Should we welcome the new climate bill?

After years of denial and feet-dragging, the US Congress may finally begin to deal with climate change. The Waxman-Markey bill now before Congress calls for a cap on carbon emissions, with tradable emissions permits distributed to industry. More energy efficient firms can sell their permits to less efficient firms, producing a financial incentive to reduce emissions.

"Cap and Trade" is not the only policy option out there. Many scholars have advocated a simple tax on carbon emissions.

On the surface, there's no theoretical reason for a carbon tax to be any better or worse than a cap and trade system. Both systems put a price on carbon emissions, which should lead to lower carbon emissions. But some people are worried about the process of permit distribution, which opens the door to political bribes, or as economists call it "rent seeking". Greg Mankiw puts it like this:

"Economists recognize that a cap-and-trade system is equivalent to a tax on carbon emissions with the tax revenue rebated to existing carbon emitters, such as energy companies. That is, 'Cap-and-trade = Carbon tax + Corporate welfare'."

However, not everyone is so down on the cap and trade plan. For Paul Krugman, cap and trade is a workable second-best strategy, which is more politically palatable to powerful groups weary of climate change legislation:

"...handing out emission permits does, in effect, transfer wealth from taxpayers to industry. So if you had your heart set on a clean program, without major political payoffs, Waxman-Markey is a disappointment.

Still, the bill represents major action to limit climate change. As the Center for American Progress has pointed out, by 2020 the legislation would have the same effect on global warming as taking 500 million cars off the road. And by all accounts, this bill has a real chance of becoming law in the near future.

So opponents of the proposed legislation have to ask themselves whether they’re making the perfect the enemy of the good. I think they are."

In my mind, the real debate is over which is worse: the dangers from climate change or the dangers from political corruption. If the only way to get a climate change bill passed is to risk some rent-seeking, then it may be worth the cost. If, however, your biggest concern is economic efficiency, then the downside risk of the Waxman-Markey bill is more than you're willing to pay.

Update: More from the Pigou Club

Here is Charles Wheelan (The Naked Economist) writing about a carbon tax. He makes an additional point about Pigouvian taxes that I left out of my previous post. Referring to the consequences of the higher price of gas he writes:

"I will add, perhaps gratuitously, that the behavioral changes we're seeing now are exactly why we should have implemented a carbon tax (with offsetting income tax or payroll tax cuts) 10 years ago. Given that we have to raise revenue somehow, we ought to do it by taxing behaviors that we would prefer to discourage. An income tax discourages work; a carbon tax discourages pollution. Which one makes more sense to you?"

Taxes serve two important functions: they raise revenue for government and discourage whatever behavior is being taxed. In America, income and investments are taxed at a higher rate than consumption. At a time when we're all so concerned about public and private debt, maybe this is something we should rethink.

Also, check out Wheelan's terrific book, Naked Economics: Undressing the Dismal Science. It's the best introduction to economics out there, and one of the only ones that wont put you to sleep.