Cap and Trade. Good, bad or ugly?

[alfred russel]

Can you give me a citation for these claims?  Or is this simply a series of "ifs" constructed to yield the desired result?

I could just as easily asay "if i am an incumbant company with an exemption to the carbobn tax, i pay no  taxes at all—direct or indirect. If I'm an upstart company, wanting to compete with the incumbent, I need to pay taxes on any carbon I (produce?  consume?  not sure what is being taxed in a carbon tax scheme). The entire plan should not be described as a tax—though it does seem like a cleverly designed scheme to protect current business from future competition. If anything, it is a tax on new business formation."

I could give links, but I don't think any of the concepts are contested and anyone here is just as capable at googling as me. If you want more specifics, then here is one:

Incumbant Company A: A paper mill using a coal powered steam plant. Initially receives allowances to cover most of its production.

New Company B: A startup paper mill that will not receive any allowances and will have to purchase them for its steam plant.

Am I wrong that the plan would work this way?

You point out, of course, the huge disadvantage of the carbon tax scheme:  since the cost of the tax is passed directly to the consumer, the utility has no incentive to cut CO2 emissions at all.  It especially has no incentive to invest in any CO2 reduction schemes, since they will pay no profit.  In a cap-and-trade system, any reduction in actual CO2 output generates a profit or reduces losses.  Your claim that a tax system avoids the problem is mere wishful thinking.

I never made the claim that a tax system avoids the problem--in fact it doesn't.

A utility company's profits are tied to rates, which are set by the state with an eye on the company's P&L. In either the case of either a carbon tax or cap and trade, I question what incentive there is in such an environment. If the incentive turns out to be weak, under a cap and trade system the result would be too few credits for the rest of the economy, while under a carbon tax you would have excessive emissions.

[alfred russel]

You point out, of course, the huge disadvantage of the carbon tax scheme:  since the cost of the tax is passed directly to the consumer, the utility has no incentive to cut CO2 emissions at all. 

That would only be the case if energy demand at the consumer is perfectly inelastic, which is demonstrably not so.

Or if regulators looked to ensure a certain return on investment, which may be so.

[grumbler]

[I could give links, but I don't think any of the concepts are contested and anyone here is just as capable at googling as me.

I do not know what this means.

If you want more specifics, then here is one:

Incumbant Company A: A paper mill using a coal powered steam plant. Initially receives allowances to cover most of its production.

New Company B: A startup paper mill that will not receive any allowances and will have to purchase them for its steam plant.

Am I wrong that the plan would work this way?

It sems to me that you are wrong.  Company B is only not granted the same status for a quarter, since the sales are quarterly.  Why do you have tht I don't?

I never made the claim that a tax system avoids the problem--in fact it doesn't.

A utility company's profits are tied to rates, which are set by the state with an eye on the company's P&L. In either the case of either a carbon tax or cap and trade, I question what incentive there is in such an environment. If the incentive turns out to be weak, under a cap and trade system the result would be too few credits for the rest of the economy, while under a carbon tax you would have excessive emissions.

Yes, and since excesive emissions are porecisely what we ant to avoid, it seems natural to me to directly stop what we want to avoid, rather than having a system that giuesses (if all goes well) towards that point.

That's really the main advantage of cap and trade (as has been demonstrated, unlike taxes): it yields the result desired, at a hopefully desired cost, rather than hopefully yielding a desired result at a known cost.

If one is serious about reducing CO2 emissions to stop global warming, I don't know how this is even a controversy.

[grumbler]

Or if regulators looked to ensure a certain return on investment, which may be so.

Or if the law was designed to limit CO2 emissions, in which case one is barking up the wrong tree.

[DontSayBanana]

Regarding the article Armyknife posted, so the talking heads that published said report are nay-saying untested political methods, but have no qualms about proposing solutions based on flawed or non-existent technology?

[DGuller]

Regarding the article Armyknife posted, so the talking heads that published said report are nay-saying untested political methods, but have no qualms about proposing solutions based on flawed or non-existent technology?

Most technologies are non-existant, you can't let that stop you.

[alfred russel]

It sems to me that you are wrong.  Company B is only not granted the same status for a quarter, since the sales are quarterly.  Why do you have tht I don't?

It could be I'm wrong--it has happened before. I've just read that we are grandfathering people in during the early years, but it wouldn't surprise me if that is incorrect. If it is, how is the system working off quarterly sales?

Yes, and since excesive emissions are porecisely what we ant to avoid, it seems natural to me to directly stop what we want to avoid, rather than having a system that giuesses (if all goes well) towards that point.

That's really the main advantage of cap and trade (as has been demonstrated, unlike taxes): it yields the result desired, at a hopefully desired cost, rather than hopefully yielding a desired result at a known cost.

If one is serious about reducing CO2 emissions to stop global warming, I don't know how this is even a controversy.

It does come to a tradeoff. With a cap and trade system, if predictions go askew the economy can take a major hit, whereas if they do in a tax system we will go over our emissions targets. I'm skeptical this is going to have much of a global impact, so I'd much rather move toward the latter.

[alfred russel]

Or if regulators looked to ensure a certain return on investment, which may be so.

Or if the law was designed to limit CO2 emissions, in which case one is barking up the wrong tree.

I wasn't arguing that CO2 emissions won't be limited, I'm just pointing out that utilities aren't really a free market and may not respond well to cap and trade incentives.

[DontSayBanana]

Most technologies are non-existant, you can't let that stop you.

You can bank on derivative tech, but a lot of these solutions are based in science that's still in the hypothetical stage. Take cars. It takes more fossil fuels to make enough hydrogen to power a car, and we're still faced with the problem of very large lithium batteries having a tendency to explode without warning. There needs to be some grounding for projections.

[The Minsky Moment]

That would only be the case if energy demand at the consumer is perfectly inelastic, which is demonstrably not so.

So it must be "perfectly" inelastic?  Any lessor sort of inelasticity will not do?

Correct.  It's a sliding scale.  More demand elasticity, the more the incidence falls on the producer.

Since the tax is on carbon, and not energy demand, I am not sure what effect this tax will have.  Who buys carbon, anyway?

It is in substance a tax on energy products.  The carbon content just determines the proportional effect.

Economically, a carbon tax and cap & trade are identical in the sense that the two relevant economic variables are quantity and price.  You can havea policy to impact quantity - which then leads to a derived price; or you can have a policy that impacts price, which then gives rise to a derived quantity. 

Administratively, they aren't the same though - and we have long experience with quotas and quantity controls that suggests that such measures are significantly more problematic to administer then levying a tax.   In terms of economic impact, while either policy can be calibrated to make sure that average prices and quantities over any significant time frame would be the same, both policies could be subject to significant fluctuations over short periods.  In the case of taxation, the fluctuations come in terms of quanitites demanded, which isn't really a problem because it is a relatively simple matter to build and liquidate stocks.  In the case of cap and trade, the short-term fluctuations come in terms of high price volatility - which is more problematic because it disrupts rational business planning and imposes significant hedging costs.

[grumbler]

I wasn't arguing that CO2 emissions won't be limited, I'm just pointing out that utilities aren't really a free market and may not respond well to cap and trade incentives.

But they HAVE responded well to cap and trade systems already!

[Tamas]

In government, failure is success. That's what I call DiLorenzo's First Law of Government. When the welfare state bureaucracy fails to reduce poverty, it is rewarded with more tax dollars and more responsibilities. When the government schools fail to educate children, they are rewarded with more tax dollars and more power to meddle in education. When NASA blows up the space shuttle, it is rewarded with a large budget increase (unlike a private airline, which would likely go bankrupt). And when the Fed causes the worse depression since the Great Depression, it is rewarded with a vast expansion of its powers.

DiLorenzo's Second Law of Government is that politicians will never assume responsibility for any of the problems that they cause. No one in society is more irresponsible than politicians, especially ones like President Obama who blame today's economic crisis on an alleged lack of responsibility in the private sector. They will always blame capitalism for our economic problems, even when capitalism is not even the economic system that we live under (it's economic fascism, to end the suspense). Nothing is more irresponsible than knowingly destroying what's left of our engine of economic growth with more and more governmental central planning, even if it is given the laughable name of "public interest regulation."

DiLorenzo's Third Law of Government is that, with one or two exceptions, all politicians are habitual liars. The so-called "watchdog media" is a myth, for pointing out the lies of politicians is the best way to end one's career as a "prominent journalist." Do this, and your sources of governmental information will be shut off.

Today's Biggest Governmental Lie is that financial markets are unregulated and in dire need of more direction, regulation, control, and in some cases, nationalization, by the Fed or by a new Super Regulatory Authority. This is all a lie because, according to one of the Fed's own publications ("The Federal Reserve System: Purposes and Functions"), the Fed already has "supervisory and regulatory authority" over: bank holding companies, state-chartered banks, foreign branches of member banks, edge and agreement corporations, U.S. state-licensed branches, agencies, and representative offices of foreign banks, nonbanking activities of foreign banks, national banks, savings banks, nonbank subsidiaries of bank holding companies, thrift holding companies, financial reporting procedures of banks, accounting policies of banks, business "continuity" in case of economic emergencies, consumer protection laws, securities dealings of banks, information technology used by banks, foreign investment by banks, foreign lending by banks, branch banking, bank mergers and acquisitions, who may own a bank, capital "adequacy standards," extensions of credit for the purchase of securities, equal opportunity lending, mortgage disclosure information, reserve requirements, electronic funds transfers, interbank liabilities, Community Reinvestment Act sub-prime lending demands, all international banking operations, consumer leasing, privacy of consumer financial information, payments on demand deposits, "fair credit" reporting, transactions between member banks and their affiliates, truth in lending, and truth in savings. And of course it also engages in legal price fixing of interest rates and creates inflation and boom-and-bust cycles with its "open market operations." This is the Washington, D.C. establishment's definition of "laissez faire" in financial markets. (Note that I didn't even mention other financial market regulators such as the SEC, Comptroller of the Currency, Office of Thrift Supervision, and dozens of state regulatory agencies).

DiLorenzo's Fourth Law of Government is that politicians will only take the advice of their legions of academic advisors if it promises to increase their power, wealth, and influence, even if they know the advice is bad (or even devastating) for the rest of society. The academics happily play along with this corrupt game because it also increases their notoriety and wealth. The most glaring example of this phenomenon today is the fact that there has been virtually no discussion at all by government officials or the media of the vast literature of the gross failures of government regulation to protect "the public interest," a literature that documents the failures of government regulation for more than a century.


There has always been some kind of government regulation of economic activity in America, but the regulatory state got its first big boost with an 1877 Supreme Court case known as Munn v. Illinois. The two Munn brothers owned a grain storage business, and the powerful farm lobby in their state wanted to essentially steal some of their property from them by having the Illinois state legislature pass a price control law that forced the price of grain storage down below the free-market price. Such laws had previously been ruled as an unconstitutional taking of private property or a violation of the Contract Clause of the Constitution, but no longer. The plunder-seeking farmers prevailed, and it was hailed by the Court as a great victory for "public interest" regulation. Thus, the first example of "public interest" regulation was unequivocally an act of legalized theft for the benefit of a powerful and unscrupulous political special-interest group at the expense of honest, hard-working small businessmen.

Either through ignorance or corruption (or both), academics – including the founders of the American Economic Association, such as Richard T. Ely – sang the "public interest" tune with regard to economic regulation for decades, creating the popular myth that markets always fail, and government regulation is always benevolent, omniscient, and correcting. They did this despite the glaring evidence all around them that regulation was always and everywhere a special-interest phenomenon. As historian Gabriel Kolko wrote in his 1963 book, The Triumph of Conservatism, big business in the early 20th century sought government regulation because the regulation "was invariably controlled by leaders of the regulated industry, and directed toward ends they deemed acceptable or desirable." "Government regulation has generally served to further the very economic interests being regulated," legal scholar Butler Shaffer wrote some thirty years later in his book, In Restraint of Trade. Kolko called this "the new Hamiltonianism" and "a reincarnation of the Hamiltonian unity of politics and economics," referring to the mercantilist aspirations of the nation's first treasury secretary.

Most academic economists, seduced by the prestige and money that came from being governmental advisors, ignored all of this reality and instead spent roughly fifty years – from the pre-World War I years until the 1960s – inventing factually empty theories about the alleged "failures" of markets and the need for benevolent and presumably omniscient government regulators to "correct" these alleged failures. It was all based (and still is) on the quite fraudulent technique of proclaiming that markets are not "perfect," but that government was, and would therefore correct any imperfections in real-world markets (as though anything on this earth is "perfect"). Economist Harold Demsetz mockingly labeled this approach to the study of markets "the Nirvana Fallacy."

The Austrian School of Economics is the only school of thought within the economics profession that never participated in this corrupt charade. The same cannot be said of the famous "Chicago School" whose acknowledged founder, Henry Simons, embraced many "market failure" theories and was an interventionist by any day's standards.

   
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But the Chicago School performed a penance of sorts beginning in the 1960s with research and publications about the actual effects of government regulation, including analyses of who benefits and who loses from it. Unlike the rest of the economics profession (with the exception of the Austrian School), they no longer simply accepted the unfounded assumption that government regulation was unequivocally a good thing. Hundreds of books and thousands of academic journal articles were published that essentially rediscovered the old truth that "as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit," as Nobel laureate George Stigler wrote in 1971. Stigler was awarded the Nobel Prize in Economics for his research on "the economics of regulation."

This research was expanded over the years to account for different kinds of regulation, such as regulation that is sought by one producer group that does not necessarily harm consumers but competing producers. Large corporations often lobby for onerous government safety and environmental regulations, for example, because they know the regulations will likely bankrupt their smaller competitors and deter the entry of potential rivals. In any event, there now exists a gigantic literature on the economic effects of regulation that shows that, for over 100 years, it has rarely, if ever, benefited consumers despite all the pro-consumer/public interest rhetoric that is attached to it. All of this literature is studiously ignored by Ivy League "superstars" like Fed Chairman Ben Bernanke, the former chairman of the Princeton University economics department. It is a shameless act of academic fraud, but unlike normal academic fraud, it will have tremendous negative real-world economic consequences.

A major thrust of this literature is the recognition that, historically, businesses that have tried to form cartels have always failed. Even the infamous OPEC Cartel only had the power to raise world oil prices for about seven years during the 1970s before it collapsed. Private attempts to cartelize or monopolize markets always fail because of the powerful temptation to cheat on the cartel agreement by cutting prices. Once one member of the cartel cheats in this way, the whole thing breaks down as everyone else "cheats" while the cheating is good and there are still profits to be made.

Businesses long ago discovered that the only way to have a permanent or at least long-lasting cartel is to have the cartel agreement enforced by government regulation, with the threat of heavy fines and/or imprisonment for cheating. Thus, the railroad and trucking industries were cartelized by the Interstate Commerce Commission, which set industry prices and was controlled for decades by those industries. The Civil Aeronautics Board cartelized the airline industry in a similar way for about half a century until it was deregulated in the late 1970s. There was vigorous competition and price cutting in the electric utility industry until it was ended by government regulation and the creation of franchise monopolies by government in most cities in America. AT&T enjoyed a telephone industry monopoly thanks to state government regulation that made competition illegal for decades. The list is almost endless.

Perhaps most importantly, the Fed was created to facilitate the creation of a banking industry cartel and the creation of cartel profits in that industry as well. As Murray Rothbard wrote in A History of Money and Banking in the United States, "the financial elites of this country . . . were responsible for putting through the Federal Reserve System, as a governmentally created and sanctioned cartel device to enable the nation's banks to inflate the money supply . . . without suffering quick retribution from depositors or noteholders demanding cash."

In other words, giving the Fed even more regulatory "authority" is like giving an alcoholic another bottle of whisky, a murderer another gun, or a bank robber another ski mask. It is bound to make things worse, not better. "We the people" have no ability to regulate the regulators in any way. Our only hope is to end the Fed before it creates an even greater depression than the one it has created for us today.


June 19, 2009

Thomas J. DiLorenzo [send him mail] is professor of economics at Loyola College in Maryland and the author of The Real Lincoln; Lincoln Unmasked: What You're Not Supposed To Know about Dishonest Abe and How Capitalism Saved America. His latest book is Hamilton's Curse: How Jefferson's Archenemy Betrayed the American Revolution – And What It Means for America Today.

[The Minsky Moment]

Thomas J. DiLorenzo  . . . author of The Real Lincoln; Lincoln Unmasked: What You're Not Supposed To Know about Dishonest Abe and How Capitalism Saved America. His latest book is Hamilton's Curse: How Jefferson's Archenemy Betrayed the American Revolution – And What It Means for America Today.

So he is some kind of idiot, I gather.

[Tamas]

Thomas J. DiLorenzo  . . . author of The Real Lincoln; Lincoln Unmasked: What You're Not Supposed To Know about Dishonest Abe and How Capitalism Saved America. His latest book is Hamilton's Curse: How Jefferson's Archenemy Betrayed the American Revolution – And What It Means for America Today.

So he is some kind of idiot, I gather.

He is way too over-zealous, but his general point is correct.

[grumbler]

He is way too over-zealous, but his general point is correct.

Disagree.  He is a wacko.  Statements like "pointing out the lies of politicians is the best way to end one's career as a 'prominent journalist'" are so obviously false on the face of them that he has zero cred with anything I cannot verify myself.