Cap and trade

I recently posted about Pigovian taxes - i.e. a Carbon tax. One of the advantages to this tax is that it would reduce carbon emissions and the tax revenue could be used to reduce other types of tax - such as payroll tax. In essence, it could be tax neutral.

An alternative to a carbon tax is a cap and trade system. This works fine if you auction a limited number of carbon credits and collect the revenue from the auction and then use the proceeds to reduce the economic burden of the higher energy costs on consumers. But if you just give them away then you achieve nothing. In fact giving too many away basically results in a subsidy to polluting firms who can then sell them at a profit. These firms collect all the excess from the cap and trade system. Case in point: the experience in the EU.

The following quote from the article pretty much sums it up.

One of the largest over-allocation of permits is to Castle Cement, which makes a quarter of all British cement at three works in Lancashire, north Wales and Rutland. The figures show carbon dioxide emissions from the three plants have fallen from 2.3m tonnes in 2005 to 2.1m tonnes in 2007. Yet, under the ETS, the firm has been handed enough permits to produce 2.9m tonnes CO2 for each of the next five years - an annual surplus of 829,000 permits.

A spokesman for Castle Cement said: "Castle Cement will not require all its allocated permits to cover CO2 emissions in 2008 as we continue to reduce our impact on the environment in line with our sustainability strategy.

"Total CO2 emissions from our three works are likely to be less than in 2007 due to further improvements in efficiency, increased use of low-carbon fuels and a weakening demand for cement caused by the general economic downturn. Surplus credits will be traded."

At the current price of £21, the company could sell its surplus permits for £83.5m over the five years.