Taxing Falling Carbon Emissions

Back in November 2007, in a long post on the relative merits of a carbon tax and a cap-and-trade system, I said that one big advantage of cap-and-trade was that it was "a dynamic hedge of fat-tail CO2 risk". The tail we were all thinking about back then, of course, was a large and continued rise in carbon emissions which proved impervious to a set carbon tax. But of course there are two tails to any distribution, and right now we’re at the other end: both carbon emissions and carbon prices are falling quite fast. Hellasious at Sudden Debt sees this as an argument against cap-and-trade alone:

As prices for CO2 permits drop – recently from 30 euro/ton to 8.85 euro/ton – industry can simply put off becoming greener until economic conditions improve. This regime, therefore, does not drive continuous greening but does so only on a marginal basis: pressure to change varies with economic activity, since most activity is still "black".

The answer to the tax or trade question is quite simple: both.

I have a certain amount of sympathy with this view, but the fact is that if all you care about is reducing carbon emissions, then a massive global economic slowdown is pretty much the best and most reliable way of achieving that — much better than any tax or cap-and-trade system.

What’s more, it now looks that any cap-and-trade system implemented by the Obama administration will come into force either during or immediately after such a slowdown. As a result, the caps in a new cap-and-trade system are likely to be much lower than they would otherwise have been. That’s good news too.

And the fact is that the only thing that really matters, from a carbon-emissions standpoint, is the aggregate amount of carbon pumped into the atmosphere over time. The planet doesn’t care whether we have "continuous greening" or not, all it cares about is how much carbon is in the atmosphere. So long as emissions are falling one way or the other, that’s a good thing, from a climate-change perspective.

Besides, with double-sided safety valves and the like, it’s possible to implement an effective minimum carbon tax even within the context of a cap-and-trade system, if you’re so inclined. So let’s keep working, hard, on a cap-and-trade system: it might take a bit longer than originally intended, thanks to the urgency of the economic crisis, but it really should be lined up and ready to go as soon as it’s legislatively feasible.

(HT: Jones)