Devils, details and cap-and-trade
A year ago, I was firmly on the fence with regard to carbon taxes versus cap-and-trade systems. My internal conversation was around abstract, theoretical versions of what might happen, and at that point it was premature to consider how the two might play together as part of a hybrid system. Since that time, we now have some real models to consider: the BC carbon tax and the Western Climate Initiative cap-and-trade system. The latter has released draft final recommendations and is aiming to have final recommendations by September.
My preferences have steadily drifted in the direction of a carbon tax over cap-and-trade, and the more I hear about WCI the more I like the carbon tax. To be clear: I do not think a carbon tax alone gets us there, but should be one part of a broader strategy that includes standards, regulations, public investments, just transition programs and alternative technology development and diffusion. A rising price signal through either a carbon tax or a cap-and-trade system matters, but nor is it a Paul Hawken “get the market prices right and natural capitalism will rescue us” story.
The Sightline Institute has a series of overview posts on the emerging WCI that are worth reading as a primer to a very complex system that has many outstanding issues to be resolved between now and the final recommendations. Things may break perfectly and the resulting system could be workable, but I’m increasingly skeptical about getting there. The main point is that we may not like the final product, and it is troubling that some political parties have staked so much on supporting cap-and-trade.
The key advantage, in theory, of cap-and-trade is the cap. One serious shortcoming in WCI is the draft recommendation on offsets, which would allow for a substantial amount of the emissions “reduction” to be achieved by financing projects in the South or elsewhere outside the WCI region. This means that the system may not in fact reach its “cap”. And offsets are problematic in general: rather than moving ahead with bona fide projects that lower GHG emissions, these projects just end up validating unsustainable emissions. There are also huge issues in monitoring and enforcement to be sure that funds are actually delivering those GHG reductions.
Monitoring and enforcement issues also cloud a cap-and-trade system’s overall effectiveness. Assmmetries of information means ample opportunity for corporations to game the system or just plain cheat. In the EU’s Emissions Trading System, this is just what happened, as companies bulked up their reported emissions prior to the system coming into place. Related to this is how sanctions would be delivered: if a company exceeded its emissions and there were no permits to buy, it might have to pay a penalty per tonne above the cap, which is effectively a carbon tax. Again, in this latter example, we may not actually reach the cap.
Timing is also of the essence. The nice thing about the BC carbon tax was that it was able to cover 70% of domestic emissions simply by changing the Motor Vehicle Tax Act. The tax was announced in February, budget secrecy was maintained, and by July the system was in place. There is the matter of the remaining 30% of emissions and some action is needed to ensure the tax covers them, too, as was recommended in yesterday’s Climate Action Team report to the BC government (the CAT is an independent body tasked with filling the gap between the government’s current climate plan and the 2020 target of a one-third reduction in GHG emissions relative to 2007 levels; the report is rather underwhelming; see this post).
But compare this to the WCI, where the system will not even begin until 2012, and only starting in 2015 will a bunch of key sectors be covered. So we will not even know if it is working until 2020 or so. And it seems to me that we need more, sooner.
Another major issue, from a fairness perspective, is around how permits are allocated. If all permits are auctioned, this is roughly equivalent to a carbon tax and governments can use the proceeds to offset regressive price impacts on consumers, or fund other climate policy measures. In the previous draft of recommendations, it was suggested that 25-75% of permits could be auctioned; those numbers have been removed from the current draft final recommendations, meaning there could be very little or no auctioning at all. This would be bad, very bad, from a climate justice perspective.
One option for merging the two would be for the carbon tax to be a base paid by all emitters of GHGs, while a cap-and-trade system was imposed on top of that for large industrial emitters. For those included in the system, the price of permits would simply be net of the carbon tax, and the carbon tax would effectively set a price floor (hat tip again to Sightline, see here). But given that tax is a four letter word in most jurisdictions, cap-and-trade may be the second-best option. I just hope we do not waste a decade on a system that ultimately does not work.
All of that said, BC’s carbon tax is not perfect and could be even better. First, the tax must be high enough to be effective and should cover all emissions, including process emissions from cement and aluminum, oil and gas (leaks from pipelines, all flaring), and bioenergy production (one final outstanding area, emissions from landfills, is being covered by regulations). Wood burning and bioenergy (generating electicity from wood burning) is an odd loophole â€“ these emissions are not part of the formal calculations in Kyoto because a tree over its lifecycle is technically carbon neutral. But emissions are emissions, and by including wood burning, we would avert a perverse situation where people stop using natural gas in favour of burning wood, potentially releasing more emissions but not having them count (the Climate Action Team also made a recommendation along these lines, though because they do not count, the government could safely ignore it as it would not undermine the 2020 target).
In order to be more effective, the carbon tax should be increased to $30 per tonne with annual increases to reach a level of $100 per tonne by 2020. These numbers may need adjustment, too, depending on how well we do towards meeting our targets â€“ annual targets for emissions, a “cap” if you will, should be part of the system.
I would like to see people with low to middle incomes have real options for changing their behaviour, and they should be no worse off under any carbon pricing scheme as a central principle. Half of the revenues should go into either a per household transfer, or alternatively, an AFB-esque refundable green tax credit with fairly broad coverage (more like the Old Age Security or Child Tax Benefit model than the GST credit upon which the current green credit is based). I’m starting to lean more in favour of the per-household transfer as it essentially proxies the idea of carbon quotas, but with dollars instead of a bank account of GHGs and the added infrastructure that would require.
I would break with revenue neutrality, which is a political consideration above all else. The remaining half of carbon tax revenues should provide funds for major transit expansion, transition programs for workers, energy efficiency improvements for low- to middle-income families, and an alternative technology development program.
Similarly, I would break with â€œtax shiftingâ€, a concept that has little traction with the public and is bad public finance because at some point in the future we want revenues to fall because we are doing such a good job a at reducing emissions. So while I would keep the transfer/credit system, no further PIT and CIT cuts would be financed by carbon tax increases. Write-offs of capital investments in emissions-reducing technologies, in lieu of existing Capital Cost Allowance, could be part of the package for the business sector. Similar write-offs could be contemplated for personal income taxes, though ideally with an increase in top rates and a new high-income bracket for income above $150,000.
[This post thanks to about 20 people who joined in yesterday for a CCPA workshop on carbon pricing. The discussions there have further shaped my evolving thinking on this topic.]