Friday, January 21, 2011

Scrap Cap and Trade

With all the back-and-forth about alternative energy sources, the whole issue of a carbon tax has been forgotten. I've always been sceptical about the whole notion of a "cap and trade" system, which like a lot of trading systems are good for the traders and little else. Professor William Nordhaus of Yale has long pointed out the technical and institutional weaknesses of a cap and trade system.

He makes a simple, but incisive point that economic institutions are very familiar with the design and collection of taxes, but totally new to international cap and trade systems. The recent issues in Europe have made his point.

Until there is some sort of tax that "internalizes the externalities" by raising the price of carbon, it seems to me that the field of alternative energy will swing back and forth to the "source du jour"--wind, biomass, solar, you name it. Once a carbon tax were in place, then relative prices would have to reset to include the market's estimated value of energy sources including their effect on carbon emissions, the greenhouse gas that started the whole climate change controversy.

Oddly enough, given the huge expansion in North American and global natural reserves, natural gas would become much more attractive relative to coal or petroleum and the switching process should begin in earnest. In the case of the U.S., electric utilities would begin the switchover that they have been hesitant to make. Switching over to natural gas (something we've discussed in previous posts) would also probably start a mini-boom in capital spending and non-residential construction. And, some of corporate excess cash would go into investment instead of to dividends and share buybacks. All this would be good for the recovery and hopefully for new jobs.

The carbon tax hasn't had a strong, visible voice in the political and economic markets for some time. Hopefully, one will emerge soon.

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