commercial, and residential use of fossil fuels. It would stimulate the production of alternatives to fossil fuels, including nuclear power, solar power, wind power, and geothermal power. It would reduce the nation’s reliance on imports of petroleum and natural gas. It also could establish a floor underneath the prices of gasoline and coal if prices should collapse in the future, which cannot be ruled out if the U.S. and global economy were to falter.
Another reason for favoring a carbon tax, according to Portney, is that it would generate revenues. Though the U.S. economy has had full or nearly full employment for an extended period, the federal government is still generating large deficits. With a large cohort of people about to enter retirement age, they will begin to collect Social Security and Medicare, which will further add to the deficit. “I would rather raise these revenues by taxing something that we’re trying to discourage than by raising income taxes or taxes on capital,” Portney said.
Auctioning off permits under a cap-and-trade system would also generate revenue, Portney said, so another option would be a cap-and-trade system in which significant numbers of permits were sold. “But I think that most of the permits in the cap-and-trade system would inevitably be given away because politicians cannot resist the temptation to give away goodies. And for that reason it seems to me that a carbon tax is to be preferred.”
Ged Davis noted that in many countries policy leaders are still engaged in an open discussion about the relative merits of a cap-and-trade mechanism or carbon taxation. He also noted that when markets are wide and deep, they can work well, but with relatively young markets there can be significant and sudden shifts in price. Such price fluctuations can reduce confidence for making long-term investments, which is an argument in favor of carbon taxes. However, “taxes can come and go depending on government positions,” Davis acknowledged. And, as Portney noted, “like Count Dracula from a silver cross or the first rays of daylight, politicians run from any mention of new taxes, especially during an election year.”
Holdren said that the fluctuations in carbon price in Europe were largely due to having set targets too low initially. The system underestimated how many opportunities were going to be available to avoid carbon emissions at a relatively low price. Also, there were problems with the allocation scheme and how many of the permits were given away. “I think we have all learned from that experience,” Holdren said. “One of the reasons that the Energy Commission changed the details of its recommendations—including the fraction of the permits to be auctioned and the size and level of the safety valve—was learning from the European experience.”
Another argument is that there should be not only a ceiling but also a floor on the permit price, Holdren said. Cap-and-trade approaches do generate variability in prices, which creates a lack of signals for firms that are trying to decide how much to invest in alternatives. More thinking needs to be done on