Out-of-Focus Thinking on Caps vs. Carbon Taxes

It's not every day that a war breaks out on the Internet over the relative virtues of a carbon tax versus cap and trade, but today is one such day. And in my role as Christian knight, I rush to the defense of poor Robert Samuelson, getting picked on by economists (or economist wannabees, if you can imagine such a grotesque creature!) who really aren't doing much besides muddying the waters themselves.

The cause of the recent hostilities was Robert Samuelson's Washington Post op ed, where he listed some objections to a cap and trade program--namely, that it would encourage more rent seeking and give the government more arbitrary power, than a straightforward tax on carbon would. These are both standard arguments, and they're why most economists would prefer a tax to cap and trade. Then in his concluding paragraph, Samuelson writes the passage that really set the hornets off:

Unless we find cost-effective ways of reducing the role of fossil fuels, a cap-and-trade system will ultimately break down. It wouldn't permit satisfactory economic growth. But if we're going to try to stimulate new technologies through price, let's do it honestly. A straightforward tax on carbon would favor alternative fuels and conservation just as much as cap-and-trade but without the rigid emission limits.

As I say, this last passage set off people, such as Ryan Avent (I have no idea who he is, by the way; so maybe if I read regularly, I would love him). In a post entitled, "Robert Samuelson Drinks Deeply From the Cup of Stupid," Avent writes:

Yowza. As any economist worth his or her salt will tell you, a cap and trade plan with auctioned permits is essentially identical to a carbon tax.

Brad DeLong thought this was great stuff, and so did some other people.

Tyler Cowen came to Samuelson's defense. Among other things, he pointed out that Avent is wrong when he says economists see no difference in the systems; actually, most economists who have an opinion favor a tax. (And even if they favor a cap and trade, it's probably because it's politically feasible, which isn't really about the nature of the two systems.)

So you'd think at this point that these economists and economist wannabees would cut their losses. Nope.

Brad DeLong posted in the comments on the MR blog, and then more formally on his own site, that at the "first order" a cap and trade is equivalent to a carbon tax. Then as you go into the higher orders, they start differing.

OK that's fine, Prof. DeLong. I buy your hierarchy. I point out that Samuelson's points all are true, as you put them in various levels of your hierarchy. Not surprisingly, Samuelson focused on the areas where the two systems differed in his column, rather than on the areas in which they were equivalent. And it's true, he didn't spell out which "order" a given difference was, since nobody but an academic would talk like that.

So, Brad DeLong, who approvingly linked to someone calling Samuelson dumb and ignorant, is conceding that Samuelson is right. Note DeLong didn't say (after being corrected by Cowen), "No, Samuelson said something that is false." Rather, DeLong said, "Oh right, we trained economists know that's the case, but I didn't see it spelled out in the Washington Post op ed the way it was in Weitzman's classic paper." (You think I'm exaggerating. That's basically what DeLong said on the MR thread.)

And then they just keep digging. DeLong credits Megan McArdle for "moving the ball downfield on cap and trade." I.e., she is making great progress clarifying this tricky area for novices. But here's what she has to say:

Ryan Avent has been doing some great posting on cap and trade versus carbon taxes. With all information known, the two are theoretically identical. But in the real world they will differ; the question is how much.

One way to think about it is that we are choosing between two kinds of transparency: transparency to regulated companies, and transparency to voters. Politicians like cap and trade because the connection between the plan and higher energy prices will be less obvious to the voters. For that reason, a libertarian should generally prefer a direct tax.

On the other hand, cap and trade provides more certainty for companies, and a more direct relationship between their actions and profits. So the tax is not always a perfect slam dunk.

Again, I just want to point out that what McArdle has done here is give the opposite view of how most economists would assess the two. One of the virtues of the carbon tax is that it is known beforehand. The government can print out a schedule for what the carbon tax will be through 2050.

On the other hand, if you know the total cap, and even how many of the permits you'll be issued for free each year, as a company you still have to forecast what the market price will be for the permits. So there is an extra source of uncertainty. (Yes, the tax could change after the politicians change their minds, but then so could the cap. The point is, even if there are no legislative changes, you still can't plan as well under cap and trade compared to a tax.)

Like I said, this isn't a tangential issue. If you had asked me yesterday to summarize the differences between a carbon tax and cap-and-trade, I honestly would've mentioned that a tax gives more certainty to businesses.

And not only did McArdle botch this point, but DeLong is praising her for it.


  1. Anonymous7:33 PM


    Did you go to DeLong's site and blow him up?

    It might be a nice notch in your belt (or is it gun, I can't remember).


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