Back to the Drawing Board : Emergent Problems

Cap and Trade vs. the Carbon Tax

Donny with an A — Fri, 13 Jun 2008 22:09:00 GMT

So I've been addressing the issue of anthropogenic climate change for some time now, and I haven't said much in the way of addressing specific policy proposals. But I was just given a delightful present by one of my fellow FEE associates: a copy of the American Institute for Economic Research's latest Economic Education Bulletin, entitled "The Global Warming Debate: Science, Economics, and Policy." I didn't read the whole thing, but my favorite part was definitely when William R. Cotton, a professor of atmospheric science at Colorado State, closed his completely science-oriented essay, "Summary View of Climate Change," with:

There are strong indications that our global climate is warming. But the question is, is the warming due to anthropogenic greenhouse gases, or is it due to some other forcing mechanisms (or their transient absence) and natural variability. As human population on Earth continues to increase, the chances of human-induced changes in climate due to greenhouse gases, aerosol pollution, or alterations in land use become increasingly likely. Thus, rather than consider climate engineering, we should devise methods of encouraging the reduction of population growth through economic and quality-of-life incentives.

Period, end of conversation. No comment on that gem anywhere else in the entire essay. Who's got two thumbs and loves it? This guy.

But anyway, that's not the point. Later in the publication was an essay by Kenneth P. Green, a resident scholar at the American Enterprise Institute, where it was argued that a carbon tax is superior to a cap-and-trade system. I bounced between frustration, amusement, and glee as I read it, and felt an immediate need to comment. Not because Green did a bad job--he did just fine--but because he was guilty of something which is very common among people who discuss climate change: he discussed the possible "solutions" to climate change without addressing the reasons that a policy was to be implemented in the first place, and how the different solutions worked to address those reasons. His argument for a tax scheme over a cap-and-trade scheme was simply that a tax scheme could achieve the same goals, but with better economic side-effects and less potential for failure. Fine, I'll even grant it. But taxes and caps are fundamentally different policies, which only make even a little sense when confronted by specific sorts of problems.

I should explain what I mean. I've discussed elsewhere the idea that in order to make any sense from an ethical point of view, pollution taxes need to be based on the idea that an individual is justified in polluting if and only if she pays compensation to her victims for any damage done to them. That idea is controversial, but for our purposes we don't need to address that controversy. The point is only that even if we accept that idea as true, there are still only certain kinds of instances in which the injustice of pollution can legitimately be dealt with through a tax on pollution. The paradigm cases are those instances in which the damage caused by pollution is directly proportional to the amount of pollution that there is, so that the tax becomes the "price" of compensating the victims of one's actions for the costs one imposes upon them.

Cap and trade schemes, on the other hand, are built for an entirely different kind of problem. In a paradigm cap and trade situation, there is a threshold level of pollution with which policymakers are concerned, and at the threshold, a certain amount of damage is anticipated. The cap and trade scheme accordingly sets the cap at the relevant amount of pollution, and then distributes "shares" of the "environmental space" below that threshold in some way (e.g., auction, grandfathering system...). Because the allocations may be economically inefficient for whatever reason, the shares can then be traded in accordance with the wishes of their owners in order to ensure that the right to pollute is distributed to those individuals who are willing to pay the most for it (note that the normal objections to the "willingness to pay" criterion are avoided by passing the buck to the distribution process, which of course must be justified separately).

The point I want to make here is that global climate change is a very different phenomenon than the sorts of phenomena for which either of these policies is built to provide a solution. As noted elsewhere, climate change is an emergent problem. That is, climate change is not the result of any individual's actions, but rather is the consequence of many individuals acting separately, so that no individual can reasonably be said to have been able to prevent climate change from occurring, and no individual could have caused climate change singlehandedly. Accordingly, it does not make sense to talk about the consequences of climate change in terms of marginal contributions. The amount of damage caused by climate change will not likely change recognizeably with an additional increment of CO2 (or any other forcing agent), so it's not reasonable to try to put a price on how much damage "a unit of climate forcing" (expressed, perhaps, in terms of GWP, or Global Warming Potential, as defined by the IPCC?) causes.

A tax on contributions to climate change, therefore, seems like a policy which would require a bit of shoehorning. Individuals paying the tax would not be paying the "social cost" of their particular contribution, taken in isolation, because that would be basically zero. They would need to be charged for their "portion" of the total amount of damage done by climate change. So what policymakers would need to do would be to determine the total amount of damage which would be done at the equilibrium price for pollution permits, and then sell the permits at that price. The problem then becomes one of economic calculation. It could be done to some degree, but it would be inherently imprecise. And remember: the end result needs to be that the victims get compensated, so the government would have to go into its own pockets (that is to say, the pockets of its treasury or, more realistically, the pockets of its Federal Reserve printing press) to take care of the balance if it aimed low. And as my wonderful economist friends would point out, there would be a considerable incentive to aim high, creating a surplus revenue stream for the government which would almost certainly not be returned. So the tax is doable, kind of, but the problem is not the kind of thing that the tax is designed for. It's just that you can use the tax to accomplish the end goal if you want.

The cap and trade system is a little harder to adapt to the task, but there are a number of ways that the idea can be useful. First, there is a level to which we could collectively exert a forcing on the climate system without producing objectionable consequences. This level of climate forcing is a threshold which could be amenable to a soft cap and trade scheme (soft like the baseball salary cap). In this kind of policy, the cap would be set at the level of forcing which would produce no negative consequences, and this "environmental space" would be allocated somehow (or, if people find this to be a bad idea, we would simply say that these shares should be allocated in proportion to one's contribution to climate change, so that the soft cap has no effect). People not receiving these shares, or polluting in excess of their shares, would be filling environmental space which represented something like "harmful social emissions". Because these emissions would not be legitimated by the soft cap, they would be the ones which would be subject to the obligation to compensate the victims (again, if the soft cap isn't being used, as mentioned above, it would just be that everyone would have to participate in compensating the victims).

Here a potential for another cap would become apparent: We might imagine that policymakers would decide on a level of pollution (corresponding to some amount of total damage) which was determined to be "socially desirable" somehow. Perhaps, using the same reasoning involved in the tax scheme discussed above, the policymakers would arrive at the level of pollution which would clear the market if everyone paid some price for it. Or perhaps the policymakers would identify a level of pollution beyond which unacceptable results would occur, and the cap would be set there. In any case, you would then have to set a cap and allocate the shares. So again, the policy could be made to work. But the problems are simply that it's difficult to identify a level of "unacceptable" pollution, it's just as difficult to identify a market clearing price in this scheme as it is with the tax (assuming that the shares are auctioned, of course), and any other way of running the scheme is sure to carry either difficulties of its own, or charges of arbitrariness which would sever the connection between the problem and the solution.

So ultimately, what we're faced with is a situation in which the only two policy suggestions that are on the table are not particularly well suited to the task of "solving" the problems arising from climate change (and I haven't even begun to address the question of how the compensation process would even work, or whether compensation could make climate change legitimate!), and the only way to make either of them work is to basically stretch and contort them until they are made to do the job acceptably. Doing so, it will be noted, requires in both cases that government decision-makers possess knowledge and foresight which they almost certainly do not have, and even then it's unclear that the policies would work properly.

Obviously, there's a lot more to say about this. I just wanted to get some preliminary thoughts down, and I think this was a good start.

Climate Change and Market Definition of Property Rights

Donny with an A — Tue, 25 Mar 2008 06:35:00 GMT

[Cross-posted on the parent blog]

A fellow named Gregory responded to my post, "Can the Free Market Solve the Problems Posed by Climate Change?" with an argument which I think deserves to be discussed in some depth. Gregory wrote:

If the market has not arrived at an efficient means regulating itself (compensating those damaged) then a government certainly will not be able to affect such a regulation efficiently. The cost of the regulation must be weighed against the benefit it provides. If economic growth is retarded by inefficient regulations, do we not harm future generations more than by waiting for the market to develop a mechanism to efficiently distribute justice?

Gregory highlights the fact that the market has not yet developed an efficient way to enforce the property rights involved in discussions of climate change. I agree that on some level, to indict the free market for this fact would be problematic. In his essay, "Market-Based Environmentalism and the Free Market: They're Not the Same," Roy Cordato wrote

...environmental problems are not an unavoidable side effect of a free-market economy. Instead, they occur because the institution setting--the property rights structure--required for the operation of a free market is not fully in place. Because, in all modern societies, government has taken nearly complete responsibility for the establishment and maintenance of this institutional setting, environmental problems are more appropriately viewed as manifestations of government failure, not market failure.

Mark Pennington bolsters this view in his essay, "Liberty, Markets, and Environmental Values: A Hayekian Defense of Free-Market Environmentalism," when he writes, "Transaction costs are not the sole preserve of the market system...and we commit the "nirvana fallacy" if we suggest the alternative to an imperfect market is a government immune from the same sort of problems."

I completely agree with these two authors, and Gregory, in saying that ill-defined and unenforced property rights are at the root of most (if not all, depending on your definition of "property rights") of the problems associated with climate change.

Further, I agree that the free market can solve some of the inadequacies in the process of enforcing justice, but often only if allowed to work without interference. Pennington writes:

Although proponents of free-market environmentalism recognize that environmental markets have limits owing to the prevalence of transaction costs, they contend that these problems are more like to be overcome within an institutional framework supportive of private contractual arrangements. In this perspective, all environmental externalities represent potential profit opportunities for entrepreneurs who can devise ways of defining private-property rights and arranging contracts (via technological innovations, for example) so that those currently free riding on collective goods or imposing negative external effects (for example, water pollution) on their neighbors are required to bear the full costs of their actions.

That being said, I do think that we oversimplify if we simply suppose that the market will find a way to handle the problem in an acceptable manner, and leave it at that. In issues of justice, the "There are many ways to skin a cat" approach taken by the free market might not be acceptable. Improper conceptions of property rights are not simply inefficient, they are unjust. In his speech, "Another Take on Free Market Environmentalism: A Friendly Critique," David Roodman highlighted this idea when he said:

Fine, I own my car. And you own your lungs. Property rights are allocated, seemingly. So now can we reach happy agreement about how to resolve the conflict? Fat chance. More likely, thousands of drivers and breathers will end up suing each other and then the problem will end up in the lap of the court, which would have to decide precisely where the right to free enjoyment of one's car stops and the right to free enjoyment of one's lungs starts.

Later, he quipped, "Judges did not free the slaves; in fact, they tightened the bondage."

I don't mean to imply that libertarian judges would be unable to come up with a decent solution. I'm only suggesting that the answer might not be as simple as Rothbard made it sound when he wrote, in chapter 13 of his Egalitarianism as a Revolt Against Human Nature:

...it would not be a very difficult task for Libertarian lawyers and jurists to arrive at a rational and objective code of libertarian legal principles and procedures based on the axiom of defense of person and property, and consequently of no coercion to be used against anyone who is not a proven and convicted invader of such person and property. This code would then be followed and applied to specific cases by privately-competitive and free-market courts, all of whom would be pledged to abide by the code, and who would be employed on the market proportionately as the quality of their service satisfies the consumers of their product.

The problem, in addition to the simple fact that this could be difficult to do, is that this group of Libertarian lawyers and jurists would need to arrive at decisions somehow. Either they could do so in accordance with majority opinion or some other procedural way, or (as I suspect Rothbard is aiming at) they could do so in accordance with the true principles of justice. If the former were the case, then I see no reason why we would call the result "rational and objective." And if the latter, then we should be able to replicate the activities of these lawyers and jurists on our own. But as those who have been keeping up with my work have undoubtedly seen, the task is not quite as simple as Rothbard makes it sound.

One approach would be to take a somewhat left-libertarian angle and say that climate change represents injustice due to an over-enclosure of the atmospheric commons. Edwin Dolan took this approach in his essay, "Science, Public Policy, and Global Warming: Rethinking the Market Liberal Perspective." Dolan wrote:

Liberalism in America, in particular, grew up in a Lockean state of nature where it was really true, or at least seemed true, that homesteaders, loggers, grazers, and industrialists could take what they needed while leaving "enough and as good for others." What the environmentalist side of the global warming debate is telling us is that we no longer live in such a world.

Because those responsible for climate change have, according to Dolan, taken more than their fair share, they must be subject to the demands of justice. He insists, "Defending the rights of property that has been unjustly acquired is a conservative position, not a liberal one."

But this approach has its difficulties. One problem is the fact that the atmospheric CO2 sink is not really a limited resource. The problem is not that "...the atmospheric commons - namely, the Earth's carbon absorbing capacity - are finite and depletable," as Tariq Banuri and Erika Spanger-Siegfried characterized it in their essay "Equity and the Clean Development Mechanism: Equity, Additionality, Supplementarity." As far as we're concerned (though technically this isn't true), we can dump as much CO2 into the atmosphere as we want. It's not like one day we'll light a fire and the CO2 won't go into the atmosphere. The thing that's available in limited quantities is the atmosphere's capacity to absorb CO2 without causing any harm.

In light of this fact, the right way to allocate the resource in question is somewhat unclear. In a world in which we do exceed the total CO2 emissions we could release without causing objectionable climate change, what is the real significance of the amount of CO2 which we could have emitted without causing harm? This, I think, is a problem which reflects the fact that climate change is an emergent problem, and is therefore sort of different from other problems we normally face.

Of course, even if we figure out the significance of this "harmless sink capacity," there still remains a boatload of work to do in order to determine exactly who is responsible for what emissions, what rights are violated by climate change, whether non-rights-violating actions can be justly interfered with, what exactly we should hold people accountable for, who should bear what burdens, what accountability entails, what our accountabilities to future people are and how they should be enforced, and how we should administer all of this (I'm sure I'm leaving stuff out). Never mind the scientific uncertainty plaguing every step of the process.

At the end of the day, we can talk all we want about the market figuring out the answers to climate change through incentives for the enforcement of justice, but someone's going to have to figure this stuff out. If it can be done, hopefully I'll be able to figure out how, or at least set the process in motion for other people. I really hope that answers your question somehow!