Cap, trade, subsidise - Obama's energy plan goes off piste

One of the huge surprises of the way that climate change is being discussed and the way we ought to try to deal with it, is that the orthodox economists have won. We don't have crazed Naderites screaming that carbon must be regulated and legislated out of business, as we did only a couple of decades ago with chlorofluorocabons and the like: no, everyone agrees that we should use either tax or cap and trade permits to create or influence the markets. And having given markets that push, we can pretty much leave them to themselves.

OK, I exaggerate a little, but only a little. For example, take Obama's climate change plan. There's not much in that that would bring a cry of anger, or even a snort of derision, from even a Chicago School economist (it helps that Goulsbee, Obama's advisor, is, um, a Chicago School economist). Sure, there are a few little things around the margins but then the man is indeed a Democrat, and broadly the plan is right there in the economics mainstream.

Just about every environmental problem, to an economist, is one or other or a combination of (and they are very closely related themselves) two essential problems. The Tragedy of the Commons and externalities.

The Tragedy of the Commons was first applied to population by Garrett Hardin in the 60s, an area where it isn't in fact quite true. But it's been quickly taken up in other areas. Essentially, if you've got a resource that anyone can pitch up and use then you've no problem - as long, that is, as demand for the resource is lower than the supply of the resource (or its capacity to regenerate). This is true of rangelands, of water aquifers, of airborne pollution, fisheries, whatever. As soon as people are taking what they can get, in excess of what can actually be consistently supplied, then that common resource gets depleted. So we need to limit access to it. We can do so in two broad ways: regulations (you need to get a permit to go into some National Parks) or a more capitalist manner: get someone to own the resource and let them figure things out. That's what we do with oil fields in the US and probably is what we should be doing with water out west, instead of the regualtions we do use. For while we might have an ideological preference for one method or another, what really makes the difference is, what is the resource itself? It's not too tough to allocate grazing rights out on the range: it's rather tougher to allocate property rights to global atmospheric pollution.

Our second problem is externalities: these are effects upon other people of market transactions, the costs of which are not included in the prices paid or received by those conducting said market transaction. I have a BBQ, I and my guests are delighted, you aren't so happy about the smoke all over your washing. I drive a car, you're not so happy about the lead in your kid's brain. I emit CO₂and that poor bastard in Bangladesh is going to drown 100 years hence. That first problem we tend not to worry about (what goes around comes around sorta thing) the second we solved by banning lead in gas and the third, well, that's what all the debate is about.

Taxing carbon

Economists argue that you deal with negative externalities by taxing them and that's what a carbon tax is. Or if you prefer - as Obama does - cap and trade, then all permits must be auctioned: the net effect of either route is, except for one crucial point, the same. You'll get the same amount of reduction in emissions for the same price via either route. The big difference is that with cap and trade you know how many emissions you'll get, but not the price: with a tax you know the price but not the amount. Which you prefer thus depends upon a prior assumption: what do you value more? Personally I value the known price because I think we know what the social cost of carbon is better than we know what the perfect level of emissions is, but everyone's free to disagree on that point.

Obama's main plank is a proposal to reduce carbon emissions by 80 per cent by 2050 via a cap and trade system, with all permits auctioned. OK, not to my taste perhaps but he's creating a property right that can then be traded - we know this works on the Tragedy of the Commons.

Alongside this we have reducing deforestation, plus investment in new technologies, R&D, yadda, yadda. Yes, at least some of this is pork, undoubtedly some of it will be wasteful but the flip side of our argument that we slap a tax on negative externalities like pollution is that we subsidise positive externalities: like, for example, long term basic research. Or, indeed, the education system which we subsidise on exactly the same argument. It's also worth noting that at $10 billion a year here and $15 billion a year there (that latter is $50 per head per year) in the context of a $13 trillion economy he's not exactly raping the Treasury to do this.

Overall his plan therefore seems well informed, with no major shockers aside from the ritual genuflection to the ethanol lobby. That this is a vastly expensive fuel, that it has higher emissions than gasoline itself, isn't unfortunately going to make much difference in a country where the Presidential elections start every four years in Iowa cornfields. We'll never get rid of that beast until the Primary system is changed.

I was all ready to give Obama's plan a top grade (for what little my grading of it is worth of course) for it most certainly could be a great deal worse from a Democratic candidate. While there's a few things around the sides, the basic economics of what he proposes is all sound, even if not entirely to my own tastes. Then I saw this in the Wall Street Journal:

“Sen. Obama would auction those permits to producers of carbon dioxide, such as electric utilities, and figures the sales would yield about $100 billion a year. Most of that would go to consumers as rebates on utility bills, he said.”

Ah, no, that's crazed lunacy. Yes, the permits create a property right which can then be traded: excellent, they'll end up with the people that value them most. Yes, we'll auction them all so there'll be no corporate pork in who gets the free allocations. Yes, we can spend some of the money subsidising the good things, like research. We can use the rest of it to reduce other tax rates maybe, we could even simply mail it out to every taxpayer once a year. Yes, we might even use it to subsidise more directly the poor, for they will be the people bearing the brunt of the price rises the permits will bring, raise the EITC maybe.

But rebates on utility bills? That's nonsense: what we've now got is a large and complex (and expensive don't forget) system whereby we discourage people from using energy by taxing it and then encourage them to use energy by subsidising them to do so. Quite insane.

I do hope he was misquoted, rather than the more worrying thought that one of Hillary's economists has managed in inflitrate his campaign. ®