Krugman v. Hansen

NYT columnist Paul Krugman is not happy with NASA climate scientist James Hansen for the latter’s op-ed attacking cap-and-trade and proposing a tax-based alternative (which I blogged about here).  Such arguments are “unhelpful,” Krugman says, because they ignore the fact that in the theoretical world of transaction-cost free blackboard economics caps and taxes are the same, and that cap-and-trade is the only game in town.  While Krugman is correct that Hansen makes some silly, populist arguments, Hansen’s ultimate conclusion — that a fully rebated carbon tax is preferable to cap-and-trade — is completely sound.

On the difference between a carbon tax and cap-and-trade, Krugman argues that they are the same because any given cap equates to a given price and vice-versa.  He even produces a graph to prove it.

The only difference is the nature of uncertainty over the aggregate outcome. If you use a tax, you know what the price of emissions will be, but you don’t know the quantity of emissions; if you use a cap, you know the quantity but not the price. Yes, this means that if some people do more than expected to reduce emissions, they’ll just free up permits for others — which worries Hansen. But it also means that if some people do less to reduce emissions than expected, someone else will have to make up the shortfall. It’s symmetric; there’s no reason to emphasize only one side of the story.

That’s true as a theoretical matter, particularly if one assumes that either policy will be implemented in a “clean” fashion, uncorrupted by political side deals, and if one ignores the fact that, ex ante, the government has no way of determining with any precision what carbon price will equal what level of emissions.  And it’s silly to endorse any particular cap without any consideration of its potential cost.

In the real world, one effect of a cap is extreme price volatility (as we saw with the acid rain program and the EU’s carbon trading system).  If allowed to persist, such price volatility kills new investment and technological innovation, which are essential if we are ever to have any prayer of reducing greenhouse gas emissions to the levels President Obama and others have proposed.  TO avoid this problem, a cap-and-trade regime can have a safety valve — a means of loosening the cap if prices rise too high — but this then kills cap-and-trade’s primary (only?) advantage over a tax, which is the imposition of a hard cap on emissions.

Two other big problems Krugman ignores are that cap-and-trade systems are more vulnerable to special interest pleading and that such programs inevitably come with offset provisions that further undermine the reliability of the cap.  In the case of Waxman-Markey, the offsets provisions are such that the bill has no prayer of achieving its stated emission reduciton goals, even with all the regulatory bells and whistles littered throughout the bill.  It’s also worth noting that a cap-and-trade program is difficult to administer and implement.  It took the EPA about five years to write the rules for the acid rain program, and it only covered a few hundred facilities.  If we’re in a rush to impose emission controls, as Krugman claims, this is the wrong path to take.  By comparison, British Columbia got a carbon tax system up in place within five months, and created incentives to reduce carbon emissions right away.

There’s more to say, but other pending matters demand my attention.  So here’s more from Reihan Salam and David Frum.  And here’s a final thought from Andrew Sullivan:

Krugman’s core point is political: cap and trade is all our system can achieve; it’s that or nothing; so shut up.I hope Hansen doesn’t shut up. His proposal is simpler, clearer, fairer and more likely to wean us off carbon sooner.

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