Online Debate: Regulating American Greenhouse Gases
CFR.org has been holding regular Online Debates on important issues for more than a year but as the presidential campaign approaches, many of the policy debates we feature invariably become more tangled in presidential politics. So it is with this week’s question: How Should the United States Regulate Greenhouse Emissions?
We asked two distinguished experts, William A. Pizer, senior fellow at Resources for the Future, and Kenneth P. Green, resident scholar at the American Enterprise Institute, to tackle this question. The debate, like all of our exchanges, runs all week. Here’s Pizer’s kickoff:
June 23, 2007
William A. Pizer
For most of the past thirty years, economists have strongly advocated market mechanisms (PDF)—either taxes or tradeable permits—to encourage emissions reductions because they effectively reduce emissions at the lowest cost to society. The alternative—regulation that tells businesses how much to emit or what technology to use—risks requiring expensive options in some sectors while cheaper options in other sectors remain untouched. Because climate change is easily the most expensive environmental problem we have ever tried to tackle, doing so at the lowest cost is critical.
Therefore, the most important feature of a U.S. program is that it should be a single market-based policy—either a tax or a tradable permit system—and it should cover as much of total U.S. emissions as possible, across regions, sectors, and various greenhouse gases.
Between taxes and tradable permits, I believe a tradable permit system is a better way to go for two overarching reasons. First, a tradable permit system can be designed to mimic all of the key features of a tax and can do more; and second, this flexibility to do more—specifically to easily provide compensation to various businesses and individuals through a free allocation—takes away pressure to exclude some sectors.
Taxes are typically advocated because they fix the price rather than leaving it to fluctuate in response to volatility in permit demand, and they raise government revenue that can be used to cut other taxes. Yet, a tradable permit system—through use of a safety valve and permit auctions—can match these two features. A safety valve (PDF) would limit the permit price by having the government supply unlimited “extra” permits at a specified price. If the emission cap is low enough, the safety valve can fix the price with certainty. Similarly, the government can sell off permits and raise money to cut other taxes.
But a permit system can do more. While a safety valve can fix the price like a tax, the safety valve can also removed as more emission certainty is desired. And, all the permits need not be auctioned—some can be given away or used to finance related technology investments. This latter flexibility is the key to why I favor permit trading.
In the end, regulation is not entirely about efficiency—it is also about the distribution of costs (PDF). Market-based climate policies, in particular, have very transparent costs in the form of higher energy prices. This creates obvious and disproportionate burden in some sectors and regions of the country, and consequent political efforts to seek redress. In a permit system, this is easily addressed by a free permit allocation. No such flexibility exists in a tax system—and the logical result is to begin excluding those sectors that face the greatest burdens. Unfortunately, this undermines the primary argument for market-based policies in general—that everyone faces a transparent price and therefore seeks out the cheapest options wherever they exist.
