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Carbon Fees Will Create a Stronger International Emissions Reduction System

To Tax or Cap, that is the question for Glen Murray (Ontario’s Minister of the Environment and Climate Change).

Murray is conducting a province-wide consultation on climate policy. He will be in Sudbury from 6 to 8 pm.on March 5 at the Steelworkers Hall. Citizens will get perhaps 10 minutes each to present their ideas.

I hope someone presents the new study that Pethig and Eichner presented at a recent conference on Energy, Resources and Consumer Protection. “Self-enforcing international environmental agreements and trade: taxes versus caps” shows that a carbon tax is superior to a cap and trade system because a tax regime is more able to support a system of “Self-reinforcing International Environmetal Agreements” (SR IEAs).

This one study would take more than ten minures to present, of course, but let me summarize it for you.

In 2012 Pethig and Eichner showed that, with cap-and-trade, regulation stable coalitions are very small and hence ineffective. This is a way of saying you can never get inclusive and comprehensive international agreements among countries using cap and trade. This is a theoretical result that seems to support the position that Stephen Harper took on the Kyoto Protocol.

In their current paper Pethig and Eichner turn the result upside-down. In theory, cap and trade can deliver the same result within a country as a carbon tax. Since the two systems are supposed to be equivalent, no on had looked at the international effect of using taxes instead of cap and trade.

Pethig and Eichner find that effective international coalitions are possible “if climate policy takes the form of emission taxation.” This puts Glen Murray on the spot. Economic theory now says he has to support a Carbon Fee if he wants to encourage a strong international system to control carbon emissions.

How strong are the results? The authors warn against over-generalizing. The simple fact, though, is that this is the best model we have so far.

Is it really possible to form self-enforcing international agreements even with carbon taxation? The model says that it is only possible under certain conditions. That is a bit discouraging. On the other hand, the authors don’t include one of the basic tools of international diplomacy: bullying. If a major importer like the USA were to adopt a carbon tax and say to its trading partners “You can’t trade with us unless you have an equivalent carbon price,” getting an agreement is suddenly a lot easier. Ontario could play this game within Canada.

This isn’t an easy paper to read. I pity anyone who attempts to explain it to Glen Murray in a public consultation. Even so, the new paper should be part of the discussion. Any volunteers?

One worrying feature of the result is that even with a tax the international agreements are only stable if the climate change damage is relativeley small and if the cost of producing fossil fuels is relatively high. That suggests that making progress will be hard, because the costs of climate change seem to be pretty large and fossil fuels really are cheap.

One interesting detail is that the Pethig and Eichner model returns all the revenue from the tax to consumers. This is just an analytical convenience – it simplifies the math – but it means we don’t have to do any more work if we want to apply this result to the Fee and Dividend approach supported by the Citizens’s Climate Lobby. Their previous model used the same assumption, by the way.

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