For quantities, we must observe emissions and permits, and for prices, we must observe emissions and revenues (since price = revenue/emissions).
Price problems
With taxes levied on domestic sources, one must verify that taxes are actually collected and not undone [by hidden subsidies].
—Jean Tirole, “Some Political Economy of Global Warming,” 2012
Comments:
- This is an old and important concern that has not received enough attention. But Cooper and Nordhaus addressed in in 2004 and 2005, and were not particularly worried by it.
- The likelihood of cheating should be low in two large sets of countries,
- the least corrupt countries (Western Europe, US, etc.)
- countries (e.g. India) receiving substantial climate-compensation transfers
- Cheating could be punished with temporary termination of compensation.
- Compensation could be delayed until books were opened.
- Some cheating would be easily detected. The prices of gasoline and wholesale electricity are easy to discover and can be used to back out, with reasonable accuracy, the tax burden on fuels.
- With few exceptions, countries are subject to detailed annual surveillance by the IMF
- The biggest incentives for hidden subsidies would be for subsidizing exports, but the WTO already deals with the problem of export subsidies.
- Although penalties for failure to achieve targets (price or quantity) are unpopular, there is no excuse for hidden subsidies which are deliberate deception and cheating.
- It should not be hard to agree on an explicit rule against this.
- It should not be hard to back up the rule with trade penalities
- Significant cheating should stand quite a good chance of getting caught. Large government transfers are hard to keep secret.
But the important question is not, Could someone cheat on a carbon price?, but rather, Would cheating on price be worse than carbon-permit scams? Nordhaus and many others have argued strenuously that this is not the case.
Countries could offset a tax on emissions with less visible compensatory policies that offer loopholes for energy-intensive and export-oriented firms that would be most adversely affected by the new carbon tax. The resulting goulash of prior distortions, new taxes, and political patches could harm the economy and also undermine the goal of making countries internalize the full cost of their greenhouse gas emissions.
—David Victor, The Collapse of the Kyoto Protocol, 2001, p. 86.
I believe such concerns are serious but can be overcome.
Enforcement of tax collection raises complicated questions, as indeed would enforcement of emission ceilings. Almost all countries (Cuba, North Korea, Taiwan, and Hong Kong, along with a number of mini-states, are the exceptions) are now members of the International Monetary Fund (IMF), and as such their economic policies, including fiscal policies, are subject to detailed annual surveillance by the IMF staff. Under a carbon tax agreement, the IMF could be asked to pay special attention during these reviews to sources of revenue, and in particular to carbon tax revenues. Each country’s revenue books would be open to inspection, and its tax officials available for questioning. Of course any country that desired to cheat could do so, but that is a problem with any regime to limit emissions, and many officials would have to be brought into the conspiracy.
—Richard Cooper, “A Global Carbon Tax?,” 2004
The IEA, within the framework of the World Energy Outlook, has been measuring fossil-fuel subsidies in a systematic and regular fashion for more than a decade.
The procedure would probably require mechanisms similar to those used in World Trade Organization (WTO) deliberations, where technical experts calculate effective taxes under a set of guidelines that evolve under quasi-legal procedures.
—William Nordhaus, A Question of Balance, 2008
Comment: It seems likely that the WTO tax and subsidy estimation procedures, which are often used under contentious circumstances, could be used to detect illicit carbon-price subsidies on exports. This would cover a major part of Chinese emissions.
Price advantages
In a cap-and-trade regime, emissions trading can make inaction legitimate for buyers of emission permits. In particular, overselling of permits by a few permit exporting countries might completely undermine the regime’s environmental effect. In a tax regime, by contrast, one country’s non-compliance can not make inaction by other countries legitimate, meaning that an agreement based on harmonized carbon taxes will always have some effect, so long as at least one country complies. We thus conclude that enforcement is more important for a cap-and-trade regime than for a tax regime.
—Jon Hovi and Bjart Holtsmark, Cap-and-Trade or Carbon Taxes?
Tax cheating is a zero-sum game for the company and the government, while emissions-control evasion is a positive-sum game for the two parties involved in the transaction for a global public good.
—William Nordhaus, A Question of Balance, 2008
Permit problems
An additional question [about permits] concerns the administration of programs in a world where governments vary in honesty, transparency, and effective administration. These issues arise with particular force in international environmental agreements, where countries have little domestic incentive to comply, and weak governments may extend corrupt practices to international trading. Quantity-type systems are much more susceptible to corruption than price-type regimes. An emissions-trading system creates valuable international assets in the form of tradable emissions permits and allocates these
to countries. Limiting emissions creates a scarcity where none previously existed; it is a rent-creating program. The dangers of quantity approaches compared with price approaches have been demonstrated frequently when quotas have been compared with tariffs in international trade interventions.
… Dictators and corrupt administrators could sell their permits and pocket the proceeds. … Consider the case of Nigeria, which has had carbon emissions of around 25 million tons in recent years. If Nigeria were allocated tradable allowances equal to recent emissions and could sell them for $40 per ton of carbon, this could raise around $1 billion of hard currency annually in a country whose nonoil exports were only $600 million in 2000.
Incentives to evade emissions limitations in an international system are even stronger than the incentives for domestic tax evasion. Tax cheating is a zero-sum game for the company and the government, while emissions-control evasion is a positive-sum game for the two parties involved in the transaction for a global public good.
—William Nordhaus, A Question of Balance, 2008
The Hack that Warmed the World
—Foreign Policy Magazine, January 30, 2015
Permit advantages
Verification is easier under cap-and-trade: under a permits system it suffices to measure
a country’s overall emissions, a very reasonable task.
—Jean Tirole, “Some Political Economy of Global Warming,” 2012
Question: Does the above statement assume monitoring by satellite? (So far, only point sources seem feasible in the near future. Is there newer information?)
Emissions Monitoring
Emissions: While both systems require emission monitoring, measurement accuracy is far more important for quantity regimes. A 30% underestimate may easily negated ten-years of emissions growth, but only causes a 30% reduction in tax-revenue compliance requirements.
Comprehensive carbon pricing in developed countries can, via international carbon markets, promote emissions mitigation in, and technology transfer to, developing countries, though monitoring and verifying emissions reductions in those countries is challenging.
Why monitoring revenue does not add to the uncertainty of emissions
It might seem that since monitoring a price commitment requires monitoring both emissions and revenue, it must be less accurate than just monitoring emissions. To see why this is not the case, consider a commitment to reduce emissions by 15% in a country where that can be achieved with a $30 price on carbon, and where initial emissions are 100.
Consider two equivalent requirements, a 15% emissions reduction and a $30 carbon prices.
Assume that emissions can be measured with 11% accuracy, and price with only 20% accuracy.
If a country reduces emissions by 5% to 95. Under emissions monitoring, emissions may be estimated at 95 – .11×95 = 84.6%, and so the country may be counted as in compliance.
But if a country with a price commitment imposes a $20 price on carbon, even if both measurement errors cut in its favor (unlikely), emissions will be measured as down (due to the $20 price) 15% from 90 to 76.5, and revenues measured as 20% above their actual value of $20×90=$1,800, or $2,160. This gives a price estimate of $2160/76.5 = $28.24, which is less than the $30 commitment. And so it will be found to be out of compliance, even though it performed twice as well as the country with the quantity commitment (a 10% emission reduction instead of a 5% emission reduction).
Hence, even though measuring price involve two errors, the emissions error (11%) and the revenue error (20%), it produces a more reliable gauge of policy than measuring only quantity.