Thursday, March 19, 2009

On reducing carbon emissions

With control of the White House and Congress both in the hands of Democrats, combating climate change is on the agenda. The Obama administration seems likely to attempt to set up some sort of Cap and Trade scheme for carbon emissions, but while, I fully support the goal or reducing emissions, I hope they will reconsider their approach.

Cap and trade introduces unnecessary uncertainty and government interference in reducing greenhouse emissions. Not only does it require that the government choose a suitable level of emissions for the country, it introduces the possibility of wild price fluctuations due to speculation and a lack of responsiveness of the total available quantity of emissions to external economic shocks. Businesses may suddenly face massive increases in costs, or conversely investments in emissions-reducing technologies may prove unprofitable as the price of emitting a tonne of CO2 falls. A carbon tax solves all these problems.

Ultimately the decision comes down to one thing: The government must establish either a price or quantity of emissions and let businesses respond by choosing the other. If the government sets up a cap and trade scheme, it is choosing the quantity and allowing the price to fluctuate (possibly wildly) even though the environmental damage done by a tonne of CO2 does not change regardless of whether its emitter paid $2 or $100 for the privilege. On the other hand, if scientists can get a rough estimate of the damage done, the tax can be set that lets businesses and consumers decide which activities and products are worth it and which aren't, and thus set a level of overall emissions that balances environmental protection with its economic impact. Even if the exact damage can't be quantified the tax could be gradually increased in a predictible way up to a level that does not impose undue burden on the economy.

A carbon tax best allows businesses to decide how much CO2 they should emit, by weighing the potential profits against the environmental consequences (conveyed to them in tax form). It also allows for a stable price for those emissions so that businesses can adequately make future plans and investments without facing yet another layer of uncertainty, and it is almost certainly easier to administer for all parties involved.

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