One of the best things about running Prometheus is the high caliber of discussions that take place in the comments. In response to President Obama’s recent comments on cap and trade, Roger Caiazza, an authority on such policies, shared the following in the comments and I thought it was worth highlighting for further discussion. I’d be happy to feature other expert perspectives as well.

Roger Caiazza on Cap and Trade

I have been involved with market-based pollution control programs since the inception of the acid rain program so I want to comment on the history of acid rain vs. CO2.

I disagree with the following [statement of President Obama]:

“Now, the experience of a cap and trade system thus far is that if you’re giving away carbon permits for free, then basically you’re not really pricing the thing and it doesn’t work, or people can game the system in so many ways that it’s not creating the incentive structures that we’re looking for.”

If the President is in fact making the distinction between CO2 cap and trade programs and those for other pollutants then we agree that they don’t work for CO2 but only disagree why.

Respectfully Mr. President I think that cap and trade programs work because they price the “thing” efficiently. For pollutants that can be controlled with add-on equipment or fuel characteristic changes the cap and trade model works well. Remember what we are talking about: a cap is established to limit pollution, allowances are allocated to affected sources equal to the cap and those sources are required to meet the cap by turning in an allowance for each ton of pollutant emitted. It works because the cost of controls varies, primarily because the cost per ton removed is lower for a larger unit. As a result, the cost of allowances eventually equals the costs of control.

On the other hand, cap and trade is not a good model for CO2 because there are no cost-effective control options for existing sources and fuel switching to a different fuel type is necessary to get reductions. Ultimately then meeting the cap has to be done indirectly and it becomes difficult if not impossible to price CO2 rationally.

If that was the primary rationale for going to cap and auction in CO2 programs, then I would not be as disappointed by the rhetoric: “people can game the system in so many ways that it’s not creating the incentive structures that we’re looking for”. However, the proponents for cap and auction are as interested in sticking it to the affected sources by making them pay up front as any other reason. Ultimately, the CO2 incentive structure envisioned is a tax by another name to pay for renewable energy, energy conservation and energy efficiency.

If you really want the free market to reduce CO2 then replace other taxes with a CO2 tax. The free market will decide how best to incorporate the cost of carbon in society. Unfortunately, the cap and trade charade will create the ultimate system for gaming. The feeding frenzy of lobbyists over all the aspects of the CO2 cap and trade is ugly now and will only get worse.