Sunday, June 17, 2007

Tax not trade

...the biggest problem, at least politically, is that carbon taxes are transparent and simple, whereas cap-and-trade systems are complicated and conveniently opaque. Under a cap-and-trade scheme, governments can pay off politically powerful polluters (such as the coal industry) by giving them permits...
-- this (from Doffing the cap) catches a key point. I've been reminded however (!) that it's far from the first time the point has been made (see, for example, Emission Impossible).

So we know well now that the case for a carbon tax is strong. How broad should it be? I recall visiting six or seven years ago John Flemming (a man of excellent qualities) and listening to him outline the advantages of making it global (acknowledging, however, that politically this was a long way from being a realistic prospect).

The political obstacles -- for proper carbon taxes (or indeed something like the auction proposed in Kyoto2 which, I have argued, shares some features of a tax) -- remain the "real story".

[P.S. A much fuller exploration of the issues now appears on Baconbutty: To cap or to tax?]


Clive Bates said...

Hi Caspar,

An interesting debate... and I tend to agree with the Economist and FT - the ETS is ever more Byzantine and hard to read and barely connected to an environmental outcomes. However I think now that both tax and trade could play different but supportive roles...

I've commented on on my blog here: To cap or to trade.


Unknown said...

This article makes some valid points but fails to mention the role of "hybrid" instruments, that is instruments that combine price and quantity approaches. This now forms part of the Kyoto2 proposals.

This hybrid approach was first presented in 1976 by Marc Roberts & Michael Spence ("Effluent Charges and Licenses Under Uncertainty", Journal of Public Economics 1976) and was recently expanded by Cameron Hepburn (Oxford Review of Economic Policy Vol. 22 No. 2, summer 2006) in "Regulation by prices, quantities or both: a review of instrument choice" with specific application to environmental regulation (

The hybrid instrument proposed by Kyoto2 is an auction (a quantity instrument) of global GHG / fossil fuel production permits (Rights), but which operates within a price band with maximum (ceiling) and minimum (floor) levels (price instruments). The floor is a reserve - once bids fail to achieve the floor, the auction stops even if there remain unsold allocated units. If it hits the ceiling, then units continue to be sold even after all allocated units have been sold, until the price drops below the ceiling.

The consequence is: 1) to guarantee investors a minimum long term price of Rights (necessary for long term investments), 2) to guarantee a minimum flow of funds to invest in adaptation and mitigation, etc, 3) to ensure that polluters may a minimum social cost of GHG production ; 4) to limit the economic impact that would arise from a very high price of Rights, 5) where demand for Rights is strong, to raise a high level of funding to invest in creating a low-carbon future, so reducing demand for Rights in future years.

Another way of preventing very high prices of Rights, and price spikes arising from short term liquidity issues, is to allow Rights to be "borrowed" from future years' allocations, under suitable constraints, so creating liquidity and flexibility in the market.

One example of a hybrid market now in place (though for many reasons it works quite badly) is the UK's Renewables Obligation, which combines a "target" for renewable production (quantity) with a "buyout price" (price) for electricity suppliers who fail to meet their target.

Oliver Tickell

Oliver Tickell
Kyoto2 - for an effective Climate Protocol