Cap and Trade, Rehabilitated

Cap and Trade , Rehabilitated Using Tradable Permits to Control U.S. Greenhouse Gases

Our presentation will include...  Introduction  Allocating the Value of Emissions  Setting Prices Versus Setting Quantities  A Reassessment of the Prevailing View  Summary and Conclusions

Introduction

What is Cap and Trade?

Total allowable emissions are limited (the ''cap'') and an equivalent number of allowances are created, which may be bought or sold on a market (the "trade").

The origin of cap and trade • Emissions trading, first proposed by Dales in 1968. • The U.S. Acid Rain Program, Title IV of the Clean Air Act Amendments.(1990)

The U.S. Acid Rain Program • to reduce overall atmospheric levels of SO2 and NOx, which cause acid rain.

• an implementation of emissions trading • allowing coal-burning power plants to buy and sell emission permits (called "allowances") according to individual needs and costs.

40%

2010 Prevent nearly 160,000 people from being dead early due to pollution.

2020

​ The benefit from this program is nearly 2 trillion dollars.

However... \Tax is better!/​ \Tax is better!/

\Tax is better!/​

How we implement Cap and Trade?

Being monitored & recorded

hand over an equivalent number of allowances to the government

How we implement Cap and Trade?

• A​firm​seeking​to​minimize its cost​of​complying​with​the​program​w ill​abate​pollution​until​its​ marginal cost = market price of an allowance

cost-effective

allow firms to bank allowances

Freely distributed, sold at auction

• Trading will give rise to an equilibrium price equal to the emissions tax that would achieve the same expected abatement.

similar in terms of administrative costs.​ CAP AND TRADE

<

5%

SO2 trading program

Emissions monitoring alone accounts for roughly 2/3 of administative costs, costs that would be the same under a tax.

 How​the​value​of​emissions​is​allocated?

 Whether​the​policy​sets​the​price​or​the​quanty​ of​emissions?

Allocating the Value of Emissions

Cap & trade vs Carbon tax 1. The value of emissions... ？

Cap & trade

Carb tax

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Allocated​ to​polluters

Captured​ by​government​

Cap & trade vs Carbon tax 2. Economic Efficiency

Cap & trade ------------------------------

An allowance auction → Same expected revenue

Carb tax

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Double Dividend → Recycling Revenue

Double D ividend

❶​Revenue​captured​by​government. ❷​Government​use​it​to​reduce​

distortionary​effect​on​labor​&​capital.

Advantage of Cap & trade Political Feasibili ty

Sustainabili ty

Value of Flexibilit y

Problem:

Rent Seeking A​drain​on​the​economy,​ since​it​diverts​resources​from​productive​uses.​

Cap & trade < Carbon tax Natural limit

Setting Prices Versus S etting Quantities

Setting Prices Versus Setting Quantities Political​Implications International​Harmonization Short-Run​Price​Volatility Long-Run​Cost​Uncertainty

Political Implications

Framing​of​ Policy​Objective

Scope​of​ the​Program

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·​GHG Tax the​size​/​ potential​cost ·​Cap Emission​target​/​ climate​change

·​The​larger​the​ scope​is, the​more​ profits​firms​ will​earn.

International Harmonization

Costeffectiveness

Internation al Participatio n

Distribution al Equity

Cap and Trade

·

Cost-effectiven ess

Linkage​cap​and​ trade​program

US allowance market

⤸ EU firms

Carbon Tax

US firms

⤸

EU allowance market

·

Common​tax​rate

Cap and Trade

International Participation

Developed country ¡ Allowance demander

Developing country ¡ Allowance supplier

Cap and Trade

Distributional Equity

Developed country Developing country

Redistribu tion

¡ Low-cost abatement ¡ Low abatement

Short-Run Price Volatility Is the price volatility a crucial factor to decide which policy is better?

No, capital return volatility plays more important role than price volatility

2 policies designed from Cap an d Trade Allowance Reserves

Flex Options

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·​In response to short-term cost shocks

·Similar to stock options in financial markets

Long-Run Cost Uncertainty

Inestimable Technology Cost

Slope of MC > Slope od MB ： Carbon Tax is better Carbon Tax

Cap and Trade $

Expected​MC Real​MC

DWL MB

Abatement

Slope of MC < Slope od MB ： Cap and Trade is better $

$ Expected​MC

Expected​MC

Real​MC DWL

MB Abatement

Abatement

Most of the economists believe that MB is flat

Carbon tax is better

A Reassessment of the Prevailing View

Two Problems with the Prevailing view

Bank

Loan

Two Problems with the Prevailing view Ease the "cost shock"

Generally we assume influence from climate change is slow and steady......

William D. Nordhaus

More and more evidences show the impact of climate change is nonlinear

Tipping points

CLIMATE CASINO

The risk is more than we thought

Generally Precautionary Theory

Conclusions of Reassessment • MB curve is 3-7 times steeper than MC curve.

• Under the condition that implemental range and time is large and long , MC .

Discount rate is 2% , representing that the rate of return on "Investing Abatement" is MC low.

MC'

Financialize

Time

More research is needed!

Range

Summary and Conclusio ns

Tax versus cap and trade, which one is better?

• The advantages of cap and trade:  Flexibility  Political feasibility  Cost effectiveness  Broad praticipation and equity in the international context  More efficient when marginal abatement costs are uncertain.

Economists should...

Market-based environmental policy

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Help promote sound policy.

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Highlighting the advantages of market-based policies.

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Designing measures to manage price volatility.

THANK S