Climate change, a suggestion

The climate has been changing continuously for as long as this ball of rock has had enough gravity to hold onto gasses in order that there be a climate. It has always and will always be in flux. Currently it is changing in ways that I fear will be detrimental to human life and I sincerely hope it is principally because of human action. This is because if humans started it then humans can stop it. I've been thinking about what can be done about climate change after an interesting discussion with Bruno of Picking Losers sparked on by my post about the Heathrow protesters. In this monster post here is my idea for trying to deal with climate change, it requires just three things.

1. A tax


2. A tax credit


3. A market

the story so far

Aside from the neo-communist ludites that want everybody throw away our technology, then crawl back into the caves and inbreed there have been three main alternatives proposed for dealing with climate change.

1. Grow out of trouble


2. Carbon offsetting


3. Cap and trade carbon credits

One idea for trying to deal with climate change has been simply to let the economy grow its way out of trouble. Normally this would be the best approach because we know that a properly constructed market left to its own devices can find the optimum level of anything. The problem is that climate change is not accurately taken into account by the current markets, it is an externality done by us that will have to be paid for by them (people in the future, mainly in the poorer areas such as Africa). Certainly growing the economy will have good effects for the environment by letting technology improve and become more efficient. We can trade so what people want can be produced with using the least resources, plus let people become richer and so able to afford a luxury like a more environmentally friendly lifestyle.

Carbon offsetting

Being environmentally friendly is a luxury. Only after they have got the basics of not ending up dead and being able to bring up there children safely do people ever think about the more abstract things like the environment that will not immediately affect them. As people become richer they can indulge their whims on luxury goods, with one of this seasons must have accessories for the uber-rich being a fist full of carbon offsets.

With carbon offsetting you are paying a company to try and reduce atmospheric CO2 levels for you now in order to reduce the level of climate change in years to come. The current schemes are far from perfect, because the consumers simply don't care enough. They are buying a better environment for somebody else in the future that you will never meet, not a recipe for intense engagement in what they are buying. There maybe a few that do this for purely altruistic reasons, but what most are really buying is a smug holier than thou feeling. There being not many people that have so much money the only thing left to buy is a justification for feeling smug, so unfortunately until we can get an incentive that will appeal to more people than smugness carbon offsetting is not going to take place on a large enough scale to be useful.

Cap and trade carbon credits

Carbon trading was a good idea, but one that failed because of the way that it was implemented. Each member state was supposed to issue only as many credits as where absolutely needed. Unfortunately everybody (except the UK) put in a figure much higher than was needed, in order to try and get an industrial subsidy off of their neighbors on the sly. The supply of credits outstripped demand and so the price fell and the price of EU carbon credits became more a measure of the level that the various members states thought they could con the system than the amount that carbon costs.

Currently EU carbon credits are used as part of the cap and trade system. In order to set the cap part of this scheme means that the state must decide how much carbon that it will allow to be released. Given that the state has been proven so bad at planning the needs of people for every other resource that it has ever tried there is no reason to think that it would do any better with carbon emissions. The current EU cap and trade system is effectively a carbon tax with an industrial subsidy (not really a surprise that there is some kind of subsidy in there, being an EU scheme). The world has no need for corporate welfare so why not just have the pigouvian carbon tax without the subsidies?

a tax

Part one of my proposal is a pigouvian tax on Carbon emissions. This should be fairly simple to implement as we already almost have one in the form of fuel duty. All that needs doing is extending it to all fossil fuels no matter where they are to be used with no exemptions (political manipulation for special exemptions being the bane of any tax of this type). Then set it at the correct level to internalise the externality of the carbon it represents.

If you have already paid for your carbon emissions via a tax why would you want to pay for them again through credits? Or conversely if you had paid for them via credits why should you pay a tax as well? You shouldn't. By offsetting you effectively do not release carbon so you should not be taxed on releasing carbon.

a tax credit

Part two of what I propose is that by buying my carbon credits you are buying tax credits of the value of the pigou tax on that amount of carbon. Whether via the pigou tax or by offsetting their emissions it is up to the producers of emissions to take responsibility for their emissions. This leaves the market to discover how much carbon it is best to release given all the information that it is able to aggregate. As opposed to some bureaucratic whim based on limited information, political biases, and political gaming that has so comprehensively wreaked the EU carbon cap and trade scheme.

a market

Part three of my idea is that you don't have governments generate carbon credits by fiat and distribute them as they see fit (as happened in the failed EU system). Allow carbon offsetting companies to make them by taking carbon out of the atmosphere and sell them for however much the market will bear. This creates a link between the market price of carbon and what it actually costs to stop carbon reaching the atmosphere.

The only thing left to do is set the level of the tax on carbon emissions. To act as a Pigou tax and internalise the externalities of carbon emissions this tax should be set at the level that these externalities actually cost. Luckily we have just set up a market which should accurately discover the cost of removing carbon from the air, which seems like a good way of finding this cost.

incentives matter

Part four therefore is to use the average price of carbon credits for sale as the level of the tax on carbon. The treasury already monitors the prices of many different products in order to measure inflation, so adding carbon credits to the list should not prove to great a bureaucratic burden. This would have some interesting effects:

• It would stop any chancellor escalating the carbon tax in order to increase his revenues. As soon as he moved it above the price of the carbon market by buying credits and using them against your tax you would start to make a nominal profit directly reducing tax revenues.


• You would not even have to wait for this kind of manipulation in order to start making money, by investing in credits from any scheme that is cheaper than the market average stands to make money.

This ability to make money by investing in the most efficient schemes is the most important feature of my idea because suddenly there is a much stronger incentive to try and get CO2 out of the atmosphere than ever before. An incentive so strong that it would work against even the most hardened climate change sceptic. Cold, hard, cash.

Instead of being good to the environment simply being yet another regulatory cost or as something that you give to other people in order to show how 'right on' you are it becomes something that you can actually make you wealthy. Instead of being shunted away to be dealt with with the minimal thought it becomes something that great thought will be taken over because any increase in efficiency to get below the average market rate would lead to a profit (which would in time increase the number of similar schemes and so reduce the average market rate towards that level). Instead of trying to abolish capitalism you harness all of its staggering power, a power that can (and in many ways already has) change the world for the better.

a good fair fight

It this point, if not before, somebody is going to say that this is effectively a license to print money. What guarantees are there that the offsetting companies won't simply dump credits onto the market that they have not themselves earned through programmes to take carbon out of the atmosphere. This could be a problem, but really it is one that is easily solvable. Currently all companies have to present true and accurate accounts as to how much money they have. In order to prove that these accounts are true and accurate they already have to be prepared to have their books audited. Simply require that any credit only be honoured if the company that originally issued it be able to produce if required an external audit that their operations do what they say they do. Any offsetting company that is not scrupulously clean would find itself cut off from the market because the people buying the credits would not want to take the risk that they would not be honoured and hence any potential profit instantly turned to a substantial loss.

conclusion

In some ways this idea is rather like Cap and Trade, it boils down to being a carbon tax and a form of subsidy. Unlike cap and trade however the subsidy does not go to the polluting industries, but is directed at companies trying to undo the pollution. There is also the difference that the value of the tax is not set by bureaucratic whim but by a large, vigorous and competitive market the profits from which act are the subsidy. In fact the closer the tax gets to perfection for internalising the externality caused by the release of carbon the lower the subsidy to firms trying to remove carbon from the atmosphere becomes. Just as there is a feedback mechanism between the market and the tax to try and discover the correct level for the tax to be set at, there is a feedback mechanism between the tax and the market so that imperfections in the market get cleaned up by causing an effective subsidy for carbon offsetting companies. The end result could be a dynamic self regulating system where each part compensates for potential imperfections in the other parts automatically.