Tag: carbon trading

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Economics Environment Politics & government

[2123] Of Abbott’s plan is suspiciously boilerplate-like

Climate change has been very much the heart of Australian politics at the federal level for the past few months. It is the source of intense debate between the Labour government and the Coalition opposition. Within the Liberal Party itself, the proposed cap and trade arrangement has divided the party. Tony Abbott successfully replaced Malcolm Turnbull as the new Liberal leader exactly because of this issue.

The Turnbull fraction is prepared to work with the Rudd government on the cap and trade proposal. Others, perhaps, now called the Abbott fraction, do not. With Turnbull out and Abbott in, the cap and trade proposal has been scuttled in the Australian Senate.

On the front page of The Australian yesterday, Abbott made known a curious position. He accepts the challenges climate change poses and he accepts emission targets that Turnbull agreed to. What he rejects is any introduction of tax, as direct as carbon tax or as indirect as cap and trade scheme. In his own words, “[t]he Coalition will not be going to the election with a new tax, whether it’s a stealth tax, the emissions trading scheme, whether it’s an upfront and straightforward tax like a carbon tax.” In its place, he proposes implementing “land management and energy efficiency measures.”[1]

This is a curious position because I am grappling to see how his plan could achieve the reduction target he agreed to. Land management and efficiency measures sound like a boilerplate idea that lacks substance.

Despite actual inferiority of cap and trade to carbon tax, if done properly, it could be as effective as the simpler carbon tax. Land management and efficiency measures on the other hand will demand maneuver more complex than cap and trade.

In fact, complexity of a scheme makes it more susceptible to higher probability of failure. That happened in Europe with its version of cap and trade. One major feature that is attributable to European failure is the granting of free permits. Free permits arrangement is present in Rudd government’s proposed cap and trade scheme.[2]

Furthermore, Abbott’s measures appear similar to the Bush administration’s proposal of encouraging development of technology to address the need to manage carbon emissions in form of the probably now forgotten Asia-Pacific Partnership for Clean Development and Climate.[3]

Technology is indeed the golden bullet. It can reduce emissions given a unit of activity. Of course, the technology is out there: carbon sequestering, micro mirror in space, the spraying of aerosol in the atmosphere, nuclear power, wind, solar, etc. But which one?

That is the weakness of Bush’s proposal.

Any proposal has to be concrete with implementable actions, Abbott’s measures are mere boilerplate. It lacks substance. It lacks actual implementable measures.

Boilerplate solution is sorely inadequate.

Perhaps it is unfair to criticize Abbott’s measures since it is still early days. After all, he is less than a week old as the new leader of the Liberal Party and as the Opposition Leader. It may be only fair to give him the opportunity to think and present his idea more thoroughly.

Unfortunately, time is running out. This is not a tired old green rhetoric. Election may loom and the Liberals risk further marginalization if there are no concrete alternative solutions, especially since the new Liberal leader accepts the need for action.

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[1] — TONY Abbott plans to fight a climate change election using land management and energy efficiency measures to slash greenhouse emissions instead of an emissions trading scheme or a carbon tax.

[…]

Pressed for an alternative, he said the Opposition remained committed to an unconditional target of reducing emissions by 5 per cent by 2020 but would not embrace an ETS or a carbon tax. He said there were “lots of things” that could be done to reduce emissions through other means, many not involving significant costs.

These included more energy-efficient buildings, better land management and biosequestration. NSW Nationals Senator John Williams claimed Australia could offset 100 per cent of its carbon emissions for 100 years by lifting soil carbon by 3 per cent.

Mr Abbott also said he would welcome a debate on the use of nuclear energy, although he did not think it was a short-term option.

“The Coalition will not be going to the election with a new tax, whether it’s a stealth tax, the emissions trading scheme, whether it’s an upfront and straightforward tax like a carbon tax,” he said “We’ll have a strong and effective climate change policy, we’ll have it early in the new year,” he said. [Tony Abbott’s tax-free carbon plan. Matthew Franklin. The Australian. December 3 2009]

[2] — See Carbon Pollution Reduction Scheme at Wikipedia. Accessed December 4 2009.

[3] — The world’s four largest coal-consuming countries have announced a pact to share technology for limiting emissions of greenhouse gases. The US, China, India, Australia – plus Japan and South Korea – signed what is being seen as a rival to the Kyoto Protocol to curb climate change, which the US and Australia have refused to sign.

The new pact will be known as the Asia-Pacific Partnership for Clean Development and Climate. It allows the countries to set their own goals for emissions of greenhouse gases, with no enforcement measures. This is in contrast to the Kyoto Protocol, which requires industrial nations to accept legally binding emissions targets. [US-led emissions pact seen as Kyoto rival. Fred Pearce. Newscientist. July 28 2005]

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Economics Environment Politics & government

[2066] Of in Down Under revisiting carbon trading and carbon tax debate

Before I begin, I must admit that there is much reading for me to do to understand the current debate on carbon emissions trading in Australia. I have not been following Australian affairs as closely as I should; I am still stuck with the New York Times, the Wall Street Journal and to a lesser extent, the Washington Post. But each time I took a peak at least up until two weeks ago, either The Australian or the Australian Financial Review, emissions trading, and climate change at large, seemed to dominate the headlines.

Even on campus here at the University of Sydney, a number of posters critical of the scheme are up.

While the debate is unique to Australia in a sense that the Liberal and others out of government squabbling with each other — the odd thing is that, the Liberals, who under Howard administration was friendly to the idea (in fact, it was the Liberal government that first introduced the idea), and the Greens are against the idea of carbon trading, at least in its current form as proposed by Rudd government — as well as the fact that the government does not have enough vote to get it past unilaterally, the mechanism of the policy is largely the same.

There is even a possibility of a general election if the bill failed to be passed. It is a possibility because the general sentiment is that, if there is an election today, the Liberals are going to get further beating with the Rudd administration strengthened. WIth that strengthened government’s position within the Parliament, the bill can then be passed without much trouble.

I acknowledge the need to address negative externality associated with greenhouse gases emissions that massively contribute to anthropogenic climate change. I have written it about in the past. As a freshman and later as a junior at Michigan, I wrote two papers related to the issue, though not specifically on the trading scheme. The acknowledgement, really, is the reason what I identify myself as a green libertarian.

For the benefits of those unfamiliar with the term externality and alien to the field of economics, here is a short introduction to it. Externality is a market failure where individual or private cost does not correspond to social or public cost. As a simple demonstration, in a situation of no law against littering at all, an outsider littering in a public space effectively suffer no cost of doing so. The community living in that public space however does suffer from the cost associated with that littering. Somebody has to clean it up but the one causing it does not suffer the cost of cleaning it up. Instead, the community does. That misalignment of private and public cost is externality, or more precisely, negative externality.

Meanwhile, positive externality is where private action brings about public benefit. For instance, if a person has a collection of really good music and he plays it on the radio that he bought, positive externality is when you happen to sit close enough to him to listen to the music without paying anything for it. You get the benefit of good music. Here, he enjoys the music and you do too without paying. Of course, if he plays bad music, the situation immediately switches from positive to negative externality. He enjoys it but you risk deafness, and uncompensated at that.

A model known as Tragedy of the Commons is the most utilized model to impress the consequence of negative differential between private and social cost. In the model, there is a grazing field, henceforth called the commons. Headers of cows have their cows grazing the field freely because it is a commons and an unregulated one at that. It is then in the interest of the herders — assuming that there is little cooperation between them — to have their cows to graze the commons more and more. They compete for the use of the commons and this competition leads to overgrazing as everybody seeks to keep resources from the commons to themselves. Overgrazing then will turn the whole commons worthless as it is left dead without grass. In the end, everybody loses in the long run.

Greenhouse gases emissions is more or less like that. Economic progress in general and definitely in the current framework, requires consumption of energy and by and large, it produces greenhouse gases, in particular, carbon dioxide. Meanwhile, carbon emissions impose little cost to individual emitter, i.e. little private cost. Assuming that economic progress is desirable, it is in the interest of individuals to commit to progress and emit carbon. But if everybody continue to emit carbon, combined emissions contribute to climate change (I will not go into the science) and climate change imposes cost on all in the end, i.e. social cost. There is obviously more nuance — for example, the cost will not be evenly distributed and in fact, some may experience benefits from climate change; one example of such benefits is the opening of sea route up down in the Arctic Ocean — to the whole issue but that simplification here is done to show why carbon emissions phenomenon, which contributes to anthropogenic climate change, is a negative externality.

The solution to this negative externality or tragedy of the commons is to equalize private and social cost. This can be done by pricing the externality. In terms of climate change and carbon emissions, it means pricing carbon.

Two most popular solutions in mainstream discussions involve tradable quota (more popularly called cap and trade) and tax (carbon tax). The tax is also known as Pigovian taxes, named after a British economist that first proposed such tax to align private and social costs, Arthur Pigou.

By quota, it means assigning rights to emit to market participants and then letting these participants trading among themselves given their endowment. The typical setting is that the government gives (either freely or auctioned) certain amount of quotas to all industries (or even individuals) players. Once endowed with permits, all players are allowed to trade it so that these players can reach to their efficient level of emissions, given multiple constrain.

Carbon tax on the other hand is simply a tax on all activities that emit carbon. I am being sloppy with definition here because even human being organically emit carbon. The idea is to reduce carbon emissions from perhaps, mechanical and electrical operations, as well as one of commercial and industrial of nature. Here again, I am being sloppy but let us not dwell on the matter because that is not the reason for this long-winded entry.

Theoretically, the two methods are the same. A certain number of quotas or permits can have the same effect to a certain level of taxation.

However, political impacts of the two policy differ and most often than not, quota is the most the popular one because nobody likes to be taxed. Quota, despite its ability to imitate the impact of carbon tax, does not directly impose tax and therefore, less obvious in its impact. It is being considered in the United States and Australia — with great controversy in Australia — and it is already in force within the European Union.

The granting of quota however is a messy business vis-à-vis carbon tax. I warn though, much written below is not original. The issue has been debated over and over again by various individuals that trying to cite them may seem like trying to cite somebody just to indicate that the sky is blue.

Firstly, the granting of quota appears to be arbitrary. How exactly does the government determine how much quota a particular firm will get? Past emissions? Forecast emissions?

If it is past emissions, paraphrasing the efficient market hypothesis, past data does a bad job at predicting the future because it does not incorporate future data that are not yet available. If forecast is used, clearly the firm has the incentive to provide overly optimistic forecast that the imposition of quota does little or even nothing to align private and social cost.

Secondly, who should get the quota is a huge problem. Relative over-endowment of permits to certain players in the market and under-endowment to others may turn the whole scheme into an unfair wealth distribution exercise rather than a mechanism to reduce carbon emissions. Some firms may find it more profitable to trade permits rather than engage in productive activity.

Thirdly, the quota system is overly open to political compromise that it stops becoming an equivalent of a tax. This happens when quotas are granted freely such as what happened in Europe and may appear to be the case in Australia. Free quotas, coupled with the first issue, tend to render the whole exercise worthless that it is practically business as usual.

Fourthly, for tradable permits to become an equivalent of carbon tax, it needs to be auctioned. The problem is that, the auction component is almost never implemented. In Australia in its current proposed form, only a fraction will be auctioned while most will be given freely. In Europe, auction is a foreign term. In the US, 85% of the permits will be given freely, if the Senate passes the American Clean Energy and Security Act or more commonly called the Waxman-Markey Bill. The House of Representative narrowly passed the bill earlier in June this year. This is perhaps the cost of political compromised.

Fifthly, the auctioning, monitoring as well as the assignment of permits require a kind of bureaucracy which I am, as a libertarian, unwilling to see taking root. That bureaucracy will require resources to run, definitely more than mechanism for carbon tax demands for.

Carbon tax does not suffer from the complexity revolving around bureaucracy and distributive issues. Imposition of tax rate can be introduced uniformly. Sure, some will lobby to be hit with more generous levels of taxation or even request for downright exemption but compared to cap and trade method, carbon tax, even under compromised outcomes, is better. Unlike tradable permits which must be auctioned in order for it to be effective, tax imposes direct cost to carbon emissions to align private cost with social cost.

This is why I prefer carbon tax.

Categories
Economics Environment

[1392] Of economists love taxes, politicians love quotas

One of the main themes of the ongoing United Nations General Assembly is climate change but it is clear that the issue is receiving token attention and nothing more. The real debate on climate change is occurring outside of the four walls of the United Nations and it revolves around the effectiveness of two economic policies: carbon tax and quota. It is a question of how, not what or why anymore. The successor of the Kyoto Protocol, which is to be discussed later in December this year in Bali, Indonesia, is likely to center around the debate.

The Kyoto Protocol which is set to end in 2012 has several mechanisms aimed at reducing greenhouse gases emissions. Central to the mechanism is a method known as cap and trade; it is quota system (also known as carbon credits). Developed countries are given certain cap or amount of quotas and each divides those quotas as they see fit to entities within their boundaries. On top of that, these countries which are officially called the Annex 1 could reduce its reduction obligation by investing in clean technology in developing countries like China and Malaysia that will aid emissions reduction effort.

Alternative to carbon credit is carbon tax. While it has no sanction in the Kyoto Protocol, its end is the same as carbon credit.

The point of these two policies is to realign private cost with social cost. Under circumstances where only private cost is considered, imposition of tax will create inefficiency. When there is a divergence between social and private costs, imposition of tax however — or subsidy depending on the scenario — will create efficiency. The phenomenon of climate change is essentially the case of misalignment of social and private costs.

In a perfect world, the effects of quota and tax are the same but the methods differ. In the real world, unfortunately, it is more about politics than economics. This is reflected in the clear division of opinion between economists and politicians on the issue.[1]

On one hand, most economists prefer carbon tax over tradable carbon permit. Politicians on the other hand prefer cap and trade method to tax. The reason for the latter’s preference is simple: the idea of direct imposition of tax on the masses is very unpopular and could cost them votes. Economists prefer carbon tax simply because the method is simpler than what a quota system will demand. Most of all, economists do not need votes to do their work but politicians do.

Under the quota system, permits have to be distributed among entities. The problem of distribution is sticky and it has to appeal to the concept of fairness whereas such concept is hard to define. Mainstream economics itself has chosen to bypass the issue of fair equity altogether and concentrate on efficiency instead. Still, that does not prevent one from questioning how does one distribute those permits fairly?

The most common method is to use past information. An authorized distributor of permits, in this case the state, gathers emissions data of various firms and offer permits to players in various industries according to past volume. For instance, if a company emitted 1 ton of carbon last year, the company would get a permit to emit a certain ton of carbon this year to accommodate growth or to encourage carbon reduction. The problem with this method is that past information is not always helpful, if not helpful at all; historical data is a bad way to project the future. Worse, such method may be biased to stable industries at the expense of expanding industries.

Another method of permit distribution is most economists’ favorite: auction. Through this, apart from all the virtues of efficient market, the government will receive income.

Despite that, the method advocates by most economists so far is carbon tax. Carbon tax is to easier to manage because it does not need all the distribution setup that the permit system requires. Furthermore, the cap and trade method might suffer what the Kyoto Protocol is suffering now. The mechanism under Kyoto Protocol as practiced by the European Union is less than perfect because of permit inflation.[2] Participating countries have issued too much permits in the name of Kyoto Protocol. For this reason, many participants are expected to miss their reduction target. Of course, the same scenario is repeatable under carbon tax regime; too low a tax rate, we will see meager reduction.

For the successor of Kyoto Protocol however, the question of whom to collect the tax will be sticky. To have an United Nations-sanctioned entity to collect it might be tantamount to the idea of world government. That itself may receive considerable objection from various countries apart from the question of how should the money collected be spent. In order to circumvent the question, we could have a cap and trade mechanism to distribute quotas among countries. Based on the amount of quotas a country receives, the country could impose comparable tax on itself. That however may be less than desirable — it might suffer the weaknesses that Kyoto suffers — though internationally, more politically feasible.

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[1] — Too bad, then, that politicians seem set on a second-best route to a greener world. That is the path of cap-and-trade, where the quantity of emissions is limited (the cap) and the right to emit is distributed through a system of tradable permits. The original Kyoto treaty set up such a mechanism and its signatories are keen to expand it. The main market-based alternative—a carbon tax—has virtually no political support.

A pity, because most economists agree that carbon taxes are a better way to reduce greenhouse gases than cap-and-trade schemes. That is because taxes deal more efficiently than do permits with the uncertainty surrounding carbon control. In the neat world of economic theory, carbon reduction makes sense until the marginal cost of cutting carbon emissions is equal to the marginal benefit of cutting carbon emissions. If policymakers knew the exact shape of these cost and benefit curves, it would matter little whether they reached this optimal level by targeting the quantity of emissions (through a cap) or setting the price (through a tax). [Doffing the cap. The Economist. June 14 2007]

[2] — [An] audit showed that several EU governments had issued permits for 66 million tons more CO2 than was actually being emitted. Everyone realized that the supply of permits was not scarce, so the price of carbon promptly collapsed to less than 9 euros per ton. By February 2007, an allowance to emit a ton of CO2 could be had for less than a euro.

The woes of the EU’s carbon market are not over. In October 2006, all of the European Union countries forwarded their proposed National Allocation Plans for carbon dioxide emissions to the European Commission. It turns out that all of the countries, except the U.K., allocated permits for emissions that averaged about 15 percent above actual current levels. The EC’s environment commissioner, Stavros Dimas, warned: “If member states put more allowances into the market than are needed to cover real emissions, the scheme will become pointless, and it will be difficult to meet our Kyoto targets.” In other words, if there is no scarcity of carbon permits, then the permits are worthless, and there is no carbon market.

Many commentators argue that the last two years of turmoil are just the shakeout phase of a carbon market that will soon be robust. But the travails of the ETS highlight the fact that governments have every incentive to cheat. If they issue enough permits, their electricity companies will be able to generate power without adding to their costs—or the costs of their customers. And low energy costs give a nation’s businesses a competitive advantage over businesses in other countries. [Which Carbon Diet Works Better?. TierneyLab. NYT. May 26 2007]