James Hansen heads the NASA Goddard Institute for Space Studies. If you have a question about radiative transfer in planetary atmospheres, he’s your go-to guy. But if you have a question about economics—say, about the merits of cap-and-trade programs—you might want to consult a different sort of specialist. Hansen’s recent New York Times piece provides ample confirmation of that.
The column oozes nonsense throughout, but it will be instructive to hone in on one exceptionally silly paragraph. Here is Hansen trying to explain why cap-and-trade is inferior to a carbon tax:
Consider the perverse effect cap and trade has on altruistic actions. Say you decide to buy a small, high-efficiency car. That reduces your emissions, but not your country’s. Instead, it allows somebody else to buy a bigger S.U.V.—because the total emissions are set by the cap.
First, this is true. But second, it has nothing to do with cap-and-trade. The same observation applies to a carbon tax. Carbon taxes work by driving up the price of gasoline and other pollutants so people will use less of them. Consider the perverse effect that has on altruistic actions. Say you decide to buy a small, high-efficiency car. You buy less gasoline, driving down its price, and encouraging someone else somewhere to buy a bigger S.U.V.
True, you have only a tiny tiny effect on the price of gas. But how big an effect do you need to trigger one more S.U.V. sale in a country of 300 million people?
Here, now, is the whole point: We don’t have to guess at the answer to that. A little bit of economics reveals that to an excellent first approximation, the carbon tax and the cap-and-trade program must have identical effects.
Here’s why: If we reduce our gasoline consumption by, say, 30%, then the price of gasoline must rise by just enough so that consumers are willing to cut their purchases by exactly 30%. If the price rises any less than that, consumers will want more gas than they can get, and they’ll bid the price up further. So the price consumers pay for gasoline is completely determined by the fall in consumption—and it doesn’t matter what triggers that fall. Cut gas consumption 30% via cap-and-trade and the price of gas will rise. Cut gas consumption 30% via a gas tax and the post-tax price of gas will rise by exactly the same amount. This one observation forces the programs to be equivalent in almost every relevant way.
Mr. Hansen prefers the carbon tax, because the revenue can be distributed to the public. (He calls this a fee-and-dividend system.) But by the same token, with cap-and-trade, the revenue from selling permits can be distributed to the public. And it’s not hard to prove (using arguments similar to the preceding paragraph) that the revenue from selling permits must exactly equal the revenue from raising taxes. So again the programs are entirely equivalent.
Mr. Hansen worries that with cap-and-trade, energy producers will demand free permits—essentially claiming the permit revenue for themselves. But energy producers that powerful could just as easily lay claim to tax revenue as to permit revenue. So again, the choice of policy makes no difference. He worries that politically powerful producers can get themselves grandfathered out of cap-and-trade. Yes, just as easily as they can get themselves grandfathered out of a carbon tax.
If you want to believe there’s a meaningful difference between a carbon tax and cap-and-trade, you’ve got to look elsewhere than the effects on pollution, incentives, consumer prices, profits, or government revenue. In other words, you’ve got to look at decidely secondary effects. Here’s a menu of choices:
- A carbon tax can be too small (allowing too much pollution) or too big (retarding too much economic activity). Similarly, a cap-and-trade program can be too small or too big. For somewhat technical reasons, I believe that it’s easier to calculate the “just right” carbon tax than to calculate the “just right” number of cap-and-trade permits. If I’m right, this is an argument for a carbon tax.
- A carbon tax is pay-as-you-go for producers. Cap-and-trade permits, depending on how the system is designed, can be a big upfront expense. This handicaps small companies with limited cash reserves and limited borrowing opportunities. This is an argument for a carbon tax.
- If you favor either of these programs in the first place, you presumably want it to last awhile. Cap-and-trade is politically self-perpetuating, because companies in possession of valuable permits will lobby to maintain the program that gives those permits their value. The carbon tax, by contrast, will come under constant assault from anti-tax lobbyists and therefore might be more difficult to maintain. This is an argument for cap-and-trade.
Me, I lean toward a carbon tax, just like James Hansen. But the differences are largely inconsequential, and almost entirely divorced from what Mr. Hansen thinks they are.