Wild Rocket Sledge Ride

Carbon Tax vs Cap’n Trade – an example

EU has currently got a Cap’n Trade scheme going, which oil companies operating on the Norwegian Continental Shelf (NCS) are participating in. One of many problems with such cap and trade schemes is that they block all additional CO2 reduction programmes – as the example below shows:

Let us assume that the Norwegian government feels very rich and decides to spend some of its oil wealth reducing the NCS emissions to zero over the next n years.

Oil platforms need very large amounts of power, which is produced offshore in compact but inefficient natural gas generators

What’s the result?
Net reductions of zero but EU’s green industries are wiped out.
?Why? What happened?

Assumptions for this example to work out:
The emissions from these companies is X% of EU’s total.
EU is planning to reduce the qouta cap by <=X% over the next n years (same amount as NCS emissions or less) 

Cap’n Trade blocks all other reduction efforts

Supplying electricity to oil platforms would be a natural first step for offshore wind energy

Firstly, the effect of this laudable action from the Norwegian government on EU’s total emissions will be exactly zero. This is because the NCS emissions reductions means that the NCS oil companies don’t have to buy X quotas. These quotas will be available for use in the EU, which will have X higher emissions than without the Norwegian efforts. The only effect is that Norway sponsors EU’s emissions reductions in these years.

Additionally, the move will be disastrous for all companies that have invested based on a belief that emissions qoutas will be restricted (and qouta prices high). All sorts of green tech companies in EU will be wiped out by the Norwegian generosity.

A Carbon Tax makes additional reduction efforts cumulative

Compare this with a Carbon Tax. Here Norway’s actions would have no impact on the rest of EU’s interest in reducing emissions – the tax pressure would remain unchanged. Just another area where a Carbon Tax is better than Cap’n Trade.

The first argument people raise against a Carbon Tax is often “it’s not politically viable”. While this isn’t really my concern – I’m discussing what we ought to do – it is of course an important detail.

Connect the Carbon Tax directly to reductions in other taxes

I believe it would be very smart to try to steer clear of the eternal right/left debate about higher/lower taxes and bigger/smaller government. To do this, the Carbon Tax should come with mechanisms to cut other taxes simultaneously, making it revenue neutral.  Preferably, the tax cuts should be itemized to every taxpayer to remove any doubt about the connection between higher petrol prices and lower taxes.

How do we get political consens on policies to stop putting so many of these in the atmosphere?

How the taxes should be cut would of course be a source of debate. The most economical would perhaps be to cut taxes that discourage value creation, such as the income tax. More left leaning people would perhaps prefer giving all taxpayers an identical tax cut – an increase in the assessment limit.

It is also worth noticing that the income from a Carbon Tax is intended to come as a hump. First the intake will increase, before falling again later as the economy gets decarbonized. This is also a reason why it will be prudent to include a mechanism that links the Carbon Tax take directly to a  tax refund instead of letting the Carbon Tax simply enter the exchequer’s coffers. This way we avoid the headache of having to find new tax income when the carbon tax take starts to fall as the economy is being de-carbonized.

A Carbon Tax is the best way of combating climate change  because it gives firms the most stable and easily predicted operating environment. A stable and predictable regulatory framework reduces risk, and risk is costly.

Cap’n Trade gives unpredictable price variations

Trade in Carbon Credits (Cap and Trade – or Auction and Trade) will result in a lot of on-off price signals to ensure that the target emissions reductions are met, and not over- or underfulfilled. These variations in emissions price will make companies that are heavily exposed towards the carbon price – either heavy polluters or very green – lose or earn money in an unpredictable fashion. Their operations will be disturbed, and some firms may even go bust due to an unexpected reversal in fortunes. Such price variation can be very expensive, and may wipe out entire industries – all for nothing since the reduction targets are all completely arbitrary, chosen for being assumed affordable and not for being “the exactly right reduction”.

Carbon Tax gives a predictable investment climate

Can you see The Future? Uncertainty ain’t good for business!

A Carbon Tax on the other hand is easily predictable. Firms choosing to make investments in green technology must take a lot of risk to begin with – will the technology work, will the market buy their products – and the very least society can do to help is to give predictable operating conditions.

Why are international climate change treaties such as the Kyoto Protocol unenforceable? Is there anything that could be done about it?

A Carbon Tax Treaty would enforce itself

If we were to agree upon a global “carbon tax” instead, the treaty would be much easier to enforce, since firms and countries would be watching each other to ensure nobody is getting an unfair advantage through a lower carbon tax regime.

Carbon Tax – the most effective method to reduce pollution

It is much easier to agree upon whether the current tax rate is as agreed or not than whether an emissions target will be met in x years time. Just look at the effects of the Kyoto Protocol – nobody has managed to follow it and it has had zero consequences. International free trade agreements regulating tolls and tariffs on the other hand – they work!

Violators refusing to implement a Carbon Tax could be brought in front of international arbitration mechanisms as modelled on existing WTO dispute settlement procedures, and countries refusing to sign the treaties would eventually end up being locked out of international trade. Eventually everyone would have to join the club and everyone would have to follow the rules.