In this economy, cap-and-trade is just too risky.
Sen. Barbara Boxer (D) of California announced this month she intends to move ahead with legislation designed to lower the emission of greenhouse gases that are linked by many scientists to climate change. But the approach she's taking is flawed, and the current financial crisis can help us understand why.
The centerpiece of this approach is the creation of a market for trading carbon emission credits. These credits would be either distributed free of charge or auctioned to major emitters of greenhouse gases. The firms could then buy and sell permits under federally mandated emissions caps. If a company is able to cut emissions, it can sell excess credits for a profit. If it needs to emit more, it can buy permits on the market from other firms.
"Cap and trade," as it is called, is advocated by several policymakers, industry leaders, and activists who want to fight global warming. But it's based on the trade of highly volatile financial instruments: risky at best.
The better approach to climate change? A direct tax placed on emissions of greenhouse gases. The tax would create a market price for carbon emissions and lead to emissions reductions or new technologies that cut greenhouse gases. This is an approach favored by many economists as the financially sensible way to go. And it is getting a closer look by some industry professionals and lawmakers.
At first blush, it might seem crazy to advocate a tax increase during a major recession. But there are several virtues of a tax on carbon emissions relative to a cap-and-trade program.
For starters, the country already has a mechanism in place to deal with taxes. Tax collection is something the government has abundant experience with. A carbon trading scheme, on the other hand, requires the creation of elaborate new markets, institutions, and regulations to oversee and enforce it.