Policy Risks of Cap and Trade

By way of Cumberland Advisors, we came across this paper on the risks of a cap and trade approach to regulating carbon emissions by LSU economist Joseph Mason. We’ve written about this previously, arguing that a cap and trade system is less efficient and more prone to corruption that a direct carbon tax. As Mason puts it:

…there is nothing wrong with financial firms profiting from making markets for stocks, bonds, and other valuable commodities. However, when a market is created and operated according to government fiat, it is all but certain that vested interests, financial firms that operate and make markets in this case, will lobby for socially inefficient provisions that increase their profits to the detriment of society as a whole… 

As far as cap and trade proposals are concerned, both Wall Street investment firms and environmentalists have similar goals — to restrict the number of carbon permits such that marginal cost to society of pollution abatement exceeds its social benefit…financial firms that make markets for tradable pollution permits will be able to make higher commissions the scarcer the permits are. An alliance between environmentalists and Wall Street presents a particularly intractable problem as far as public choice theory is concerned.

This argument comes from an econ professor, and apparently there are at least two financial services firms (ours and, I assume, Cumberland) that agree with it. This highlights a glaring logical inconsistency among some proponents of cap and trade: many of the same interest groups, pundits, and policymakers who rail against the failures of markets in the recent financial crisis endorse cap and trade markets wholeheartedly! That can probably be best understood by politicians’ reluctance to utter the word “tax”, and by following the money. Some privileged few are going to become quite wealthy administering a cap and trade system for the rest of us. Ah well, perhaps it will mean a few more corporate benefactors for public broadcasting…

URLs:

http://www.cumber.com/special_reports_archive.aspx

http://www.cumber.com/content/Special/mason100109.pdf