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Saturday, May 23, 2009

Gas Tax vs Cap and Trade

One should really posses an extraordinary trust in the US political system, politicians and electorate to be ready to entrust them with something like cap and trade. A huge country America is, the US have lobbies and interest groups for just about everything in the world. That's why it should come as no surprise that the bill to be eventually presented to the Houses and Senate came out watered down to the extreme. The Economist says the price for a ton of carbon proposed by the bill is too low, let alone that the bill intends to hand out most permits for free. The bill is said to be good for coal and bad for oil with power generators getting a lion's share of free permits.

Even if the idea of such a drastically scaled down bill is to "pass it now, tighten it later", to pass such a bill means very little in practical terms. A complicated system based on per industry, if not on per facility, permits, any attempt to tighten this thing is prone to quickly degenerating into the biggest carnival ever held by lobbyists in the history of America. Given so many free permits, president Obama has supplemented the bill by announcing a major tightening of fuel efficiency standards. Despite certain enthusiasm this measure has evoked in some quarters, in practical terms it may well mean a death verdict for the US car manufacturing now hanging on government's bailouts. The car sales have all but collapsed and new cars are bound to be either vastly more expensive or of the kind Americans stubbornly avoided for decades. Tightening energy efficiency standards creates no incentives for the current owners of SUVs and other gas guzzlers to replace them, neither such a measure undermines a market for used ones in any way.

Another step under consideration may well do the trick though. The administration is considering to increase the mandatory ethanol blend from 10% to 15%. Such a blend can shorten the lifespan of the currently employed vehicles as ethanol has a certain tendency to destroy engines that were not designed with ethanol in mind. Ironically, the ethanol industry does not think it's getting any favors from the current administration and the new fuel efficiency regulation did little to abate the siege mentality ethanol producers have been developing recently. Ethanol's energy content falls short of gas by something like 30%-40%, which many interpret as the new standards basically banning ethanol from the race. Combined with repealing of tax breaks for domestic oil producers, who on top of this would be massively denied free emissions permits under the current cap and trade bill, the latest initiative may actually end by significantly undermining the US energy independence.

Such paradoxes created by this confused regulation aside, one thing that calls attention in particular is a confusion surrounding the gas tax vs cap and trade debate. Those who followed my the case for fuel tax could notice that much of my argumentation in defense of the tax has very little to do with environment. It was mostly about geopolitical costs of oil consumption, energy independence and such stuff. In fact, one of the gas tax major proponents, Charles Krauthammer, is a climate change agnostic and refers to carbonic emissions reduction as a marginal benefit of the tax. Most economists seem to agree that taxes are the most effective way to cut emissions, with the cap and trade coming only a distant second. However, the gas tax has very little to do with climate. It serves a different purpose.

Consider the fact that the US accounts for a lion's share of global oil imports. The US depends on Arab oil just as much as the Arab world depends on the US buying it. This gives the US just as much leverage over oil producers as the producers have over their customers. It's roughly comparable to the situation of a person who owes a million to a bank. As long he owes a few thousands, it's that persons' problem. When the debt grows into millions, it becomes the bank's problem. That's why such a gas tax implemented through a tax swap can benefit the US taxpayers as it discriminates against producers, which in this case are mostly based outside the US. Finally, from biofuels to hybrids we have plenty of technology to reduce consumption of autofuels for a reasonable price.

The situation is very different with coal. Coal has no geopolitical costs associated with it whatsoever. The global coal reserves are virtually unlimited. The environmental costs of coal are yet to be realized, let alone that the bulk of them is to be paid outside the US. So attaching cost to carbonic emissions produced by coal amounts to a sheer tax, a large part of which will be rolled over onto consumers, means taxpayers. Clean coal technology is expensive, alternatives are either non existent or too expensive. That's why for all practical purposes to cap and trade coal is pretty much a waste economically. This is not to say that it does not make sense in terms of environment and climate change. Making electricity expensive will encourage saving and so translate into less emissions even if pretty much nothing happens on the coal side, but it will come with a price and it's a heavy price. Other than that, coal may be ideal for cap and trade as it tends to be burned in a limited number of locations to produce electricity. There it may be even possible to measure the precise volume of carbonic emissions.

On the other hand, the distributed nature of oil consumption with gas and diesel mostly burned in vehicles and others means of transportation makes them a good subject for classic taxes instead of cap and trade. The thing is that when it comes to gas, cutting its consumption or cutting its emissions is pretty much the same thing anyway. I know about no technology in the offing for reducing carbonic emissions of gas/diesel by filtering them out and storing somewhere. To cut emissions is to cut consumption and so the gas tax is perfect for the job. Even carbon tax is not needed here. Some technologies considered for capturing and storing emissions from coal stations may justify a cap and trade for coal, though it's still open to debate if a simple carbon tax can't do the same thing better.

Basically both the gas tax and cap and trade can be implemented side by side, as there is no contradiction between the two. The first targets the nasty geopolitical consequences of oil consumption and aims at energy independence, while the cap and trade is mostly about environment. From the point of view of the gas tax, even if all emissions produced by cars are captured and stored under ground, this changes nothing. The gas tax serves a different purpose. The tax targets consumption, not emissions. Emissions reduction comes as a by-product of the gas tax. The tax's purpose is to bill both foreign policy/defense expenses associated with oil consumption and the price of energy independence into the price of gasoline/diesel. Implemented through a tax swap, it's about restructuring taxation system with a view of making it correct and more effective.

What becomes clear now is that a failure to consider the difference between the objectives of the gas tax and cap and trade and trying to pursue all of them with the cap and trade alone, even when complimented by tightening of fuel efficiency standards, leads to bizarre situations in which the US government with one hand is undoing what it's trying to achieve with the other one. Ethanol may not be very environmentally friendly, but it's instrumental in reducing the US dependence on foreign oil. You can't compare ethanol and gas only by their environmental externalities, since oil has also tremendous geopolitical ones which, unlike oil's environmental costs, make the US budget hemorrhage billions this very moment in the Middle East and elsewhere. Unless oil's geopolitical costs are factored into the price of gas, the current cap and trade thing may even end destroying the nascent biofuels industry.

The Economist and others seem to have reluctantly given up on carbon taxes, coming to terms with this vastly diluted and ineffective cap and trade bill. As Jeffrey Sachs has put it, it's still better than nothing. And yet, carbon taxes making their way down the tube, nothing has changed when it comes to the gas tax. The tax is pretty much as relevant today as it was before the cap and trade bill.

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