Carbon Taxes, Cap and Trade, and All That
There are at least two things wrong with this solution. The first is that the agency is very unlikely to know enough to do it right. How is it to figure out what the lowest cost way is of reducing pollution—scrubbers, low sulfur coal, both, or one for some power plants and some for others? How, indeed, is it to figure out when pollution ought to be reduced and when the cost of the reduction is more than the benefit? Carbon dioxide, after all, is said to be a pollutant via global warming; it does not follow that we should all stop breathing.
The second problem is that even if the agency had the information, it might not be in its interest to use it correctly, to require reductions of pollution if and only if they are worth their cost and by the least costly means. Such an agency is run, after all, not by philosopher kings but by bureaucrats appointed by elected politicians. If states that produce high sulfur coal are politically influential, it might be wise to impose regulations designed to discourage utilities from switching to low sulfur coal even when that is the lowest cost way of reducing the amount of air pollution they produce (a real world example, as it happens; see Regulation Magazine Vol. 14 no.4). If the steel industry has made generous campaign contributions to the majority party, perhaps it should be spared, in the national interest, the rigors of regulation of its emissions.
An alternative which many economists prefer is a "Pigouvian Tax," named after the economist who came up with the idea. Let the agency determine the external cost imposed by each ton of sulfur dioxide released into the atmosphere. Firms are free to pollute as much as they want, provided they pay for their pollution. It is then in the private interest of each firm to find the lowest cost ways of reducing its pollution and implement them, provided that the cost of the reduction is less than the benefit.
This does not eliminate all of the problems, since the agency still has to measure cost and still may be biased in its estimates of the differing costs of different effluents in different places by political considerations. But it looks like a considerable improvement on direct regulation.
A very similar alternative is currently being discussed under the label of "cap and trade." The government sets the total amount of effluent that may be emitted—say 80% of the pre-regulation level. Each firm is issued permits for its share of that amount, 80% of the sulfur dioxide it produced last year. A firm that reduces its emissions below that level can sell the excess permits to other firms; a firm that pollutes above the level it has permits for must buy additional permits. In effect, the price of the permit is the equivalent of the effluent fee under Pigouvian taxation. A firm that pollutes more than its share must pay that price for each additional ton of effluent. A firm polluting less than its share gives up, for each ton it emits, the opportunity to sell a permit for that price. Once the level of emissions is set, the market determines the cost of reducing emissions to that level and sets the required tax.
In a system run by philosopher kings, there is one important difference between the two alternative versions. A straight Pigouvian tax requires the agency to estimate the damage done by an additional ton of the pollutant. A cap and trade system requires it to estimate what the optimal amount of the pollutant is, how far it is worth reducing it. One can imagine some situations where the former information is more readily available, some where the latter is.
In a system run by elected politicians, there is another large difference—who gets the money. With an effluent fee, the tax goes to the government. With cap and trade, the payments are by one firm to another. Firms that can easily reduce their output of effluent end up richer than they would be without the scheme, since they can sell their excess permits to other firms for whom reduction is more difficult. Indeed, the regulated industry as whole may end up richer as a result of the regulation. Depending on the details of the situation, the increased income from the higher price for (say) electric power due to the higher cost due to the regulation might be more than the cost to the firms of reducing their emissions to meet the limit.
Which brings us to current proposals for cap and trade of carbon dioxide as a solution to problems of global warming. In a system run by philosopher kings, the only important difference between that and a carbon tax is the information required to set the level of emissions or amount of tax. In the real world, cap and trade has the (political) advantage of getting large parts of the regulated industry in favor of the regulation and thus eliminating a lot of potential opposition. The cost, possibly more than a hundred percent of it, is shifted to the customers, which is to say the general public—a dispersed and politically impotent interest group. And if the government retains considerable flexibility in just how emission permits get allocated, it can use some of them to buy political support from other groups or to reward them for past support.
Cap and trade has a political disadvantage as well, of course; a carbon tax would bring in lots of money. But that money would show up in the budget, get labelled taxation, and so make it harder for the administration to deny that it is raising taxes to pay for its programs. And much of it might end up spent to get the carbon tax passed by buying off organized interest groups that were potential opponents.
Think of the cap and trade version as eliminating the middle man.