A Carbon Added Tax, Not Cap and Trade

Paul Krugman devoted a recent lengthy New York Times Magazine article to the promotion of a disastrous “cap and trade” regime for reducing carbon emissions. Though he doesn't outright endorse it, he strongly suggests that the Waxman-Markey bill that passed the House would be acceptable to him. Krugman then proceeds to pooh-pooh the carbon tax idea, one that I believe has far more merit.

Cap and trade would be a debacle for a slew of reasons. The most important is that it won't even reduce carbon emissions. Two of the EPA's own San Francisco attorneys dismissed the Waxman-Markey cap and trade regime as a “mirage” that would not reduce carbon because of the ability of polluters to obtain fictitious carbon offsets, among other problems.

Even if cap and trade would require American producers to reduce carbon emissions, it would do nothing about overseas polluters. An American manufacturer could escape cap and trade simply by moving production to China. Given China's massive coal-based electricity infrastructure and other notoriously polluting practices, carbon emissions would likely only get worse as a result, in addition to the US jobs lost.

Krugman suggests this can be fixed with a carbon tariff, but that's dangerously naïve. There's no guarantee a carbon tariff would be put in place after cap and trade passed. In effect, it requires two completely separate policy mechanisms be put in place and kept synchronized over time, which seems dubious. Our trading partners would surely chafe at any carbon tariff, which would be vulnerable to challenge under international trade treaties.

Cap and trade also has huge distortive impacts within the United States. The Brookings Institution crunched the numbers and found that cap and trade costs vary widely across the country. Compliance costs would be minimal in California and rest of the West and Northeast, while the Midwest, Mid-Atlantic, and the South get pummeled. It should come as no surprise that it is California Rep. Henry Waxman who's pushing the bill. One can't help but suspect these regional disparities are the real implicit goal of the bill. Indiana Gov. Mitch Daniels denounced cap and trade as “imperialism”.

Perhaps the most diabolical part of cap and trade is in its very name. The operative word is “trade”. Who do you think will be doing the trading? Why, none other than the very people who got us into the economic mess we're in today. Cap and trade is a gigantic giveaway to Goldman; it's yet another instrument for speculation; it's another way for the profiteers on Wall Street to line their pockets at our expense.

So in a sense it’s also another way that, perhaps unintentionally, the richest sectors, the upper classes, and the financial centers like New York, Boston and San Francisco are being favored over the poor Main Street rubes who have taken it on the chin during this recession without a bailout. If you think things are bad now, just wait until CDS stands for “carbon default swap”. It's pouring fuel on the fire of inequality between the haves and have nots.

Cap and trade is nothing more than another tranche in the never-ending merry-go-round of bailouts for the financiers. And didn't we learn anything from Enron's electricity trading shenanigans? When an Iowa farmer opens up in his electric bill that's suddenly spiked, or has to pay double to fuel his farm equipment, it's not too much to ask that it be in the service of actual carbon reduction, not houses in the Hamptons, owned by people to whom the added cost is not material given their wealth.

There is a better way, and that's the Carbon Added Tax. Similar to a European-style Value Added Tax, a CAT tax would directly tax the quantity of carbon emissions added to the atmosphere in each stage of the production cycle. The tax could be set at a level that would provide certainty of price such that investments in lower carbon technologies are financially feasible right now, not decades from now.

Also, similar to the US income tax system, the CAT would apply to the carbon emitted globally, not just in the United States. A deduction would be permitted for any bona fide carbon taxes paid in a foreign jurisdiction, up to the level of the US tax. A true-up on the carbon tax due would be paid at the point of import into the United States. That is, an importer would have to pay the CAT on products brought into the country, less any deductions for foreign carbon taxes paid, at the port of entry.

While this global approach is a widely, and correctly, maligned feature of the US income tax code, it has important benefits from a carbon reduction perspective. First, it is location neutral. Since the tax is the same whether the carbon is emitted in China or the United States, it doesn't encourage business to move offshore. But it also doesn't discriminate against foreign producers. (Like any anti-carbon regime, it would raise costs in the US, affecting both domestic consumers and the competitiveness of exports).

The CAT is also functionally equivalent to a carbon tariff, but is a unitary regime. That is, you don't have to figure out how to bundle in or pass a separate carbon tariff as part of implementing a domestic cap and trade system. You simply pass a CAT on global carbon emissions and you are done.

And this system allows each country to decide on its own level of carbon taxation. If countries like China want to have no tax, that's their choice. Or, European countries could decide to have a higher tax. The complexity would come in figuring out the allowed deductions for emissions in countries that adopted other schemes like cap and trade, but this should be a readily solvable technical issue.

There will still be divergent regional domestic impacts under a CAT. This is unavoidable in a nation where carbon emissions are unevenly distributed. But by preventing the financiers from skimming off the top, the total burden is reduced, and a CAT is a more location neutral, transparent mechanism for carbon reductions.

A Carbon Added Tax is a far superior way to reduce carbon emissions than a cap and trade system only a Wall Street trader could love.

Aaron M. Renn is an independent writer on urban affairs based in the Midwest. His writings appear at The Urbanophile.

Photo by Gilbert R.