In the midst of the debate over exactly what commitments will come out of the Copenhagen Accord follow-up discussions, and how a cap and trade system to incorporate those might work, we asked long time carbon trader Olivia Fussell, the CEO of Carbon Credit Capital in New York, to opine a bit on myths on cap and trade v carbon tax for the layman. Cleantech Blog has written lots on this topic, but it always needs more.
Myth 1: A Carbon tax provides much greater price stability than emission trading under a cap and trade system.
This argument is valid only when an emission trading system is designed without banking and borrowing options which allow firms to smooth emissions over time. This in turn contributes to leveling of the price of allowances and creates certainty in the market and thus spurs investment.
Moreover, tax regimes can easily be changed by legislative bodies which in turn can also introduce instability.
Myth 2: A carbon tax is a preferable option because the revenues from taxation can be used to invest in low carbon technology and/or used to offset potential regressive effects of carbon taxes on poorer households.
This argument is valid only with the assumption that allowances are grandfathered in an emission trading scheme. One solution to this potential problem is the auctioning of allowances which can potentially generate the same revenues as a tax.
In addition, governmental funding tends to “pick a winning” technology, whereas technological innovation is needed in many areas (renewable energy, energy efficiency, energy storage, etc). A cap and trade system provides an important incentive for the development of these technologies by providing a price signal that enables firms to capture the value of new technologies. Because cap and trade is not technology specific, it can encourage and accommodate any emerging GHG control technologies or practices.
Myth 3: The introduction of a carbon tax is simpler than an emission trading scheme under cap and trade.
True, an emission trading scheme is much more complicated than taxation. The introduction of a new tax does not require setting up a new system with additional administrative costs attached to it. However, having an international agreement on a global tax is highly unlikely if not impossible. This statement is supported by an example of the unsuccessful attempt to impose carbon tax in the 1990s within its multi-national European Union’s structure. Also the Clinton administration unsuccessfully tried to introduce an energy tax in the mid 1990s but encountered strong opposition in Congress.
Myth 4: A Cap and trade system creates market and environmental uncertainty.
Not true, a tax does not set a quantitative, legally enforceable limit on emissions. On the other hand, a cap and trade system measures, monitors, and achieves a specific environmental objective.
Myth 5: Cap and trade doesn’t work because the European Union Emissions Trading (EU ETS) Scheme did not prove that significant emissions reductions were achieved.
The fact that Phase I of the EU ETS achieved only small reductions in emissions was not due to the embedded flaw in the cap and trade but because the emission cap was set too high. In addition, the EU over allocated allowances. This was mainly due to many countries lacking reliable data monitoring and information standards of GHG emissions when the scheme was first introduced. Since then the EU has solved the problem of monitoring and reporting and tightened the cap for Phase II.
Myth 6: A Cap and trade system allows for ‘windfall profits’ for regulated firms.
It is true that implementation of the trading scheme in the EU led to the increase in retail electricity prices. However, this situation can occur under any type of regulation and it’s not cap and trade specific. The determining factor is not the type of regulation but the ability of a company to pass through the costs to consumers. Based on the EU ETS example, electricity generators were able to make profits because they were able to reflect the value of allowances in prices of electricity, even though they received the allowances for free (‘grandfathering’). This problem can be addressed through the mechanism of allocating allowances and more specifically through auctioning. Regulators would require companies to purchase allowances, and this could ensure that the companies incur direct costs, thus reducing their profit margin. However, this does not solve the problem of passing costs onto consumers. One can solve this by passing the revenues from the auctioning of allowances back to the consumers.
You can reach Olivia for comment at http://www.carboncreditcapital.com/
