Thursday, July 10, 2008

Economics of Cap and Trade

Peter Orzag, the head of the US Congressional Budget Office, has written a major opinion piece in the Washington Post.

He argues strongly for the importance of "banking and borrowing provisions" that allow emitters to shift their allocations slightly from year to year. He is also concerned about offsetting the costs to people on low incomes. These sorts of options will make cap and trade more palatable to a domestic audience which will in turn lead to more effective reductions in emissions and thus better outcomes in international negotiations.

Given that climate change is a global problem, effective solutions will require care toward not only these domestic design issues but in coordinating efforts with other major emitters. Whereas timing flexibility and the use of revenue from allowance sales can be legislated, such coordination is difficult to legislate -- but may be easier to negotiate the more credible the U.S. effort, which in turn depends on avoiding excessive domestic costs. Giving firms flexibility about when they reduce emissions and devoting the revenue from selling allowances to reducing either the macroeconomic costs or the distributional consequences would not make it free to reduce the risks associated with global climate change, but such strategies could reduce the domestic economic costs substantially.

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