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Another Nail in the (Intellectual) Coffin of Cap & Trade

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Another nail in the (intellectual) coffin of Cap and Trade
(spoiler alert: bad pun a the end of this note)

In a new paper, Jessica Coria and Jurate Jaraite show that the cost of running an emissions trading system is higher than the cost of a carbon tax. The paper is called Carbon Pricing: Transaction Costs of Emissions Trading vs. Carbon Taxes.

Lets start with some details about the study. Coria and Jaraite compare the Swedish CO2 tax and the European Union’s Emissions Trading System (EU ETS). The transaction costs they look at are the costs of monitoring, reporting and verification (MRV), essential parts of any emission trading system that are not needed with a tax system. Empirical evidence indicates that these costs, at least in the case of the EU ETS, are the most important costs of compliance, with a share that might exceed 70% of the total transaction costs. The study does not include implementation costs as both the CO2 tax and the EU ETS have been in place for many years.

The transaction costs they consider do not include the cost of running a trading system, by the way. They only include the costs involved in making sure that polluters are not cheating. I have not yet found an estimate of the cost of the trading systems, but they should also be included in the calculation.

The result is exactly what any economist would predict, and not really a surprise. The authors find that the average MRV cost is 2.6 €/t CO2 higher for firms under the trading system. If they include also external costs, trading costs firms 7.4 €/t CO2 more than a tax would. These costs are large compared to the actual carbon cost and ultimately are paid by consumers.

Coria and Jaraite also found that that most firms agree or strongly agree with the statement that the EU ETS is too burdensome for small emitters. This is a fairly devastating criticism, since it means that complete coverage with a trading system will be costly and will therefore be resisted. Cap and trade systems are likely to be a trap for politicians attracted to the apparent low political cost of implementation: they will be hard to improve.

The Coria and Jaraite paper matters because it provides some numbers and takes away any chance to pretend that carbon trading is efficient.

Proponents of emission trading system argue that in theory trading systems has some (still unmeasured) efficiency gains relative to a tax on carbon. They have almost always ignored the costs of running their system. Now that a subset of the transactions costs have been measured, they have to show that the theoretical gains they claim for their particular trading system are at least as large as the extra transaction costs involved.

It is also important to notice that in theory a tax (or a “fee”, as many like to call it) works as well and as cheaply when you include very small CO2 emitters, while a trading system gets more costly as you include smaller emitters. Not surprisingly, Coria and Jaraite find that cost per ton of CO2 emissions is the largest for the smallest firms. To illustrate with a slightly silly example, it isn’t worth the effort to trade an emission permit for a backyard barbeque, (“Honey, I can’t barbeque tonight. I forgot to pick up an emissions permit when I was at Canadian Tire!”) A tax automatically gets the barbeque, but transaction costs make it cheaper to ignore the barbeque, as trading systems do.

This paper is a nail in the intellectual coffin of cap and trade systems. Unfortunately, the undead are not quite ready to lay down in the box and be nailed in. Cap and trade systems are still out there eating the brains and the lunches of innocent people. ( Sorry for that – I just couldn’t resist the metaphor once I started with “nail in the intellectual coffin of Cap and trade.”)

Please pass this note on to your favorite provincial or federal politician.



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