The ETS again

As someone - and I regret to say I've forgotten who - commented, the ETS (European Trading System) CO2 permit price (aka EU carbon allowances, or European Allowances (EUAs), apparently) seems to have spiked recently. Why?


Of course, I don't know, so I asked Google. The answer looks to be mostly the EU fiddling with the supply. See the FT, or the EU's own ETS Market Stability Reserve will start by reducing auction volume by almost 265 million allowances over the first 8 months of 2019. This, of course, is one of the problems with any such scheme: people fiddle with it when it delivers the "wrong" answer. In this case, the low price was a "yes" answer to the question "did you pols bung too many permits at heavy industry in order to buy them off and make yourself popular?".


Phil said...

What happens if we get the carbon tax wrong? Tax rate needs to change with time, unless you get the future exactly correct the tax rate will be too high or too low.

Anything you do isn't going to be exactly correct. So better have a way to adjust it for unknowns, changes and correcting errors.

William M. Connolley said...

If you get the carbon tax wrong, you change it. Indeed, as I've said before, the obvious thing to do is to start it too low and ramp it up. But unlike permits, no-one owns anything. Also unlike permits, the science on the "correct" value of the tax changes slowly.

Phil said...

I agree that a carbon tax is in general a good idea. It just isn't the only idea that works, of which there are many beyond cap and trade vs carbon tax. I don't see how a carbon tax or cap and trade is any better or any worse in general. Might be in specific cases, of course. The devil is in the details, as usual.

I probably should get this directly from Dilbert, but it applies.


Notice that small changes in the correct real discount rate make huge changes in the proper level of taxation.

In other news, looks like Washington State is going to try again.


I have not really thought through the details yet, and the last carbon tax proposal had a serious problem in the details.

David B. Benson said...

I 1631 seems to have it right. I plan to vote for it.

William M. Connolley said...

> I don't see how a carbon tax or cap and trade is any better or any worse in general

They aren't the same, and it is possible to think about the differences; see for example https://wmconnolley.wordpress.com/2011/06/06/carbon-tax-now-1/.

> I 1631

https://yeson1631.org/? "I-1631 would put a fee on the state’s largest polluters, like the oil industry and utilities that have not switched over to clean energy, and invests in protecting our air and water and new clean energy infrastructure across the state". That doesn't sound like the right answer. far, far too fiddly and trying to please (aka buy off) everyone.

David B. Benson said...

William, politics is the art of the possible. I don't attempt to tell you how affairs in Cambridgeshire should go. Don't try to tell me the "right" answer for Washington state.

William M. Connolley said...

> Don't try to tell me the "right"

That's a strange comment. It was you who raised your vote; if you don't want to discuss it, don't.

Phil said...

RE: Carbon tax vs cap and trade and all the other possible actions...

Sorry, but I see these alternative policies as situational: There are clearly times and circumstances where carbon taxes are the preferred option. There are clearly times and circumstances where other policies are more effective. The implementation details matter. Almost more than the policy choice.

Consider two technologies, C for clean, P for polluting.

If C in huge volume production and P in large production are similar in economic cost, and P has a large external cost, then fairly clearly we should prefer C. However, C in prototype and low volume production is almost surely far more costly than P, and perhaps even more costly even when considering the external costs. If so, then an exactly proper Pigouvian tax would NEVER allow C to pass the low volume production threshold if P is the incumbent technology.

Real world example is solar energy. Or electric cars. Or LED bulbs. Or ...

Am I in favor of a carbon tax? Usually, unless too badly done. Even a sub-optimal policy can be better than no policy at all. Washington State's last attempt was fairly badly done. I voted for it, although I'm actually fairly happy in some ways that it didn't pass.

I-1631? Frankly, I've got too much work related reading to do now for me to spend the time to study both the wording and think through possible impacts. A quick look finds both details I like and details I don't.

William M. Connolley said...

Your example doesn't show that there are times to prefer cap-n-trade over carbon taxes, since both would produce the same result in the example you describe.

I think you're trying to demonstrate the virtue of govt "pump priming" subsidies to young industries. There's probably a reasonable case to be made for that, with care; but also there's a case that current subsidies aren't sensible.

Phil said...

I was discussing other policies, not your favorite battleground around tax vs cap & trade.

Both carbon taxes and cap and trade are flawed. You believe in carbon taxes, and I'll accept carbon taxes. The difference is I'll accept good enough, you want perfection. Carbon taxes are not perfection, as I've pointed out in the past.

As for some subsidies not being sensible, of course. Hydrogen cars, for example, doesn't seem make sense, even if fully developed technology. Hydrogen as an energy store might make sense for other uses, and technology developed for cars can be reused, so I'm not opposed. Biofuels don't make sense in many cases, but not all. Fusion is a huge question mark, at best a coin flip. And likely decades too late to help much. About half of the EV charging stations are poorly placed, waste of resources. I know this because I drive an EV. I strongly suspect many of the stations were installed at the direction of people who don't drive an EV. Many of the newer stations are better located, perhaps some learning is going on. And the list goes on. Do you have a specific example?

There is a problem with making decisions without perfect information. You will make mistakes. However, to freeze at current technology may be also a mistake. Some of your bets may pay off, and you will cover the cost of the mistakes. Or maybe not, and perhaps burning coal until the seas cover the coal mines and most of humanity dies as does any advanced civilization is the optimal choice.

I'd rather make the bets.

Phil said...
This comment has been removed by the author.
Phil said...

On cap and trade vs tax:

Take two pollutants.

One is time limited, so discount rate doesn't matter much. Damage per ton release is fairly well known and fairly linear.

The other pollutant has a long period of damage, so discount rates matters a lot. Damage per ton isn't well known, isn't linear, and has known or suspected thresholds where the damage increases rapidly for a small variation of release. The total amount that can be safely released (in total, or per year) is fairly well known.

Look to me like the first is well handled with a Pigouvian tax. Do you agree?

What about the second?

William M. Connolley said...

> Do you have a specific example?

Of what... oh, of current subsidies being not sensible. Yes: what the Germans are doing. and the UK too, though to a smaller degree, since we're throwing less money at it.

> Do you agree?

Seems reasonable.

> What about the second?

That's the carbon tax (well, your desc doesn't quite fit, but close enough). I think that's the best solution, though (as noted in many of my previous posts) not perfect, so that's what I argue for. Which is why your "you want perfection" is wrong.

Phil said...

I was trying to get a bit beyond carbon actually... I don't think anyone knows exactly how much carbon we can release before causing unacceptable damages. Do you?

If the damage per unit is known accurately, a Pigouvian tax is fairly easy to setup and defend politically.

If the amount that can be safely released is fairly well known, but the damage isn't well behaved, then a Pigouvian tax isn't as easy to set up.

If the damage is far into the future, then a Pigouvian tax becomes very dependent on the chosen discount rate. The farther into the future the damage, the more the selection of discount rate matters. And discount rates are hardly an exact science.

Don't you see that at some point of increasing delay of damage and increasing non-linearity of damage function that a cap and trade type system is simpler and more robust? Contrariwise, as the damage becomes more linear and the time horizon shortens then a Pigouvian tax becomes simpler and more robust?

Leaving economics, politically one or the other might be easier to enact, enforce and such.

William M. Connolley said...

Happily, we are in a position where neither the damage, nor the total amount that can be released "safely", are well known. As I said somewhere recently... ah yes, Carbon budgets and carbon taxes, the problem with "amount that can be safely released" idea is that it gives no-one and no-time any incentive to do anything about it, and every incentive to shunt the action off to someone else or some other time, since after all we're not going to exceed the total today.

I don't think there's any difference between cap'n-trade and carbon-taxes in terms of difference into the future. Both need to know the damages, and what those damages cost. That's true unless there is some hard limit or tipping point, but evidence for that is thin at best. So the so-called "limits" are really rather arbitrary: you can exceed them, at the cost of marginally more damage.

Tom said...

As I told MT ages ago, focusing on the Last Ton really means only the Last Ton will be focused on.

Phil said...

"I don't think there's any difference between cap'n-trade and carbon-taxes in terms of difference into the future."

In other words, you know exactly what the discount rate should be. Cap and trade, with caps that reduce in the future, let the market discover the discount rate. You are smarter than the market.

"That's true unless there is some hard limit or tipping point"

Or the damage is non-linear or just is not zero at zero release. You can't set a realistic tax rate when the cost of a smaller release is negative (ie a gain) and the cost is of a larger release is positive (ie a cost).

This is a messy problem, I'm mostly trying to get you out of using bogus arguments for a carbon tax. A carbon tax isn't the only solution, and is probably not even the best or ideal solution. On the other hand, a carbon tax is clearly better than no solution.

William M. Connolley said...

> Cap and trade, with caps that reduce in the future, let the market discover the discount rate

Why? The ETS, obviously, has not allowed the market to discover the discount rate.

> Or the damage is non-linear

That would depend on how non-linear.

> the cost of a smaller release is negative (ie a gain)

AFAIK the "negative" costs are too small to worry about.

> trying to get you out of using bogus arguments

I don't think you're doing very well.

Phil said...

No, I don't think I'm doing well at all.

I've assumed some common values, and incorrectly it seems.

I should have assumed deconstruction of the administrative state. Making America Great Again.

Like this:


Tom said...

The debate about carbon tax vs. cap and trade has two components:

1. What is best for dealing with climate change?

2. Which of the two proposals is politically feasible?

I think a carbon tax is best for the climate. I think cap and trade is more politically feasible and not for good reasons. (More pork can be larded into cap and trade).

I will hold my nose and support a cap and trade policy, but I really like a carbon tax with proceed used for lowering employment taxes and the price re-evaluated decenially.

Phil said...

Liberals generally support a carbon tax. For example:


Cap and trade is technically better, but is not as politically feasible. I've got the chance to vote in a carbon tax this November.

Deconstructionists of the Administrative State generally hold that carbon taxes are a Chinese plot.


William M. Connolley said...

> pork

You have a stronger nose than me :-)

> Cap and trade is technically better

Why? I don't think you've said anything to demonstrate that, or linked to anything that does.

> but is not as politically feasible

That's an odd thing to say. I (like Tom) would say the reverse.

Phil said...

I've got the chance to vote in a carbon "fee" aka tax this November.

I don't have any cap and trade proposals to vote on.

Why again is a cap and trade proposal more politically feasible?

Didn't even make the ballot, did it? No organizations working for one, unlike at least three local different carbon tax groups, all with different ideas about how to enact a carbon tax in Washington State.

Of course, politics is local. What is true in the US of A might not be the same where you live.

Phil said...

"but is not as politically feasible"

Carbon tax bill is proposed to the House.


While is very unlikely to pass, remember that global warming is a Chinese plot, there isn't a carbon cap and trade bill proposed to the House.

Phil said...

Cap and trade and carbon taxes are both ways to put a price on carbon releases so as to reduce the carbon releases and reduce future harm.

These would likely have broadly similar effects to the first order. So to the first order I don't care that much which is implemented. As carbon taxes seem more politically popular, at least locally, and all politics is local, then I'm in favor of a carbon tax. Especially if subsidies for start up of alternatives continue.


Which of these two policies is better depends on a list of factors. For example, what is better known: the current non-economic damages of the carbon released or the costs and possibilities of reduction in releases? Which is more important, reduction in carbon released or the variations in carbon pricing? What are the start up costs of alternatives?

Not every reduction in carbon will have the same economic cost. So consider the following case:

Economic damage of pollution = $1000 per unit.

Economic cost of reduction of pollution at 1% per year reduction:

First 1% $2,000
Next 9% $1001
Middle 80% $100
Next 9% $1001
Last 1% $2,000
Any 1% faster reduction will add $2,000 to that years cost.

So that is the problem statement. What about policies to address the problem?

A pollution tax would be set for $1000, and not have any impact at all on the production side. None. Zero. Doesn't exceed the reduction startup costs, or even the first decade's higher costs. Only impact would be on the consumption side, size depending on elasticity of demand.

A cap and trade with a 1% reduction per year to a 90% or a 99% reduction would see a price spike the first year (how much depends on elasticity of demand, investment discount rate, and more), followed by a decline in price for the next 89 years. If demand was completely non-elastic, then the price would spike to $2000 the first year. Elastic demand would cause a lower spike lasting longer.

So is this example unrealistic? Start up costs are a real part of any production. The very first solar cells cost about $1,000,000 per watt, not installed. In 2010, was around $4.50 per watt including installation in a utility scale project. Current solar cells including installation for a utility scale project cost around $1 per watt. Much of that historic real world reduction post 1990 or so was a side effect of "start up" subsidies, a different topic. Projects in the future will be less, below $0.50 per watt by about 2022, assuming solar cell production continues to increase.


It should be clear that there is a production level that must be exceeded before an alternative's production is impacted by a pollution tax. If you disagree, please explain why.

So is the cap and trade proposed above optimal? No. If you want to explore faster reductions and lower economic and non-economic impacts you would want to include subsidies, different ramp rates and more. An optimal policy would try to minimize the total of the economic costs, both direct and indirect. The above example was only to point out a case where a pollution tax as the only policy is clearly non-optimal, and a cap and trade is better but not economically optimal.

For The Deconstruction of the Administrative State it would seem that carbon taxes or no policy at all are both always better than cap and trade or start up subsidies. I can't see a counter argument.

William M. Connolley said...

> policies to address the problem?

To set those policies, you have to know what the problem is. You appear, implicitly, to have assumed that the problem is "to reduce pollution". But you've expressed the problem in pure economic terms, so an alternative formulation is "for the externality of pollution to be felt by the polluter". In that formulation, being taxed at exactly the cost is a perfect solution to the problem.

What would happen, if such a tax were applied? To answer that, you have to know the economic value of the activity causing the pollution. You appear to have missed this entirely in your analysis. Suppose it is less than $1000 per unit. Then, the activity ceases. Suppose it is significantly greater: then the activity continues, but with profit reduced by $1000 per unit. If that is a large enough number that the polluters would rather not pay it, then they will, obvs, look for means to reduce the pollution.

Anonymous said...

"being taxed at exactly the cost is a perfect solution to the problem."

If a $1000 tax per unit forever is better than a $190.09 cost of the cap and trade, sure you have reached ideological perfection.

"then they will, obvs, look for means to reduce the pollution."

Sure, if there are no start up costs. If economics was linear, and if wishes were fishes...

Phil said...

"being taxed at exactly the cost is a perfect solution to the problem."

This is mostly a moral/ideological statement, and not an economic statement.

The problem isn't "to reduce pollution". That's easy to do, end industrial civilization, which I wouldn't like.

The problem is to focus "on the behavior and interactions of economic agents and how economies work," and by doing so produce the best possible outcome.

It is fairly easy to show that for some types of pollution with impacts in the near term, near linear economics and simple impact cost estimates, that a tax at roughly the external cost of pollution is probably the best, lowest cost possible solution. These are some very specific assumptions. CO2 is NOT that type of pollution.

As the externality is in the far future, then the tax rate must know the perfect discount rate to be used. As discount rates determination isn't exact, and different alternatives give costs that vary by one to two orders of magnitude.

As start up costs of alternatives are high relative to final production costs, the economy has two or more potentially stable states.

As the cost of CO2 pollution varies with both history and the future of CO2 releases, the current cost of a CO2 release can't identified unless both the past and the future release are known.

William M. Connolley said...

> "being taxed at exactly the cost is a perfect solution to the problem."

This statement is correct, in the context that I put it. Removed from its context it no longer makes sense. So, don't remove it from its context.

> produce the best possible outcome

But without defining "best" you can't solve the problem, even in a theoretical sense. Worse, we're in the real world with massive unknowns, so its even harder.

> As start up costs of alternatives are high relative to final production costs

This is true, in theory. But in reality, entrepreneurs are pretty good at spotting opportunities. Amazon went for years without making a profit. It is commonplace for startups to spend years burning money.

> the current cost of a CO2 release can't identified unless both the past and the future release are know

True, in theory, but not interesting in practice, since starting with something moderate like $20 would be a good start (also, we know the past, so I don't know why you mentioned that). And similar can be said for caps. So, the arguement doesn't help you to choose.

Phil said...

I should stop after getting to "true in theory".

"But you've expressed the problem in pure economic terms, so an alternative formulation is "for the externality of pollution to be felt by the polluter". In that formulation, being taxed at exactly the cost is a perfect solution to the problem."

Is that enough context?

I disagree, unless you are making a moral statement rather than an economic statement.

The correct level of taxation isn't known to an order of magnitude, much less perfection.

> > the current cost of a CO2 release can't identified unless both the past and the future release are known
"So, the arguement doesn't help you to choose."

This argument does help you choose, if you are being economically rational. Which is a bad assumption, of course, people often are not ideal economic rational deciders.

The current social cost of carbon releases isn't known to an order of magnitude, but the future quantity that can be released is known more accurately than an order of magnitude. So yes, both a cap and trade system and a tax system are imperfect, but the tax system is more imperfect. So on economic grounds only, if I choose a cap system I'm making a better choice.

Doing either is better than doing nothing.

This isn't only an economic choice. Your above statement of "being taxed at exactly the cost is a perfect solution to the problem", when read as a moral statement of how you want the world to be can't be dismissed just because economics of doing so isn't ideal. So framed as a moral choice, or as a legalistic or political statement that a tax is easier to enact, then support a carbon tax can be justified. It is just not economically ideal. Yes, like all plans can be improved with improving knowledge. And both are better than doing nothing, which I fear is far more likely.

I've read I-1631. I suspect that few others will follow on that, and read the whole thing. Better than nothing? Looks like it passes that bar. The last one didn't. I'll vote for it.

William M. Connolley said...

> Is that enough context? ... The correct level of taxation isn't known

No, not enough context. You've omitted your "Economic damage of pollution = $1000 per unit". The assumption that the damage was known was yours, not mine.

> isn't known to an order of magnitude

I'm not convinced that the uncertainty is that large. But nor do I think that arguing about the exact value, or the exact uncertainty, is terribly interesting.

> if I choose a cap system I'm making a better choice.

Ah, now I know why you think that. But I think you exaggerate the uncertainty in the cost, and the certainty in the cap, and the importance of the cost. But in all of this, the most important part is having something clean. Cap-n-trade (from the example of ETS) looks inevitably dirty to me. I-1631 is unclean too, but I don't think that's inevitably true of a carbon tax.

> when read as a moral statement

I don't think you should read it as a moral statement. It's an economic one. Again, you can't drop the context.

> I've read I-1631

Good. Do you care to defend it against my assertion that parts of it appear to have been written by children?

Phil said...

"unclean" looks like a moral/political statement to me.

Would you vote for I-1631 if you could, knowing you are unlikely to have another choice for at least 2 years, and the next one might not be any better? Or against it? The last one, while "cleaner", was worse. Or would you vote against I-1631, waiting for a better choice, which might never come?

"But I think you..." Seems to be conceding that there might be some cases where a cap and trade scheme might be a better economic choice. And perhaps claiming that a cap and trade is never a better choice on political/moral grounds. Is that fair?

William M. Connolley said...

> "But I think you..."

No, because you've discounted "the most important part is having something clean", which overrides what comes before it; the clue is the phrase "most important".

As to voting, I'm pleased not to have to decide on I-1631. You'll notice that in my post I carefully didn't offer advice on which way to vote.