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Critical Topics in the Debate

        The following text distinguishes the carbon tax-and-dividend from emissions trading.  The press release provides a useful summary. The sample resolution itself is an outline, with references below it.

Problems persist after auction of permits

        As explained in detail at the Carbon Tax Center, under “cap-and-auction” permits to pollute would be auctioned off by the government instead of given away as under cap-and-trade. Cap-auction avoids the billions of euros that are being given to polluters in Europe under cap-trade there. The resultant windfall profits do not motivate transition to renewable energy sources. In contrast, a tax would immediately motivate reductions in emissions.

        After the auction of permits, the “trade” would take place in the emissions trading market. As with cap-and-trade a portion of consumers’ energy payments would still be funneled into brokers’ retirement accounts via the trading fee. “Cap-and-auction” should be renamed “auction-and-trade”.

        This page addresses problems that persist for emissions trading, whether under cap-and-auction or cap-and-trade. Therefore the term cap-and-trade applies here to either approach to trading.

Cap-and-trade more expensive than a tax

        The costs would be higher under cap-trade due to income extracted by beneficiaries such as traders, brokers, attorneys, and an extensive new regulatory bureaucracy that would be charged with investigating this complex new commodities market for possible cases of fraud. Although these extra costs of cap-trade would be a fraction of the overall market activity, they could amount to tens of billions of dollars.

        If consumers struggling to pay energy bills were asked if they’d mind paying for the incomes of market participants, they’d probably object to the extra energy cost. Small business and household consumers would be especially disconcerted by the unpredictability of energy bills, fluctuating as the demand for permits available to utilities varied with even small changes in economic conditions.

Tax-and-dividend more beneficial for the economy

        Despite cap-trade causing these economic hardships of extra expense and variation, most proposed legislation for emissions trading does not provide for support of consumers. Yet consumers’ support for the legislation would be needed for decades to avoid repeal. In contrast, most legislation for an actual tax would return the revenues to the American people. Consumers would be motivated to reduce usage of fossil fuel energy due to increased cost from the tax, while the dividend would alleviate the added costs the tax imposes on energy as suppliers work to reduce those costs by reducing emissions.

        The dividend could be made in equal amounts to every citizen or through reductions in payroll taxes combined with an expansion of the Earned Income Tax Credit. Consumers would still be motivated to use less fossil fuel, but would receive funds to partially compensate extra costs. In brief, “Tax what you burn, not what you earn”.

        The sample resolution specifies that the majority or all of revenues be returned. The remainder of revenues could be used to support relevant meritorious projects such as methane capture. An example of another tax with the revenues used for relevant projects is the cigarette tax used for health projects. For local governments concerned about federal usage of the revenues from a carbon tax for irrelevant purposes, the resolution could be changed to specify that all revenues be returned, making the tax revenue-neutral.

        A study by the Congressional Budget Office found that a tax would be substantially more financially efficient in reducing carbon emissions than cap-trade because of its permit price variability (Policy Options for Reducing CO2 Emissions). Furthermore, making the dividend could mean that the overall impact of the tax on the economy could be slight, as has been shown by modeling. The benefits of the dividend to consumers and the economy would be so great that political pressure could be applied by consumer and business groups so that the government would make the dividend.

        Advocates of cap-auction argue that the proceeds could be used for a dividend. However, such a dividend would not compensate for the extra energy cost of the fees extracted by the beneficiaries of trading: traders, brokers, attorneys and the large new regulatory bureaucracy.

        Both trading and the tax are “market-based” motivators that let individuals and companies figure out how to reduce emissions. This widespread decision making is believed to be more financially efficient than command-type motivation that involves the government specifying how companies should reduce.

        What about the effect of emissions reduction on America’s international competitiveness? The playing field could be kept even by imposing a border tax adjustment on goods upon import from countries that do not have a carbon tax (carbon tariff).

        That adjustment could not be made under emissions trading. A cap is a quota, and quotas are not allowed under the World Trade Organization’s General Agreement on Tariffs and Trade. Therefore cap-trade would damage America’s international competitiveness.

        Furthermore, cap-trade would not be applicable as a model in China for political reasons: The monolithic Chinese government no longer exists. China has decentralized, so that regional governments now make their own decisions about energy generation. Those governments see continued economic growth as essential to their survival because hundreds of millions of subsistence farmers expect to rise out of poverty by working in manufacturing.

        If the central Chinese government attempted to impose caps on regional governments, they probably would reject them firmly. Therefore cap-trade is not a useful model for effecting the necessary long-term reductions worldwide.

        However, imposing a U.S. border tax adjustment could influence regional governments in China (and India) because of the effect on their competitiveness and growth. Therefore a carbon tax could both maintain U.S. competitiveness and effect worldwide policy changes to reduce fossil fuel emissions. Moreover, the central government of China probably would succeed in imposing a national carbon tax, because it would not set up an internal battle as would setting caps region by region. After all, corporation taxes have long been collected nationwide, and the personal income tax has recently been initiated.

        Concern has been expressed about damaging America’s international competitiveness if strong federal legislation got enacted. The possibility of a border tax adjustment could allay that concern, easing passage in the U.S. of the legislation for a carbon tax.

        Offsets associated with trading would worsen the balance of trade. For these many reasons tax-and-dividend would be better for the economy.

Trading’s variability a disadvantage

        The variability of trading is portrayed as a benefit by proponents, because the “dynamism” of the market would respond to changes in demand for energy immediately. The permit price would rise with demand. In the case of a tax the response of the agency responsible for adjusting the tax rate would be slower and periodic, every year or half-year.

        However, many economists believe that trading’s variability could burden the economy because less predictable energy costs make it more difficult for companies to justify investments. This burden could well outweigh the touted efficiency of the dynamism of the market.

        Disruptions to the economy due to variability could undermine support for cap-trade. The tax would be increased periodically along with the dividend, but would not take the economy on the market’s roller coaster ride.

Trading has greater exposure to fraud

        Emissions trading would be less effective than a tax because companies trade away the responsibility to reduce pollution, with the purchase of possibly questionable permits or offsets. Trading entails more opportunities for hidden abuse, due to persistent problems with determining the amount of emissions actually represented by permits offered for sale in complicated transactions on the wide-ranging new commodities market. Even a large bureaucracy charged with oversight would probably be seriously challenged to detect most overstatements of emissions being reduced.

        Do we really want to make the Earth-critical process of reducing emissions dependent on the judgment of brokers who are pitching deals? For example, a project for reducing emissions entails a degree of uncertainty in estimates of the amount of emissions being reduced, so that a broker would be motivated to increase the value by emphasizing the high end of the range.

        An actual tax would be less readily abused because of its relative simplicity. Taxation would be based on the weight and type of fossil fuel, a straightforward measurement. If the tax is levied upstream upon the first sale after extraction or import, then fewer entities need to get taxed, with only a minimal bureaucracy required.

        Here's the concern regarding fraud in trading put briefly:

1) Complex trading is more vulnerable to abuse than simpler taxation.

2) Taxation can motivate reductions by increasing price (and the associated dividend).

3) Considering the stakes, failure is not an option.

4) If trading has a chance of failing to meet goals because of fraud or other reasons, then the choice must be taxation.

Cap-and-trade failing to meet the regulatory goals

        Goals for reductions in emission levels are likely to be too modest. Considering the possibly disastrous consequences of failure to meet or exceed long term goals, to reduce risk it would be advisable to reduce emissions more than the goals require.

        Under emissions trading, any company that managed excess reductions would either sell them to another company, or bank them for future use. Thus the trading system would not likely motivate reducing more than the overall goal.

        Furthermore the probability of abuse of the trading system implies that the goal would rarely if ever be met in actuality, after accounting for fraudulent permits.

Cap-and-trade flawed either way it is written

        Beyond the problem of fraud, legislation for cap-trade would be inherently flawed because of escape clauses: In one version, a maximum permit “stop” price would be set by a government agency. If the permit price exceeded that amount, the emissions cap would remain the same, with the government selling extra permits beyond the planned amount. The extra permits would derail the scheduled reductions of carbon dioxide emissions, resulting in a critical failure in reduction of emissions, thereby invalidating the rationale for the entire program.

        Yet without this maximum permit “stop” price, the permit price would be forced even higher, worsening variation in energy costs. The worsened swings in energy costs would make it more difficult to gauge probable returns on investments in energy conservation and renewable energy, tending to hinder such vital investments, an ironic effect because cap-trade is supposed to motivate such investments.

         In addition, if the variation disrupted the broader economy, pressure would mount to extend the amount of borrowing of permits from future years. Increased borrowing would lessen the demand for permits and the high swing of the permit price. Because borrowing would delay reductions, it also would defeat the purpose of cap-trade. Therefore, whether with or without a “stop” price, emissions trading would very probably perform more poorly than a straightforward tax.

        Climate change has no escape clause. For the fire to sputter and go out, we have to stop fanning it.

Meeting goals using carbon taxation modeling

        A carbon tax would not in itself set a goal for emissions reduction analogous to the cap with emissions trading. Instead the Environmental Protection Agency would use the carbon tax as a policy tool to arrive at a goal for reductions, based on price-demand modeling.

        In other words, increasing cost lowers usage (as price increases, demand decreases), even of gasoline. The tax would be raised periodically to meet emissions reduction goals, also increasing the dividend. If emissions were not being reduced enough to meet the policy goals, then the tax could be increased to motivate more energy conservation and a more rapid transition to renewables. After observing the responses to initial rates of taxation, economists could adjust the models to make more accurate predictions of the rate of taxation required to meet goals for reduction, and to account for energy demand. In this way a tax would achieve goals for reduction of emissions by applying price-demand modeling as a public policy tool.

        Put briefly, if emissions are not decreasing fast enough, raise the tax and its associated dividend. In contrast, if trading under-performs it will be difficult to abandon the system because of entrenched beneficiaries.

        The few bills for the carbon tax that have been introduced thus far are preliminary, only increasing the tax on a fixed schedule. In the event that support for the tax builds across the country as this Initiative grows over the coming months, given encouragement from advocates Congress could consider stronger legislation that makes use of the modeling described in this section.

       Using a guideline based on such modeling the tax (and dividend) could be increased enough to motivate the very substantial reductions in usage of fossil fuels needed to meet emissions reduction goals. This powerful tax-and-dividend approach would more reliably motivate reductions than emissions trading with its escape clauses, potential for abuse, and permit price riding the market’s roller coaster.

        Supporters of the tax-and-dividend approach are listed here.

Near term implementation of a tax

        During set-up, the myriad details of a complex cap-trade system would have to be resolved through lengthy negotiations. The simpler tax could be implemented much sooner.

Tax critical for transportation fuels

        Emissions are dispersed through the stages of production and consumption of transportation fuels, making establishment of caps even more difficult. A carbon tax could provide incentives for emissions reductions in the transportation sector via public transportation, car-pooling and efficiencies.

        The Union of Concerned Scientists is for an increasing tax on transportation fuels combined with cap-and-trade without a stop price. However, legislation proposing that cap-and-trade approach still allows borrowing from the future as well as other flaws outlined on this page.

Mayors concerned about climate change

        Over 750 mayors from the U.S. Conference of Mayors have pledged their cities to emissions reduction, demonstrating concern about the issue, and representing a total population of over 76,000,000 citizens. After consideration of the merits of a federal carbon tax, a significant percentage of the Mayors may help bring resolutions in support to their city councils for consideration.

Inappropriate analogy with trading in sulfur dioxide permits

         It is often argued that the cap-and-trade market in sulfur dioxide permits has been functioning to reduce those emissions, which can contribute to acid rain. The Environmental Defense Fund was a key player in the establishment of that market, mainly among coal-burning power stations. EDF is a proponent of using the model for carbon dioxide emissions. However, the analogy of the sulfur dioxide (SO2)market with cap-and-trade in CO2 breaks down due to the diversity of fossil fuels that would require an unmanageably large scale of market oversight.

        Setting CO2 caps among numerous competitors lobbying for marginal advantage would become a tangled political exercise on a grand scale. Monitoring compliance would be yet another. The potential for abuse would be substantially greater for cap-trade in greenhouse gasses than for the smaller scale of sulfur dioxide permits.

       The SO2 market in the U.S. was used to justify starting the European experiment in cap-trade in CO2 that has been called a failure in part due to giving away billions of dollars worth of permits to pollute, and in part due to trading away responsibility to reduce emissions at the source with the purchase of possibly questionable offsets. This failure provides historical evidence that the analogy of the market in sulfur dioxide permits with one in greenhouse gasses is inappropriate. 

        In other words, all proposed legislation for cap-and-trade has either already proven problematic in Europe or is untested, with no working example. Assertions about cap-and-trade’s prospects for reducing emissions are based on faith not fact, theory rather than successful experience. Further failure is not an option. Yet the Senate’s Lieberman-Warner bill would set up a replication in the U.S. of the European experiment in cap-and-trade (for a critique see Legislation). As detailed above in “Meeting goals using carbon taxation”, a straightforward tax would make a more reliable means of motivating reductions in usage of fossil fuels by increasing the cost.

No exemptions

        One of the advantages of taxation is that the pressure to reduce is continuous, so long as exemptions are not made. Watchdog groups must raise the alarm if exemptions are being considered. Instead of exemptions, in regions where coal-burning supplies most electric power, loan guarantees could be extended for the construction of renewable energy power stations such as wind farms.

Worldwide protocol for taxation administered by each country

        For an international accord a carbon tax would be more appropriate because of its simpler administration, transparent and open to public scrutiny. Any and all proposed exemptions could and should be fought against vigorously. In contrast, abuses of cap-trade would be difficult to detect and oppose, such as poorly documented sources of permits to pollute that would be traded on the market. Many governments might not be able to provide effective oversight to prevent the many more opportunities for corruption inherent in complex and opaque cap-trade. China is a critical case in point.

        In addition a carbon tax could be accepted more widely for a worldwide protocol than emissions trading because each country’s revenue from a tax would remain in that country with minimal infringement by foreign countries on national sovereignty.

        A tax delivers revenue to a nation’s government rather than to private entities, thereby motivating the government to enforce compliance. Returning the revenues to citizens could increase the prestige of the government from the consumer’s viewpoint.

Command-and-control not effective on a widespread basis

       What about trying to avoid both an actual tax and the covert tax of emissions trading? Command-and-control (CAC) regulations specify how companies manage pollution-generating processes, as well as uniform standards for emissions per unit of output across firms. CAC is known as the “heavy hand” of government.

       This approach relies on detailed regulations followed up by an ongoing inspection program. Examples are the Clean Air Act and the Clean Water Act. Using this approach resulted in decreases in pollution from industrial sources.

       Of course building codes need to be upgraded ASAP. Also the production of powerful heat-trapping refrigerants needs to be regulated to prevent escape of waste gasses using available technology for capture and disposal. Funding for retrofits could be from loan guarantees instead of offsets.

       However, with more distributed sources of pollution such as burning fossil fuels, CAC is not effective. To reduce emissions of carbon dioxide throughout society, everyone needs motivation.

       The only way to provide widespread motivation is by increasing cost. Which brings us back to a tax.

Rationing problematic

        Strict federal rationing of carbon dioxide emissions would be like cap-and-trade without the trading of permits to pollute. The main reason to move beyond strict rationing to consider the flexibility of trading is so that the cost of rationing does not overwhelm industry, possibly sending the economy into a recession.

        Under strict rationing, those who did not use their entire ration would be tempted to buy fuel, then sell it at higher cost to those who wanted more than their ration. A legal trading system avoids the pressure to form a black market. However trading opens up a Pandora's box of opportunities to abuse the system, with giant polluters most able to “game” it.

        Tax-and-dividend would probably perform better as well as be more equitable financially.

Large size an advantage under trading

        Larger polluters would be more able to afford the staff required to investigate emissions trading. That extra cost would be spread over a larger volume of business and pollution, making polluting cheaper for larger polluters.

        One example of gaming that would be legal: larger companies would be able to negotiate cheaper offset packages than smaller competitors.

        These advantages of size would give giants even more power.

        Other legal and illegal financial games would probably be attempted.

Broad-based political support for a tax possible

        For reasons described here, the debate has moved beyond the science of climate change to the wisest way to motivate reductions of emissions of heat-trapping gasses. Whether the next President is Republican or Democrat, legislation is likely to be enacted to reduce emissions.

        All of the options being seriously considered involve taxation in one form or another. Emissions trading acts like a covert tax because polluters will pass the costs on to consumers, but trading would be more expensive due to traders extracting fees. An actual federal carbon tax would be less expensive and less readily abused because it’s simpler.

        Trading would be worse for the economy as described above in the section “Tax-and-dividend more beneficial for the economy”. This view is held by many conservative and liberal economists, and commentators as well as former Federal Reserve chairmen Paul Volcker and Alan Greenspan, former chairman of President Bush’s Council of Economic Advisers Gregory Mankiw, commentator Thomas Friedman and former Duke Energy CEO Paul Anderson (Carbon Taxes Versus Carbon Markets).

        A concern is that the government would not return tax revenue. Clearly watchdog groups would need to keep tabs on the usage of the revenue. However, the same challenge arises regarding the usage of the revenue from cap-auction.

        Cap-trade avoids having the government collect revenue, but gives billions of dollars worth of permits to polluters as windfall profits. Such giveaways would probably discomfort consumers faced with increased energy costs.

        For these many reasons, tax-and-dividend could become the preference of Americans holding greatly varying views on other policy issues, in a broad consensus with bipartisan potential.

Offsets excuse business as usual

        Persistent problems arise in quantification and verification of claims made for the effectiveness of offsets. A well-known but flawed example of an offset is trying to compensate for the heat-trapping emissions from personal travel by funding the planting of trees. The value is often overestimated by applying the offset project’s cumulative effects over its entire extended lifetime against present-day emissions.

        Certainly it is desirable to donate money for tree planting. However the application of any offset against annual emissions of heat-trapping gasses has to be made based on the offset’s annual effects on heat-trapping gasses, not over its entire lifetime. Otherwise the present-day emissions supposedly compensated by the offset actually build in warming during the lifetime of the project, over decades of growth in the case of tree farming. In other words, the extra blanket from the present-day emissions remains over the Earth causing warming during the growth of the trees for decades.

        In a different twist, owners of existing woodlots are looking forward to being paid for an offset in order not to cut down the trees and burn them. The company purchasing the offset would get to continue business as usual such as coal-burning. Based on this transaction and countless others, the questionable claim would be made that society is reducing emissions.

        The European experiment with cap-trade has shown that letting brokers find and promote offsets produces seriously flawed results in a process replete with opportunities for deception. Offsets are analyzed further on this website at ArticleCarbonTax.

        The key to reducing emissions is to motivate transformation of “business as usual” to a reduced-carbon economy using tax-and-dividend. Because of the increase in cost with the tax, less fossil fuel gets used and investments in renewable energy sources become more attractive. In contrast, even “justifiable” offsets such as funding renewables excuse business as usual.

        Finally, the Carbon Cycle argument against offsets: Put briefly, in the Carbon Cycle emissions from decomposing organic matter get absorbed during photosynthesis and by other means. Burning fossil fuels adds human-induced carbon to the natural Cycle. No known financially feasible offset removes carbon from the Cycle.

Illusory financial windfalls from sale of offsets

        Some local governments may plan to sell offsets in emissions trading to help fund projects that reduce heat-trapping emissions. However, the value of those projects might be undercut by competition from inexpensive offsets from abroad.

Sources of funding that avoid the offset system

        Even the most rigorously assessed offsets encourage the continued burning of fossil fuels by “guilt-washing”. If meritorious projects such as methane capture from biomass (landfills) can get funded by conventional means such as loan guarantees, then the offset system can be abandoned.

        Taxation increases the value of projects such as renewable energy sources by increasing the cost of fossil fuels, mobilizing the market to develop renewables. A tax makes renewables easier to invest in because returns on the investments can be estimated more accurately than under trading's increased variability.

        Even now, and especially as concern about climate change continues to build, national priority could be given to support for such projects. In this way the problem-ridden offset system could be avoided, with its encouragement of business as usual.

        Considering the stakes, the offset system is too high risk. The need is to reduce emissions at the source. Reductions can be motivated by a carbon tax.

Reducing coal burning using taxation

        Under a carbon tax, utilities that burn coal for power would be motivated to first emphasize generation of power from natural gas power stations instead because of the higher energy output per carbon of gas, then motivated to consider investing in wind farms. Under trading the utilities would tend to postpone such changes, instead conducting business as usual while purchasing permits to pollute more than their caps, at possibly substantially lower cost than a tax might impose. If trading includes windfall profits for coal burning, motivation to reduce would be lowered further.

Carbon tax examples

        Using tax-and-dividend as one motivator, between 1990 and 2006 Sweden cut its CO2 emissions by 9% while enjoying economic growth of 44%. Denmark has trimmed CO2 emissions 15% from 1990 to 2005 (Revenue Recycle: Lessons). Norway's carbon footprint has increased despite a tax, but Norway is the world's third largest oil exporter. The Canadian provinces British Columbia and Quebec are implementing taxes (Behind British Columbia’s Carbon Tax). It will be interesting to note the results.

Politics

        When the carbon tax-and-dividend is mentioned, proponents of cap-trade sometimes get defensive, claiming that talking about the tax is a distraction from what is felt to be the “only politically viable possibility”, cap-trade. It is felt to be more politically viable because it does not have the word “tax” in its name, even though cap-trade is indeed a covert tax. The merits are really on the side of the actual tax as has been described here, so that it must be given consideration and support.

        Suggestions are made that the name of the tax be made more explanatory, perhaps calling it a “carbon pollution fee” or “climate harm charge”. However, calling it anything other than a tax would open up supporters to charges of trying to hide the fact that it is a tax. On the other hand, a more descriptive name would communicate more of the purpose.

Avoid boondoggle of cap-trade

        Cap-trade is a classic example of a boondoggle, that is, a wasteful or pointless activity that gives the appearance of having value. Cap-trade is a “Rube Goldberg” machine with many places to go wrong. A carbon tax keeps it simpler, with greater reliability. The added expenses associated with cap-trade and its probable poor performance could disillusion the public in the several ways mentioned on this page.

        It is counterproductive to promote both cap-trade and a tax. In combination with specific command-type regulation such as upgrades in building codes for energy conservation as well as policies such as renewed support for public ground transportation, a carbon tax-and-dividend could do so much: motivate the necessary reductions in emissions while leaving the economy in better shape to sustain the investments needed to make those reductions, and retaining consumers’ support with the dividend.

        Let’s not put the Earth-critical process of reducing emissions into the hands of brokers pitching deals. Let’s get this epochal, overarching environmental policy decision right, enacting the more effective, economical, and equitable carbon tax, not the second best and built-broken cap-and-trade.

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