Tax versus max

Hard to resist a direct question. Tim Dunlop asks in relation to Appendix D of the Emissions Task Group report on taxes versus permits:

Economists such as Harry Clarke and Joshua Gans have discussed the report but haven’t given much attention to this part of it, so I’d be curious to hear what they (and others like Jason) think about it.

So I turned to Appendix D and it presents the usual sets of arguments. If the government knew everything and what it wanted, taxes and permits could achieve the outcome. But there is uncertainty … blah, blah, blah … and in the end we supported permits. The reason appears to be that they want the emissions target itself to be certain and committed to rather than uncertain and that this is supposedly easier to fit into an international trading scheme should that arise.

In reality, we will have both. First, there will be a need for a market on emissions permits to handle situations where we could benefit from such a market. This will likely flow out of electricity where there is an established market and tacking on emissions would not be too difficult.

Second, there are so many areas where having emissions permits will just be impractical. Take, automotive. For this to work, you would have to measure emissions from each car. Notice that just looking at kilometers travelled won’t be enough because your emissions depend on speed. Looking at petrol consumption might be a good proxy so long as quantity in is the same as quantity out but we know that isn’t the case for, say, older cars. In this situation, we will need to estimate individual emissions and price them accordingly. That is, we will need a tax.

And here, we have another ready-to-go way of doing this, road pricing. The way we do this is that we expand Citilink to most roads and use flexible pricing to charge people with an adjustment for the type and age of their car. That way you can tell people on their bills (a) if you chose to go to work an hour earlier, you would save $x; and (b) if you had a different car, you would save $y. Having people acquire and trade permits will be a poor cousin to the information contained in proper pricing or taxation.

So practicalities will drive a hybrid model (and it is entirely possible that such things are optimal economically). Indeed, the Task Group already suggests that when they argue for a ‘safety valve.’ This is essentially a cap on emission permit prices and let’s face it, once we hit that cap, we have a tax.

4 thoughts on “Tax versus max”

  1. Joshua, look at page 107 of the report. Transport emissions will be included through upstream coverage (in essence, requiring the refineries to obtain permits for the fuel they produce).

    From a scientific perspective (and avoiding the question of the extra forcing from aircraft emissions for a moment) it doesn’t really matter where and in what you burn a liter of petrol or diesel, the end result in terms of CO2 is the same. Hence, the carbon charge can be efficiently and applied at the refinery gate.

    There are some minor complications. Different engines emit proportionally more or less nitrous oxide (yep, laughing gas), which is a very potent greenhouse gas. But, particularly as on-road vehicles are already heavily regulated as to nitrogen oxide emissions, a flat per-liter charge is a reasonably accurate approximation.


  2. Joshua

    strange isn;t it that the McKibbin Wilcoxen Blueprint which underlies the report is a hybrid. That is what we have been saying for a decade. This approach is referred to in the Pizer article you have linked to. A more up to date version can be found at

    Pity more economists didn’t read this literature on the optimality of hybrids before signing the Kyoto ratification letter!

    Warwick McKibbin


  3. Warwick, the Task Group explicitly rejects hybrids for some reason. So it isn’t just economists.

    But you know I have read your work but I signed the letter regardless because it is more than just about Kyoto. You and I know that when anything like a global agreement is implemented, intra-nationally, countries will choose the set of measures that is best for them.


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