is it possible from them game the system to encourage emissions?

    I find it hard to imagine a carbon tax scheme where the revenue beneficiaries could work to perpetuate emissions. Can you provide an example?

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  14. Michael, I dont think RB has pushed farming as silver bullet, but as a potentially important "wedge" to help. When you have food production that depends on growing grain to feed to animals/birds, then there is definitely carbon advantage to convert land use from grain production to direct managed grazing.

    Of more concern to me here in NZ, is whether it is possible to reproduce carbon capture observed in prairie soils outside of that environment and how much does it depend on grass types with limited climate range? The only places where grazing has recorded a soil carbon gain instead of loss here is where grazing was introduced onto badly degraded soils formerly used for grain. As RB has pointed out, there is no shortage of badly degraded soils to work with however.

    I am persuaded by literature that he has provided, that a lot more work should go into research of low-input managed grazing techniques with different pasture types, rather than the high-input irrigated grazing that typifies most of our dairy systems. Our meat production occurs almost exclusively on low input, hill country, ex-forest soils and so far I cant any find any examples of enhanced soil carbon in these systems.

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  15. Some research done in Asia of the potential of CO2eq avoidance gives between 18.7 to 22 tons/ha/year CO2 equivalent, which can be reduced with water management (60%), removal of straw from field (30%) and slow release fertilizers. Mainly CH4 is the source. 

    source: Vietnam average rice cultivation emissions (, thO2 is from own calculation for a particular area in the Mekong from the Biomass resource map ESMAP 2018. 

    If RedBaron is mentioning 5 - 20 ton, it will be CH4 and N2O avoidance, not so much CO2. As for avoiding CH4 etc., a mineral book keeping method does work, regulating how much minerals are optimal instead of dumping tons of manure and loads of artifical fertilizers onto pastures.

    Pushing a Emissions Trading System ETS where (developing) countries can trade their (simple) avoided GHG gasses with developed countries to fund better equipment (power plants, tractors) and infrastructure (dykes, roads, efficient transport, irrigation). 

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