31 December 2009

Will Cap-and-Trade Work?

Posted by Admin under: Cap & Trade; Carbon Tax; Evolution; Forum; Future; Science; Sustainability .

A couple of years ago I suggested to Frank Felder, Director of Rutgers’ Center for Energy, Environmental, and Economic Policy (CEEEP), that we co-sponsor a debate on the relative merits of cap-and-trade vs. a carbon tax. The idea went nowhere, because the conventional wisdom, then as now, is that anything with the word “tax” in it is a political nonstarter.

I thought this was shortsighted then, and think it is still short-sighted now. If we fail to discuss what may be better alternatives because they are not politically popular, they will never get the chance to become widely considered, and we will have allowed a self-fulfilling prophecy to dictate our fate. Political acceptability is an important factor in choosing a course of action. But it is not the only one. If a carbon tax (or, as some prefer to call it, a “fee”) is a better approach, then we need to figure out how to make it palatable. And if cap-and-trade will, as others claim, do more harm than good, then we need to consider how to de-legitimize it.

On the other hand, it is also important to address what actually is the political reality. As Paul Krugman states, “we have a real chance of getting a serious cap and trade program in place within a year or two. We have no chance of getting a carbon tax for the foreseeable future. It’s just destructive to denounce the program we can actually get — a program that won’t be perfect, won’t be enough, but can be made increasingly effective over time — in favor of something that can’t possibly happen in time to avoid disaster.”

We may want things to be otherwise, but the only way things can change is to change from the way they are now. We don’t want the perfect to be the enemy of the good, because our only purpose in seeking the perfect is to drive the transformation of the system in the right direction in the first place.

Moreover, it’s possible that different approaches can coexist and even reinforce each other. While we are debating the issue as if cap-and-trade and a carbon tax were alternatives, and indeed the only alternatives, Sarkozy is trying to add a French carbon tax to the already existing EU carbon trading system. Why can’t we advocate for both, and try to make each of them work the way they are intended to?

Some colleagues and I have been debating this topic for the past week or so, so I guess in some sense the public discussion has been re-ignited. And it certainly doesn’t hurt that Annie Leonard, the creator of the widely-acclaimed The Story of Stuff, has just released The Story of Cap and Trade. She’s already been criticized for numerous falsehoods and oversimplifications – see Cataloguing the Errors in “The Story of Cap and Trade” for one example – but The Story of Cap and Trade is probably going to do more than all the academic assessments in getting people to start asking the hard questions about what we’re getting ourselves into. Of course it’s oversimplified; but it’s also engaging and entertaining, and that’s the point. And in the last few weeks, as Copenhagen has come and gone with plenty of hope but also plenty of disappointment, some pretty heavy hitters have gotten into the act as well.

Paul Krugman’s critique of Jim Hansen’s position against cap-and-trade led me to look more closely at what Hansen is really arguing, and at what is increasingly being debated in the most advanced technopolitical circles.

What Hansen is advocating is “an alternative solution called fee-and-dividend, which would impose a fee on any pollution source (mines, ports of entry) and distribute the revenue back to the public. Both fee-and-dividend and cap-and-trade attempt to reduce carbon emissions by raising the price of fossil fuels, but Hansen insists the former is simpler and less vulnerable to speculation and gaming.” (James Hansen: Good Riddance, Copenhagen. Time for Better Ideas, Yes! Magazine, 22 Dec 2009)

Paul Falkowski, head of the Rutgers Energy Institute, stated on December 24 that “Cap-and-trade is a pretty lousy idea.” (New Jersey scientists oppose cap-and-trade, support carbon tax, NewJerseyNewsroom.com.)

“It doesn’t reduce emissions in the near term, and we have to reduce, not just keep emissions steady. If we put a cap on and start trading, we’ll slowly get off a carbon diet, but it’s not going to be a steep curve, and it’s going to be painful.”

And Dr. Karina Schäfer, a Rutgers ecosystem scientist and coordinator of Rutgers climate studies, also expressed an obvious real-world concern:

“Cap-and-trade will be the next bubble. We’ve seen how unstable the financial and housing markets are – we’ve watched them increase and crash. Do we want to have the earth’s climate rely on those instruments?”

Falkowski favors “a simple carbon tax,” according to the article. “It costs ‘x’ amount of money to put ‘x’ amount of carbon in the atmosphere, and everybody pays that cost. We know the sources of oil everywhere in the world and how much oil is put on the market every day – futures trading is based on it. We know most of sources of coal and every major supplier of natural gas. We can tax the suppliers.”

Bill Wolfe, founder of NJ PEER (Public Employees for Environmental Responsibility), who is perhaps NJ’s most perceptive environmental critic, takes issue with Krugman, and states:

“There is much confusion about the issue of regulatory mandates versus market based cap/trade. Supporters of cap/trade mistakenly claim that a cap/trade for GHG can work by pointing to the EPA acid rain cap/trade program which effectively reduced SOx pollution from coal power plants by 50%. This is a false analogy because the SOx cap/trade program was backed by EPA legal mandates and enforceable State Implementation Plan (SIP) and plant specific air permit limits under the Clean Air Act. There were no “offsets” and “leakage” for SOx and only one discrete source: coal power plants. None of that is true for GHG emissions from coal plants and other sectors and sources. A market approach can not work without enforceable standards and legal mandates.”

Bill Wolfe, incidentally, has also documented many of the flaws in the Regional Greenhouse Gas Initiative (RGGI), that NJ touts as a successful cap-and-trade program, and is not afraid to call a spade a spade, and speak truth to power as he sees it, at his remarkable and prolific Wolfe Notes.

Michael Aucott, who is a more cautious, highly respected scientist currently at DEP, essentially agrees:

Krugman’s critique of Hansen’s well-reasoned essay repeats the fable that the acid rain program proves that cap and trade works. In fact what has worked is acid gas control technology, low sulfur coal, and shifting from coal to natural gas.  Europe has cut its emissions of SO2 as much or more as the U.S. without a cap and trade program through its Gothenburg Protocol.  (This has the cap part, but skips the trade part.)  And, on neither continent has the acidity of precipitation been reduced to the degree necessary for long-term improvement of sensitive environments.

For a vigorous discussion of carbon taxes and their benefits, see http://www.carbontax.org/.

In my view Krugman is also off target with his recent pronouncements that the cure to the industrial world’s economic malady is more stimulus. This is almost certainly a wrong approach because of peaking (it may have already peaked) global petroleum production and the inexorable rise in the cost of energy that will result.  The industrial economy is built on cheap energy and the promise of continued growth of same; things are different now and the old economic models that Krugman was reared on almost certainly won’t  work.  For an interesting recent critique of Krugman’s statements on the economy see James Howard Kunstler’s blog post, “Courting Convulsion.” I have started a blog where I discuss these issues also – michaelaucott.blogspot.com.

Reading Kunstler’s piece led me to a remarkable YouTube video in which two EPA lawyers speak out against cap-and-trade,  The Huge Mistake. And this in turn caught my eye in passing during the video:

Cap-and-Trade’s Unlikely Critics: Its Creators
Economists Behind Original Concept Question the System’s Large-Scale Usefulness, and Recommend Emissions Taxes Instead (For the full article see http://online.wsj.com/article/SB125011380094927137.html.)

…[Thomas] Crocker [the University of Wisconsin graduate student who came up with cap and trade idea in the 60s] sees two modern-day problems in using a cap-and-trade system to address the global greenhouse-gas issue. The first is that carbon emissions are a global problem with myriad sources. Cap-and-trade, he says, is better suited for discrete, local pollution problems. “It is not clear to me how you would enforce a permit system internationally,” he says. “There are no institutions right now that have that power.”

Europe has embraced cap-and-trade rules. Emissions initially rose there because industries were given more permits than they needed, and regulators have since tightened the caps. Meanwhile China, India and other developing markets are reluctant to go along, fearing limits would curb their growth. If they don’t participate, there is little assurance that global carbon emissions will slow much even if the U.S. goes forward with its own plan. And even if everyone signs up, Mr. Crocker says, it isn’t clear the limits will be properly enforced across nations and industries.

The other problem, Mr. Crocker says, is that quantifying the economic damage of climate change — from floods to failing crops — is fraught with uncertainty. One estimate puts it at anywhere between 5% and 20% of global gross domestic product. Without knowing how costly climate change is, nobody knows how tight a grip to put on emissions.

In this case, he says Washington needs to come up with an approach that will be flexible and easy to adjust over a long stretch of time as more becomes known about damages from greenhouse-gas emissions. Mr. Crocker says cap-and-trade is better suited for problems where the damages are clear — like acid rain in the 1990s — and a hard limit is needed quickly.

“Once a cap is in place,” he warns, “it is very difficult to adjust.” For example, buyers of emissions permits would see their value reduced if the government decided in the future to loosen the caps….

… Another economist, David Montgomery, advanced their ideas in the 1970s, converting their theories into the complex mathematical formulas to demonstrate that they weren’t merely an idea but were also economically feasible. Mr. Montgomery, too, is a skeptic of cap-and-trade for greenhouse gases. He prefers an outright tax.

“You get huge swings in carbon prices with a cap, which creates more volatility and uncertainty for business,” he says…

If even the people who came up with the idea don’t think it will work, shouldn’t we be advocating abandoning it?

An even more damning critique has also just been published in the UK:

Why Carbon Offsetting Will Not Save the Planet
Press release: 1 December 2009

Global carbon markets may well have been hailed as the saviour of the planet by reducing greenhouse gas emissions, but in many ways they are doing more harm than good, according to new evidence. In fact, two academics from the University of Essex argue that measures put in place to reduce carbon emissions following the Kyoto Protocol on climate change have only made matters worse.

Launched to tie-in with the United Nations Climate Change Summit in Copenhagen (COP15), Dr Steffen Böhm and Siddhartha Dabhi’s new book, Upsetting the Offset: The Political Economy of Carbon Markets, challenges the environmental claims made about carbon markets and carbon offsetting schemes. The book – which collates contributions from more than 30 leading experts – is another voice in the growing criticism about the business of carbon and how it has failed to deliver promised reductions in greenhouse gases.

Few would argue that climate change is the biggest challenge the world has ever faced, and reducing our carbon footprint is essential to the future of the planet. Carbon offsetting has become a multi-billion-dollar global business which has captured the imagination of organizations worldwide who want to do something to help combat global warming. The reality, however, is that many of these schemes have actually made matters worse.

Dr Böhm and Mr Dabhi, of the University of Essex-based Essex Business School, advise governments, businesses and other organizations to reduce their carbon footprint by undertaking initiatives closer to home than funding carbon offsetting programmes in deprived countries thousands of miles away.

‘Carbon offsetting and carbon markets haven’t really delivered the reductions of greenhouse gas emissions they claimed and in many ways have just made the problem worse,’ they explained. ‘These schemes have often just provided an incentive for big polluting companies to continue emitting greenhouse gases rather than to change their ways.’ ‘Often, carbon offsetting schemes have very negative effects on local communities and ecosystems in developing countries.’

The book contributes to a growing field of critics of carbon markets by highlighting several up-to-date examples of where the system has failed and often led to negative social, economic and environmental impacts in deprived countries.

‘Carbon markets simply don’t address the underlying and root causes of climate change, which is an over-consumption of finite fossil fuels,’ added Dr Böhm and Mr Dabhi. ‘We are addicted to oil, gas, coal and a whole range of other fossil fuels, which, when burned for heating, electricity generation or other usages, release greenhouse gases. It is now time to make up for the lost decade since Kyoto and start to deal with our underlying reliance on fossil fuels.’

At the same time, I would argue that it’s worth looking at what might allow a cap-and-trade system to operate as effectively as a tax, or whether it can be accompanied by one. Most of the arguments against the cap-and-trade approach are practical ones, not theoretical ones: they boil down to “it won’t work to reduce global emissions,” not “it can’t work because it’s intrinsically flawed.” Josh Polsky makes the point, for example, that cap and trade does not necessarily mean the same thing as offsets, which is where a lot of the criticism is focused. And my colleague ISE Research Fellow Matt Polsky (Josh’s dad) points out that “some of the anti-cap & trade arguments miss the point, and are equally valid against a carbon tax.”

This suggests at least the possibility that for every valid criticism of cap-and-trade there is, or should be, a fix. For example, if the economic damage from climate change is difficult to estimate, then we could, as a precautionary measure, use the highest plausible estimate of such damage to determine the cap.

According to Climate Progress, a project of John Podesta’s Center for American Progress, after some initial problems the European trading system has worked, and offers lessons for U.S. policy makers:

Since 2005, Europe’s cap-and-trade system has established a carbon market worth €40 billion (US$56.6 billion) annually and, despite initial stumbling blocks, has reduced emissions by 50-100 million metric tons of CO2 per year (or by around 2.5-5%). Simultaneously, European businesses benefit from Europe’s transition to a carbon-free economy since “the EU ETS has increased overall profitability in all participating sectors” while supporting a sizeable boom in clean energy jobs in spite of the global recession.

They cite a report by the German Marshall Fund of the United States, which states that:

MIT estimates that the EU ETS has cut European emissions by 120–300 million metric tonnes of carbon dioxide (MtCO2) during its first, highly imperfect phase—up to 5 percent of emissions from the covered sectors, despite excessive allocations of emissions allowances. It captured private sector attention like no other climate initiative, and its rapid introduction and impact contrasted with a decade of dispute over (failed) attempts to introduce a European carbon tax.

Since it seems likely that we will get a cap-and-trade system sooner than a tax (or “fee,” as some prefer to call it), what characteristics would make such a system better than the ones that have been tried, and what are the leverage points for amending it? The GMF report, “Climate Policy and Industrial Competitiveness: Ten insights from Europe on the EU Emissions Trading System,” offers some detailed recommendations as to how to get it right in the U.S. Critics of cap-and-trade need to address an optimally-designed system, not one that is obviously loaded with loopholes and giveaways.

Krugman may be wrong that emissions taxes and cap-and-trade are “essentially equivalent in their effects.” This is only true if you have the economist’s blinders on. But surely he is right in his pragmatic conclusion, cited above: that “we have a real chance of getting a serious cap and trade program in place within a year or two. We have no chance of getting a carbon tax for the foreseeable future. It’s just destructive to denounce the program we can actually get — a program that won’t be perfect, won’t be enough, but can be made increasingly effective over time — in favor of something that can’t possibly happen in time to avoid disaster.”

I still believe it’s better to argue for the better solution – just as I was disappointed when Obama and the Democratic leadership took “single-payer” off the table – but it’s equally important to get the best outcome that’s available at the time. If this means leaving the private insurance companies in place but regulating them, or having a cap-and-trade system that needs to be continuously tinkered with, evaluated, and eventually reformed or replaced, so be it. Action (which at least acknowledges that yes, we have a problem) is better than inaction, which has us continuing to head toward the edge of the cliff. Even if, as Kunstler claims, we are already out over the abyss and just don’t know it, surely the proper response is Hawken’s: “Do what needs to be done, and check to see if it was impossible only after you are done.”

At the beginning I asked, why can’t we advocate for both, and try to make each of them work the way they are intended to? Surely each of them has to be designed correctly in any case; an ill-conceived tax will fail just as surely as a poorly-designed cap-and-trade system. The question is not, “will it work?” but “how can we make it work?” If we use this as our starting point, and perhaps advocate for a carbon fee as well, we’re effectively saying: we have to put a premium on reducing carbon. You can do it because it’s good business, or you can do because it would be bad business not to. The critical thing is to put both the incentives and the disincentives in the right places to foster the outcome we need, while still leaving the market free to innovate and to expand the range of sustainable technologies at our disposal.

Groups like Carbon Trade Watch, a project of the Transnational Institute, should and will continue to point to the flaws in the cap-and-trade system, especially from an international standpoint; but we should regard the GMF’s reference to “a decade of (failed) attempts to introduce a European carbon tax” – not to mention the initial defeat of Sarkozy’s plan – as a warning that the wrong kind of debate (which we’ve seen too much of already in the global warming arena) could certainly delay if not entirely derail U.S. action.

In the long run, we also need to change our behavior and live more in harmony with our environment, which often means looking for alternatives and both-and solutions. Nature thrives on diversity, and constantly finding new solutions to challenging circumstances. So will we, if we put our not inconsiderable minds to it. After all the debate, however, it still seems to me that we’ve really only started to do this, and that there’s a lot more work to be done on implementing either or both systems, whether nationally or in New Jersey.

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