ed dolan is a senior fellow at the Washington-based Niskanen Center.
Illustrations by roy wiemann
Published July 26, 2021
I am a longtime fan of carbon pricing. I see making polluters pay for the harm they cause not only as simple justice, but as a way to mitigate climate change by making producers and consumers alike more aware of their sins against the earth. Over the years, I have done a lot of sparring over carbon pricing with libertarians and conservatives, but they are not the only critics. Lately, I have turned my attention to the increasingly vocal group of pricing skeptics who are card-carrying greens. There is some sound, pragmatic thinking behind the skepticism of these green critics, with a certain amount of nonsense mixed in. Yes, some of what they write is driven more by ideology than by reality. Some of it looks backward at early-generation emissions- pricing designs that have been superseded by better models. Over all, though, there is a lot that carbon pricing advocates can learn from the green skeptics.
Not All Carbon Pricing Is Alike
Economists often use the term “carbon pricing” as a catchall to encompass both carbon emissions taxes (or “fees,” as they are sometimes called, in deference to kneejerk tax-haters) and “cap-and-trade.” Both are ways of limiting total emissions. In a textbook, they look pretty much the same.
You draw some intersecting supply-and-demand curves. They cross at a sweet spot where the cost of reducing emissions by one more ton of carbon (or other gases with equivalent impact) just balances the harm caused by that same marginal ton. If you are imposing a tax, you set it equal to the price at the point of intersection and let market forces adjust the quantity. If you are doing cap-and-trade, you set the quantity of emission permits to correspond to the intersection of the curves and let trading in the market for permits determine the price.
But the green skeptics of carbon pricing don’t buy the equivalence. Even those who have reservations about any form of pricing save their harshest criticisms for cap-and-trade schemes like the European Union’s Emission Trading System.
For example, Danny Cullenward and David Victor, authors of Making Climate Policy Work, a best seller in the pricing-skeptic genre, spend chapter after chapter in dis-praise of cap-and-trade. In practice, they argue, all such policies are full of loopholes and vulnerable to manipulation. They label the markets for trading emissions allowances as “Potemkin markets,” in reference to the tidy fake villages that Grigory Potemkin set up to hide the squalor of real rural life from Catherine the Great when she toured her Russian empire in the 18th century.
The concept of offsets earns Cullenward and Victor’s most pointed ire. Suppose you oversee a Belgian steel mill. You would like to emit 1,000 tons of carbon dioxide in the process of fulfilling a profitable contract, but you don’t want to spend the money it would cost to buy the necessary emission allowances. Instead, you take advantage of a rule that lets you “offset” your emissions by cleaning up the equivalent amount of carbon elsewhere — say, by buying a tract of forest on the island of Borneo and fencing it off from loggers. Voilà — you have cleaned up the atmosphere by 1,000 tons of CO2.
Or have you? For one thing, slash-and-run log poachers might break through your fence and cut the trees anyway. More important, fencing off one tract of trees just means that loggers will cut a different patch of trees somewhere else to meet the global demand for lumber.
Another reason carbon taxes work better than cap-and-trade is that they are inherently simpler. Jonathan H. Adler of the Case Western Reserve University Law School points out that British Columbia adopted and implemented its carbon pricing scheme in less than six months. In the United States, by contrast, it took the EPA years to design and implement a cap-and-trade system to control acid rain, even though the emissions that caused acid rain came from far fewer sources than those for CO2. Furthermore, Adler says, greater complexity not only slows policy implementation, but it also creates more opportunities for legal challenges. The tortuous path of the Obama administration’s Clean Power Plan is a case in point.
Pricing vs. Regulation
The interaction of carbon pricing and direct regulation is a frequent theme in the writings of the green skeptics. Typically, the tone is one of “regulation = strong, pricing = weak.” In a widely read piece in The Boston Review, Matto Mildenberger and Leah C. Stokes, writing about California’s carbon trading policy, argue that “rather than carbon pricing, other regulations — clean electricity standards, clean car programs, and aggressive energy efficiency — deserve much of the credit for the state’s progress.” Another critic, Jessica Green, approvingly quotes Cullenward and Victor as saying that “the real work of emission control is done through regulatory instruments.”
But a closer look shows that the relationship between pricing and regulation is not as simple as critics seem to assume. In fact, pricing and regulation often do not even pull in the same direction.
Based on experience with the European Union’s Emissions Trading Scheme, Cullenward and Victor give an example of how regulation can actually undo the useful effects of pricing. Suppose (as is often the case) that firms subject to a carbon trading scheme are also subject to performance standards that require them to reduce emissions regardless of the cost. Since they have to clean up in response to the regulations anyway, they have no need to buy emission permits. As demand for permits falls, their prices fall. Lower permit prices, in turn, weaken the incentive for other firms to cut emissions. Critics like Green look at the outcome and argue that regulations, not prices, are driving emission reductions. But looked at differently, we can see that the regulations just move emissions from some firms to others — a phenomenon sometimes known as the “waterbed effect” — while undermining the overall effectiveness of the pricing system.
It is not hard to find other kinds of regulations that render carbon pricing less effective. For example, regional cap-and-trade schemes in the northeastern U.S. and California are supposed to incentivize electric utilities to supply cleaner electricity and users of electricity to buy it. In some cases, such as switching local generators from coal to gas, it actually works. However, the sources of the most abundant clean energy are often far from the centers of greatest demand, and a thicket of regulations blocks the construction of needed transmission lines. A result? “Laws, rules and systems designed for a different century” are slowing decarbonization of the electricity sector “to a snail’s pace,” as David Roberts explains in his newsletter, Volts.
Getting to Zero
Yet another claim made by the green skeptics is that pricing is suited only for cases in which the goal is a steady optimum level of pollution. Pricing cannot work for carbon pollution, they say, because the carbon emissions must be brought all the way to zero. As Anthony Patt and Johan Lilliestam (writing in the journal Joule) aptly put it, carbon taxes stimulate a search for low-hanging fruit, but when we need to pick all of the apples on the tree, we need a ladder.
The critics are right that it would be hard to get to zero using the textbook version of carbon pricing as I have described above. However, there is no reason that either a capand- trade system or carbon taxation could not be modified to attain full decarbonization by some specific date — say, 2050.
For cap-and-trade, the modification would be to define the cap as the total carbon “budget” of the atmosphere that must not be exceeded if global temperatures are to be stabilized, rather than as a certain quantity of emissions per year. Suppose, for example, that a budget of 500 billion tons of CO2 would hold the global rise of temperature to 1.5°C. That is about 12 years’ worth of global emissions at the current rate. The United States currently emits about 15 percent of the global total, so let’s assign it a quota of 75 billion tons. (The global quota could instead be divided according to population, GDP or some other standard.)
Divide the U.S. share of the budget into 75 million permits, each allowing emissions of 1,000 tons of CO2 or the equivalent in other greenhouse gases. Put the permits on the market (allocating them however you wish) and let trading begin. When someone buys a permit and uses it to emit their 1,000 tons, that permit is extinguished forever. Other people might buy permits to hold, hoping they will rise in price as the remaining supply shrinks. For that matter, conservation groups might buy permits, stamp them “canceled” and throw them in the trash, thereby helping to get to zero even faster.
As fewer permits remain, the price will rise, but it will hit a ceiling: Permits will never sell for more than the cost of direct air capture — that is, the cost of removing carbon dioxide directly from the air via chemical or other means. Eventually, all the permits will be used up. Any remaining processes that unavoidably emit CO2 into the atmosphere will be required to offset their emissions fully with direct air capture. None of the other dodgy kinds of offsets that Cullenward and Victor criticize would be allowed.
Cullenward and Victor acknowledge that the failure of carbon pricing “is not rooted in the economic logic of markets or in the idea that resources must be devoted efficiently. The problem with markets is political.”
A carbon tax could be modified to get to net zero in a similar fashion. The tax would start at some baseline amount (say, $50 per ton of CO2) and increase according to a specified schedule. If emissions did not decrease along a path sufficient to meet the target date for full decarbonization, the tax rate would automatically escalate according to a preset formula. As technology improved with time, the rising level of the tax would meet the cost of direct air capture, which will probably fall as technologies improve. At that point, emissions would fall to net zero. In short, a properly designed system of carbon pricing could provide just the kind of custom-designed ladder needed to pick all the apples on the tree.
Politics and Ideology
Many green critics give a half-hearted hat tip to the economic merits of carbon pricing and then go on to challenge its political feasibility. Mildenberger and Stokes concede that carbon pricing “provides an elegant response to a complex problem” but insist that “as the centerpiece of climate reforms, it has proven a political disaster.” Cullenward and Victor acknowledge that the failure of carbon pricing “is not rooted in the economic logic of markets. Nor is it rooted in the idea that resources must be devoted efficiently, so that more protection from the ravages of global climate change can be obtained at lower economic cost.” Rather, they say, “the problem with markets is political.” Patt and Lilliestam flatly characterize carbon taxes and permit fees as “a dangerous political distraction.”
Some critics, including Cullenward and Victor, see the political problems of carbon pricing in pragmatic terms. Climate change, they note, “pits the diffuse public interests of the future — where everyone, to varying degrees, benefits from protecting the planet — against the private concerns of the present.” Those concerns of the present are many and varied, and each is a seed around which a coalition can form against carbon pricing. Cullenward and Victor emphasize opposition from workers and shareholders in price-sensitive and trade-exposed industries. Daniel Rosenbloom and colleagues (writing in the Proceedings of the National Academy of Sciences) note the challenge that pricing poses to “longstanding practices and livelihoods, such as car-based and suburban lifestyles.”
Backers of carbon pricing have tried to meet such political opposition by fostering counter-coalitions. For example, they suggest bringing trade-sensitive industries over to the side of carbon pricing by including “border adjustments,” which would penalize imports of goods or services from countries that do not have equivalent carbon prices of their own.
In other cases, designers of cap-and-trade schemes have co-opted industrial polluters by giving them a limited number of free permits, which they can then either use themselves to pollute without penalty or sell to others at a profit. While that might make political sense, it creates a temptation to hand out too many free permits, thus driving down permit prices in the market and reducing the effectiveness of the system. A report from the EU’s Emissions Trading Scheme, for example, found early free allocations to have been poorly targeted. In the future, free allocations will be tightened and the share of permits that are auctioned by government will be increased.
Under a carbon tax, there are no free permits. As a result, for any given emission target, a carbon tax raises more revenue than a capand- trade scheme seeded with free or partially free permits. The revenue can then be used to build coalitions in support of the tax. Organizations like the Citizens Climate Lobby and the Climate Leadership Council propose distributing 100 percent of tax revenues as a citizens’ dividend. Others favor using some of the revenue to compensate low-income households and investing some of it in green energy or infrastructure projects, hoping to garner support of workers in those industries. Cullenward and Victor warn that without proper oversight, spending for such purposes could degenerate into “green pork” — projects that garner political support from special interests without doing much to reduce emissions.
In contrast to the pragmatic approach to coalition building, other green critics of carbon pricing adopt an ideological tone, often reflecting reservations about prices, markets and capitalism as a whole. For example, in an article in Jacobin magazine (“a leading voice of the American left, offering socialist perspectives on politics, economics, and culture”), Green disparages carbon pricing as being “consistent with ‘liberal environmentalism’ — the widely accepted notion that capitalism and environmental protection can happily coexist.”
Similarly, a report on carbon pricing from the Climate Justice Alliance characterizes capitalism as “a mode of production based on racialized, sexist and colonialist economic hierarchies” and concludes that “when a carbon tax scheme is proclaimed a ‘success’ by journalists or green-market enthusiasts, what is actually meant is that the tax legislation just passed is one that corporations are happy with, not that the legislation will actually achieve a reduction in emissions.”
To me, such language represents the divisive opposite to coalition-building in support of climate action. It leads to political tragedies like the defeat of the 2016 Washington State carbon tax referendum, when green organizations and the state’s Democratic Party teamed up with fossil fuel interests to whip up votes against what could have been one of the country’s most effective climate initiatives. To prioritize an end to capitalism rather than working toward effective climate policy within the framework of the institutions we have now means to settle in for a long wait.
What to Learn From the Critics
When all is said and done, it turns out that carbon pricing enthusiasts can learn a lot from their green critics. Some key points:
Not all pricing is alike. The critics are right that the results of many existing pricing experiments have been disappointing. Although it is inevitable that attempts will be made to manipulate or evade any climate policy (pricebased or not), experience to date favors carbon taxes over cap-and-trade in that regard.
First-generation carbon pricing was designed to reduce emissions to a steady but positive optimal level. In view of the increasing urgency of achieving full decarbonization, future versions of carbon pricing should be designed to fit a fixed carbon budget that will bring emissions to net zero by a designated target date. Once that date is reached, no offsets should be permitted other than direct air capture.
In designing next-generation pricing policies, care must be given to the way pricing and regulation interact. In some cases, it will be necessary to change or repeal existing regulations that block the effectiveness of pricing. Regulations such as performance standards may speed market adjustment to pricing policies, provided the two are properly coordinated. In other cases, regulatory reform or direct public investment may be needed to facilitate the build-out of complementary infrastructure, such as transmission corridors for green electric power.
The critics are right again when they say that carbon pricing is a hard sell politically. It is a simple fact that climate policy of any kind, whether price-based or not, involves immediate, specific costs (government spending, taxes, private investment, career changes for workers) in return for diffuse future benefits. The advantage of carbon pricing (especially carbon taxes, but to some degree auctionbased cap-and-trade) is that it generates revenues that could be spent to build political coalitions. That revenue should be spent wisely and not wasted on “green pork.”
An “all of the above” approach is the only way to achieve acceptable climate goals. Conservative Christian stewardship activists, libertarian defenders of the property rights of pollution victims, progressive Green New Dealers and eco-socialists are all going to have to resist the temptation to storm out of the room if their ideological preferences are not met in full.
Critics are right when they call it naïve to think that establishing a price for carbon and then “letting the market do the rest” would be enough. But it would be equally naïve to think that prices don’t matter. Earnest environmentalists nagging at people to reduce their carbon footprints won’t have much effect if the numbers on the gas pump are telling them, “Fossil fuels are cheap! Fill ’er up to your hearts content!”
Efficiency matters, too, as much as some critics distain it as the gathering of low-hanging fruit. To ignore efficiency is to unnecessarily increase the cost of getting to your goal. Higher costs are going to generate more pushback, no matter how hard you try to bury those costs deep in some 500-page EPA regulation. Whatever your political beliefs, the economics of waste will come back to bite you.