Even if simplicity is the only criterion, cap-and-trade might still be the best bet

By Gernot Wagner, Nathaniel Keohane, October 10, 2008

Any system clearly needs to be well-designed. On that point, we all agree. The question then becomes whether a cap-and-trade system or a tax would allow for the best possible system to be put in place. We’ve already argued that a cap would be much more preferable on environmental grounds. So now we’ll turn to simplicity.

Janet Milne has argued that a tax would be simpler than a cap. We disagree. The reason that a tax seems simple is that no one has proposed the detailed kind of tax that Congress would actually pass. After all, the Lieberman-Warner climate legislation considered by the Senate in June started as a two-page skeleton outline, which, in our estimation at least, seems simple enough. It’s the process of getting a bill to the point where it will attract 60 votes that makes it complicated. (The U.S. tax code encompasses nearly 17,000 pages for a reason.)

Another common pro-tax argument is that a tax would be easier to administer and monitor. But cap-and-trade programs impose exactly the same emission-monitoring requirements as taxes. As David Weisbach points out, what affects monitoring costs is rather the “point of regulation.” Under a cap-and-trade system, tradable allowances can be defined with respect to the carbon content of fossil fuels, and the allowances collected “upstream” from petroleum refineries and natural gas distribution hubs. In fact, that’s exactly what the Lieberman-Warner cap-and-trade legislation proposed. Additionally, the costs of monitoring end-of-smokestack carbon emissions are pretty low–especially since virtually every U.S. power plant already has continuous emissions monitoring technology installed, collecting hourly carbon emissions data. (See for yourself at the EPA’s eGRID data website.)

Finally, tax advocates claim that a cap-and-trade system will require an onerous administrative bureaucracy. It’s true that cap-and-trade requires the creation of tradable instruments and a tracking system to monitor trades. But the costs of such a system would be small for two reasons. First, the system is already in place for electric power plants, thanks to the sulfur-dioxide trading system–these plants are a major contributor of carbon emissions. And second, experience from that program shows that the administrative costs associated with the emissions market amounted to an upfront cost of at most $20 million, along with something on the order of $70,000 annually–a tiny amount of money in a market with total compliance costs of more than $1 billion. Conversely, the bells and whistles tax advocates suggest to patch the holes in a carbon tax–i.e., refund systems to credit carbon sequestration, something that would be unnecessary in a cap-and-trade system–would only increase the tax’s administrative costs.

Indeed, keeping things simple should be a prerequisite–although certainly not the most important one. The most important goal is preservation of the environment. That is, after all, the reason we’re debating this issue in the first place. Yet, even if simplicity was the only criterion in this debate, a cap might still come out ahead.

Topics: Climate Change


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