Make us your home page

Today’s top headlines delivered to you daily.

(View our Privacy Policy)

Finding the price of carbon

Either cap-and-trade or a carbon tax would help to price carbon emissions appropriately.

Either cap-and-trade or a carbon tax would help to price carbon emissions appropriately.

In his State of the Union address, President Barack Obama proposed the creation of a cap-and-trade system to control the amount of greenhouse gas emissions resulting from our national energy use. Unfortunately, since then he has had to shelve this proposal for now since there was no hope that this Congress will pass such a program. So on June 25, he announced that the Environmental Protection Agency would impose strict emission limits on power plants and other manufacturing polluters.

It is a shame that cap-and-trade could not be implemented in the current climate. Perhaps it is not well understood that this idea originated among conservative economists. Thanks to President George H.W. Bush, we have a highly successful cap-and-trade program to curtail sulfur-dioxide (acid rain) emissions implemented as a key part of the 1990 amendments to the Clean Air Act.

Cap-and-trade is a two-part policy aimed at solving a problem that the market does not solve on its own. The government creates a market mechanism in emission rights, forcing firms to treat the atmosphere as the scarce good it really is.

First, the caps: The government sets an enforceable limit on a firm's allowable emissions by issuing a limited number of permits to pollute. Firms can only pollute an amount corresponding to the number of permits they have been awarded. Second, the trade: To pollute above its cap, a firm must purchase additional permits from other firms. The firm that sells the rights must pollute less than its originally assigned cap, such that total pollution remains unchanged by this exchange of rights.

Once the government establishes the permit system, trade in permits mimics market forces. If an electric power company in Ohio values sulfur dioxide emissions less than does an electric power company in West Virginia, the Ohio firm can sell its pollution permits to the West Virginia firm, and in so doing both firms improve their profits without changing the total amount of pollution drifting into Canada.

To illustrate: Suppose the Ohio firm values a pollution permit at $5 and the West Virginia firm values it at $10. If the sale is for any price between $5 and $10, both firms benefit. For example, a price of $7 would yield a gain of $3 to the West Virginia firm and $2 to the Ohio firm. The total amount of pollution remains unchanged; the Ohio firm now finds it more profitable to cut pollution and the West Virginia firm saves money by emitting more sulfur dioxide.

In the cap-and-trade system, pollution rights have a price determined in the same manner that markets determine the price of all scarce resources: supply and demand. Just as the supply and demand of labor establishes prices called wages and the supply and demand of loanable funds establishes prices called interest rates, the cap-and-trade system allows a market to form so that the supply and demand of pollution rights establishes the price of the right to pollute. While the markets for labor and loanable funds develop naturally since labor and funds are scarce, the government must create the prerequisite scarcity for pollution rights.

But the advantage of cap-and-trade does not end there. Because trade in pollution establishes a market price for permits, firms have an ongoing incentive to improve their emission-reducing equipment. If a firm can pay less for pollution-reducing equipment than it pays for pollution permits, then it has a strong incentive to do so; the end result being greater environmental protection.

An alternative way to establish prices for pollution without using cap-and-trade is simply to tax pollution such as CO2 emissions.

A carbon tax would impose a price for each unit of CO2 emitted. Economists tend to prefer emissions taxes over cap-and-trade for two reasons. First, taxes generate revenue for the government that can be used to clean up environmental damage done by polluters that are no longer in existence. Second, emissions taxes are easier to implement. Conservatives tend to oppose pollution taxes since it involves taxes and government. Since cap-and-trade is already a proven method and involves less direct involvement of government, it is more likely to be implemented in an ideologically mixed Congress.

Cap-and-trade works in principle and in practice. It is an efficient mechanism for controlling pollution. In addition to the existing cap-and-trade market for controlling acid rain emissions, California has established a state cap-and-trade program for controlling greenhouse gas emissions, and the European Union has created the largest cap-and-trade program in the world.

William L. Holahan is emeritus professor of economics at the University of Wisconsin-Milwaukee. Charles O. Kroncke, retired dean of the College of Business at UW-M, also recently retired from USF. They are co-authors of "Economics for Voters." They wrote this exclusively for the Tampa Bay Times.

Finding the price of carbon 07/06/13 [Last modified: Friday, July 5, 2013 2:57pm]
Photo reprints | Article reprints

© 2017 Tampa Bay Times


Join the discussion: Click to view comments, add yours

  1. Florida education news: Makeup days, accountability, charter schools and more


    MAKEUP DAYS: The Pasco County school district alters the daily schedule of 11 schools to make up teaching time missed because of Hurricane Irma, avoiding the …

    With students back in school after Hurricane Irma, schools across Florida begin scheduling makeup days for missed classroom time.
  2. How visiting a scenic Cuban resort can help save green sea turtles


    The Florida Aquarium has been collaborating with Cuba's National Aquarium since 2015 to help save coral dying throughout Caribbean waters.

    The beaches of Cuba's Cayo Largo are home to a large population of green sea turtle nests. The Florida Aquarium will lead eco-tours of Cayo Largo next year that will help protect the turtles and fund research.  [Avalon Outdoor]
  3. Photo of the Day for September 22, 2017 - Willets taking flight

    Human Interest

    Today's Photo of the Day comes from Dan Cleary of Madeira Beach, FL.

  4. Why a true freshman quarterback doesn't kill FSU's title hopes


    Florida State's James Blackman will make history Saturday when the No. 12 Seminoles host North Carolina State in their first game after Hurricane Irma.

    Florida State quarterback James Blackman warms up before a game against Alabama on Saturday, Sept. 2, 2017, in Atlanta. When Florida State's Deandre Francois, Georgia's Jacob Eason and Texas A&M's Nick Starkel all got hurt in their respective season openers, true freshmen ended up taking over the rest of the way.  (Joe Rondone/Tallahassee Democrat via AP)
  5. Puerto Rico could face months without electricity after Hurricane Maria (w/video)


    SAN JUAN, Puerto Rico — The eye of Hurricane Maria was nearing the Turks and Caicos early Friday as Puerto Rico sought to recover from the storm's devastation.

    A pregnant woman carries empty plastic bottles to collect water a day after the impact of Hurricane Maria, in Yabucoa, Puerto Rico, Thursday, September 21, 2017. As of Thursday evening, Maria was moving off the northern coast of the Dominican Republic with winds of 120 mph (195 kph). The storm was expected to approach the Turks and Caicos Islands and the Bahamas late Thursday and early Friday. [Associated Press]