Eco-nomics: Carbon Tax

Why do most economists favor a carbon tax as a way to address the harmful consequences of carbon emissions? Efficiency.

Here is a smart and succinct defense of carbon taxes over cap-and-trade by Ted gayer of the Brookings Institution, it was his testimony before the U.S. Senate Committee on Energy and Natural Resources on December. It is all about the incentives... [HT: Greg Mankiw]

1202 Carbon Tax Gayer

That said, cap-and-trade is a heck of a lot better than nothing, and a pretty good second best: I am not that convinced that the incentives problem Gayer talks about is going to be that important (the plant a tree so you can say you saved a tree - you are still creating one more tree which in this case stands for carbon reduction). Here is Paul Krugman's defense of cap-and-trade:

A tax puts a price on emissions, leading to less pollution. Cap and trade puts a quantitative limit on emissions, but from the point of view of any individual, emitting requires that you buy more permits (or forgo the sale of permits, if you have an excess), so the incentives are the same as if you faced a tax. Contrary to what Hansen seems to believe, the incentives for individual action to reduce emissions are the same under the two systems.

This is true even if some emitters are “grandfathered” with free allocations of permits, as will surely be the case. They still have an incentive to cut their emissions, so that they can sell their excess permits to others.

The only difference is the nature of uncertainty over the aggregate outcome. If you use a tax, you know what the price of emissions will be, but you don’t know the quantity of emissions; if you use a cap, you know the quantity but not the price. Yes, this means that if some people do more than expected to reduce emissions, they’ll just free up permits for others — which worries Hansen. But it also means that if some people do less to reduce emissions than expected, someone else will have to make up the shortfall. It’s symmetric; there’s no reason to emphasize only one side of the story.

The key is reduced carbon emissions, cap-and-trade gets you there and appears to be the only thing politically feasible. The world is getting warmer as we speak, it is time to act.

Oh, and one last thing, if we are really going to address this problem, the wealthy countries are going to have to help out emerging economies.