03 Jul 2009

Will Cap & Trade Lead to a Transitional Gains Trap?

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Pete Boettke links to this post concerning the “transitional gains trap” and cap & trade.

The trap arises when a government restricts some activity, often for the specific purpose of increasing prices or otherwise aiding targeted beneficiaries. The limited rights to engage in these activities become valuable as the constraints bind more severely. Owners of these rights become an effective political force for preserving the status quo. Think taxicab medallions, tobacco quotas, land use restrictions and the U.S. sugar program.

I think Margolis’ general point is right. If and when cap & trade goes into effect, it will be extremely hard to unwind it, just as a tariff would be, because all of the carbon-free sectors will go nuts claiming (truthfully) that they will be hurt.

However, I think Margolis’ technical analysis is off, because he seems to be treating an emission allowance as analogous to a medallion:

Carbon cap and trade will establish restrictions on economic activity that will bind future generations. Perhaps that’s what some supporters like about it. But notice who pays. For the most part, it’s not us—not the baby boomers. Sure, we’ll bear some of the cost of these restrictions. But the president’s proposed auction collects the present value of the scarce carbon-use rights from here to eternity, then distributes it in the course of a few years.

The part I put in bold is wrong. The auctioned allowances don’t give you the perpetual right to emit a ton of carbon annually. (In contrast, you buy one taxi medallion, and you get to drive your cab, year after year.) To put it another way, the government is going to have auctions every year.

Now there are complicating factors; for example I’m pretty sure Waxman-Markey allows you to “bank” allowances and possibly even borrow against future allowances. But even there, each allowance still just gives you the right to emit such-and-such amount of carbon dioxide (or other greenhouse gas).

So the point is, if the government decides to abolish Waxman-Markey in 2040, so long as the abolition doesn’t occur until 2041, then nobody gets stuck holding allowances that suddenly drop to a market price of zero. There will still be political opposition to ending W-M if it is ever implemented, but it won’t be perfectly analogous to taxi cab drivers freaking out if NYC suddenly said anybody could drive a cab, and they don’t need no stinkin medallion.

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