Who is Going to Pay?

  • 207 Comments

While there is a large and growing consensus that CO2 emissions must be reduced, there is a looming battle in Congress as to who will pay for it.  While a carbon tax has received some attention, the most likely program to be implemented in the United States is some form of cap and trade.  A cap and trade system grants a property right (or permit) to each entity (say firm) as to how much CO2 it can emit.  The amount that can be emitted is called a “cap.”  The cap and trade program then allows firms to trade these permits amongst themselves.  Firms that wish to emit more CO2 than their cap can buy permits from firms who wish to emit less than their cap. 

The question is who will pay?  If we auction the initial allocation of permits, businesses that emit a lot of CO2 (such as power plants) will have to pay a lot to the government for these permits.  If the government gives away these permits, then firms will have a valuable asset (CO2 emission permits) that they can then trade for money.  Moreover, if the allocation is based upon current CO2 emission, the government would be rewarding firms who current emit a lot of CO2 and punishing those who are already CO2 efficient.  Ultimately, however, taxpayers (if auctioned) or consumers (if given away) will foot part or all of the cost.  If cutting CO2 is costly for businesses, they will pass at least some of that cost onto the consumers of the United States.  Casey Mulligan, an economist at the University Chicago, nicely articulates these costs in his New York Times blog found at:  http://economix.blogs.nytimes.com/2009/05/27/how-much-will-cap-and-trade-cost/#more-14497 .

The question for you:  should the government auction these initial permits or should they give them away?  What are the political considerations?  What are the economic considerations?  Read Professor Mulligan’s article and share your thoughts.

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  • 207 Comments

Comments

  1. Vitor Horibe says:

    In order to successfully implement the cap and trade initiative, the allowances should be auctioned and not given away for free to the energy firms. This recommendation can be supported by three main arguments.
    First, one can question the underlying assumption that firms will pass the full auction cost along to the value chain and, consequently, to the end consumer. Competitive and market pressures among the players in this industry will most likely partially deter this impact. As new technologies to reduce industrial carbon emissions are being commercialized and implemented, those firms will have more alternatives to reduce their emissions economically.
    Second, in order to align the incentives of the firms to reduce their carbon emission control efforts, the cap system should not be determined according to historical emissions. The cap should be set according to each industry and be proportional to the production volume of the firm. Government and independent agencies should be responsible to have experts calculating this volume and, also, updating the number periodically to account for new industry patterns and trends. This would avoid the misalignment of firms starting to pollute more in order to have a higher allowance once the initiative is implemented.
    Lastly, if the allowances are given for free, one can also question the assumption that governments will pass the full auction cost not received from the firms to the tax payer. The implementation of this carbon tax to the population certainly will face great barriers within the different political parties. Each party and its representatives will have different opinions and agendas on how to defend or promote this clearly unpopular measure. In essence, why tax payers should be paying now for the consequence of past actions from the firms? Of course the tax payer is also the end consumer, but the rent distribution or the value distribution does not seem balanced in the battle of this subject under debate.
    In summary, allowances should be auctioned and cap system should be proportional to production volume in order to promote market competition and fair value distribution among the participants of the market and non market.

  2. Ryan says:

    The goal of carbon regulation is to impose an artificial price on carbon creation, thus increasing the costs associated with manufacturing in a way that internalizes the environmental costs. Because carbon permits have some intrinsic value, firms will maximize the amount of permits they own under either system. If the government simply gives the permits away based on some multiple of their current carbon emissions, any incentives to reduce pollution in the interim are largely offset by the promise of more permits.
    This makes it extremely difficult for regulators to properly calculate the amount of permits to distribute. Though regulators may be able to review the historical emissions of the polluters in order to decrease the chance that companies will “game the system,” this is time consuming and involves high transaction costs. On the other hand, an auction environment is not without its own problems. If auction prices are too low because of high transaction costs for smaller polluters, then firms will overpollute.
    If auction prices are too high due to speculation, firms will pollute at a level that is less than socially optimal. Risk averse firms will respond to this environment by hedging; they will reduce exposure to potentially high prices by reducing pollution at a known cost. Most firms value information, and do not want to unduly subject themselves to uncertainty. Thus, if a firm is able to reduce pollution at a fixed price, rather than face uncertainty in an auction environment, it may opt for the certain outcome. This could also lead to high pollution levels.
    In light of these considerations, it seems that distributing the credits may be the best approach. While there is a risk that innovation will stifle in the interim, the government can offset this problem by monitoring (ensuring, at least, that pollution levels do not rise), and by quickly implementing the system.

  3. Kristin says:

    First, I am fundamentally opposed to the idea of cap and trade policies, as I believe they disenfranchise Americans by 1) costing jobs, either through a shift to foreign production or by reducing the domestic workforce, 2) imposing hidden taxes through a rise in energy costs, 3) encouraging fraud and unfair business practices amongst companies vying for “credits,” and 4) crippling the ability of American business to compete with foreign countries.

    However, between the choices of “auctioning” or “giving away” the permits, (I put the phrases in quotes, since ultimately it is US consumers or taxpayers who bear the high cost of either option), I choose the auction.

    In order to show why the auction is the more desirable choice, it is best to show how utterly undesirable giving away the permits would be. If the government were to assign the permits, it would need to do so based on the carbon emission rate presented to it by a firm. Since credits may be traded, likely at a very high price, firms would be incentivized to artificially inflate their emissions with the goal of obtaining as many credits as possible. While this would not only increase carbon emissions in the short run, in the long run firms would adjust their emissions practices to function within the new higher, and now government approved, standards – completely undermining the goal of reducing emissions.

    Under the auction choice, purchasing expensive permits will, at least in theory, deter firms from buying more than the bare minimum they need to function. Furthermore, while an auction might open the door to collusion and fraud between firms, the price of the permits will be passed on to consumers through a rise in the product’s price. As the product becomes more expensive, consumers will purchase less of it, contributing to lower production, and eventually, lower emissions. The goal of reducing carbon emissions will be met on a two-pronged front: by reducing both production and consumption.

    Politically, firms will most likely lobby against any policies at all, or for the giving away of permits. Since they are large, well organized, and resource rich, they will most likely be a formidable opponent. An auction format will present less opportunity for lawmakers to be influenced by campaign contributions and lobbying expenses than a give-away, since the allocation of the permits will be based on each firm’s purchasing power, not the government’s discretion.

  4. rocio says:

    The government should auction the initial permits, because if industries are forced to pay in order to pollute, they will reduce their pollution levels. Likewise, constituents will feel happy because they will not pay extra and government would be fighting climate change. On the other hand, if the government gives the permits away, companies will have more assets and might not try to reduce pollution. Companies will commercialize these new assets and a new market, which cannot be controlled by the government, will appear.

    Nevertheless, political considerations must be taken in account. Many companies that need these permits are rich and powerful and influence representatives and senators. Since companies will benefit if the permits are given away, they are going to pressure Congress. In addition, after the Citizens United Supreme Court ruling, companies can give as much money as they want to political campaigns; therefore, politicians might be willing to favor them.

    On the other side, the taxpayers elect senators and representatives. Therefore, if they force taxpayers to pay more, they might not get reelected. Even if climate change is an issue that concerns most of the population, the majority of the people are willing to fight against it as long as it does not cost them a dime. In conclusion, most politicians will ponder what option will give them more votes.

    Finally, the companies that cannot afford to lower their pollution levels, nor buy the permits, will face economical crisis. If many companies face this problem the economy will be threaten as a whole, which means that the market is not ready for the new legislation. Congress has to take in account the possible economic consequences when they put a price to the permits, and maybe find a way to protect smaller business at the beginning.

  5. rocio says:

    The government should auction the initial permits, because if industries are forced to pay in order to pollute, they will reduce their pollution levels. Likewise, constituents will feel happy because they will not pay extra and government would be fighting climate change. On the other hand, if the government gives the permits away, companies will have more assets and might not try to reduce pollution. Companies will commercialize these new assets and a new market, which cannot be controlled by the government, will appear.
    Nevertheless, political considerations must be taken in account. Many companies that need these permits are rich and powerful and influence representatives and senators. Since companies will benefit if the permits are given away, they are going to pressure Congress. In addition, after the Citizens United Supreme Court ruling, companies can give as much money as they want to political campaigns; therefore, politicians might be willing to favor them.
    On the other side, the taxpayers elect senators and representatives. Therefore, if they force taxpayers to pay more, they might not get reelected. Even if climate change is an issue that concerns most of the population, the majority of the people are willing to fight against it as long as it does not cost them a dime. In conclusion, most politicians will ponder what option will give them more votes.
    Finally, the companies that cannot afford to lower their pollution levels, nor buy the permits, will face economical crisis. If many companies face this problem the economy will be threaten as a whole, which means that the market is not ready for the new legislation. Congress has to take in account the possible economic consequences when they put a price to the permits, and maybe find a way to protect smaller business at the beginning.

  6. Pong says:

    The government should pick the auction option because auctioning the permit will force firms to maximize their resources and invest in technologies to reduce the CO2 emissions which will help the country and even the world achieving its goals of a better economy in terms of efficiencies and a better environment where all firms will try their best to reduce the emissions as long as the cost of reducing them is lower. In addition, some firms would even give up some revenue to invest on controlling CO2 emissions because they hope to gain an environmental-friendly image which may ultimately pay them more in return.
    Undoubtedly, either auction or giving away option, taxpayers and end consumers will have to bear the costs eventually. But, currently, we all know that the most important thing is environment. Consumers shall be aware of the higher prices and can decide whether to against the auction system or think before consuming recklessly.
    Furthermore, passing the auctioning law will be more difficult because larger firms who emit most CO2 will be heavily affected by this new system and they will lose a lot more if the law passes. Therefore, they will try their best to prevent the auctioning system to happen. Plus, with their extremely high resources and benefits, bringing it down are considerably easy for them.

  7. Hal Gore says:

    To auction or give away? Many view this as a question of fairness. But considering that we have been unable to resolve this issue for years, it’s time to analyze it from a new paradigm. The question “To auction or give away?” is a purely political question. If we value the environment and want to implement a cap and trade system, we need to give up on what we think is a fair allocation of credits and adopt the allocation scheme that is politically exigent. A compromise must be made. It’s time to split this baby.

    Three groups (and their constituencies) have a substantial, but different stakes in the allocation: powerful politicians, heavy carbon polluters and light carbon polluters. Many powerful politicians prefer an auction system. Heavy polluters prefer an allocation based on historical carbon emissions. Light polluters prefer an allocation based an energy output so that they are not squeezed out for being clean. None of these parties is willing to back down, therefore, all of these parties should be given what they want: 1/3 of the credits should be auctioned, 1/3 of the credits should be allocated based on historical emissions, and 1/3 of the credits should be allocated based on energy output. All parties have had their demands partially, but not completely fulfilled. All the parties can report success to their constituencies. And we saved the environment. You’re welcome.

  8. Eventually, sooner or later, the consumer is paying the bill. If the Government auctions the permits to the companies, then the companies are finally going to pass the cost on the price the consumer will be paying for the product. If the government gives the permits away, then the companies are not paying for them and the companies that pollute the most are the rewarded ones considering the permits as valuable and tradable assets. Afterwards, those companies will trade with the companies needing more caps. At the end, the companies paying for more caps will traduce their costs into the final prices the consumers pay. Inevitably, the answer looks to be the same in both cases.
    Taxation is not likely to be the solution. The problem is that the issue will lead immediately to a massive lobby from the significant CO2 producers (Ex. car making industry).
    The cap and trade system will surely be effective on trying to reduce the CO2. Indeed, the European Union has experienced good results on applying this kind of regulation.
    To decide on how to allocate the permits it would be interesting to ask ourselves what would be fairer? As said, if permits are given away, there will be an undesirable disequilibrium in market. If the Government decides to go for the auctions then those who are polluting the most are paying the highest cost and in the same way those consumers contributing to those industries are equally and proportionally affected. The right thing to do is to make the industries polluting the most to pay higher prices. Consumers paying for this are also beneficiaries and that makes the decision fairer.

  9. Sam says:

    No matter permits are auctioned or given away, down in the end of the chain are the consumers, and consumers will be the ones actually paying. It comes clear to mind that if making the government issuing these allowances, tax payers will end up paying, or in other words, the consumers. Therefore, I believe that companies should be the one ‘actually paying’ for this.
    Permits should be auctioned in a collective manner for a better tracking system to be implemented. While some might be worried about allowance becoming a type of resource for firms, I think that this can be regulated and tracked to make sure firms do not benefit from this issue. Giving these permits away just brings more issues about fairness, proportionality and also having the trouble of firms passing on the costs to the consumers. Since, environmental policies should be strictly monitored, the costs of giving these permits to the firms would increase also in the government sector, which in the end, will be passed on to the tax payers. Not to mention by giving the permits will arise much more issues in the congress, having firms even more active in seek of power. The best policy to be taken should have a foundation on auctioning the permits but also having a system to keep track of firms. Also, to make sure that the consumers are not being ‘charged’ for these permit costs.

  10. Matt R. says:

    In determining the initial allocation of the CO2 permits, I come to the conclusion that the government needs to distribute the permits based on the current output of different firms. The reason they need to do this is the looming possibility of a speculation and an accompanying market failure. If an auction system is announced, some investors are sure to recognize an opportunity to corner the market. By raising large funds to purchase permits that their business does not need, or worse, as investors who don’t have a business that pollutes at all, they could turn around and resell these permits at a premium. This could seriously harm many industries, and possibly even drive some utility producing firms out of business, if purchasing the permits at a premium is too costly, even though their production would be efficient at a normal market price without speculation. This will harm both those firms and the consumers who would have benefitted from the production. The most effective way to remove the possibility for speculation is simply to allocate the permits on the basis of those already in the industry.

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  2. [...] economic efforts such as carbon tax and cap and trade. The students all read a post on our site "Who is going to pay" by Dr. de Figueiredo. They then wrote comments – to the post which can be seen and [...]

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