Prof Mankiw at Harvard published another article in last Sunday's NY Times commenting on the current Cap and Trade Bill. Back in May I wrote an analysis of HR 2454 or the Cap and Trade Bill. But let me go back to a simple example before I address Mankiw, who I greatly respect but with whom I disagree on this issue, and the cap and trade bill.
Let us consider a simple example from the 19th century.
1. Let us assume that a railroad company builds a set of tracks from city A to city B and it is length 100 miles.
2. Let us assume that along the track between the two cities are 100 farms each a mile on both sides of the track, and each owned by a different farmer.
3. Let us assume further that each farmer grows corn, say each farmer grows 40 acres of corn and that the yield is 1,000 bushels per acre and that the farmer would get 40,000 bushels selling at $50 per bushel. That is $2 million per farm per year.
4. Now assume that the railroad has a choice of good brakes, namely ones which do not make any sparks, and bad brakes, those which make sparks. The cost difference is $500 per brake per year, a typical train has 100 brakes and would cost $50,000 per year and there are ten trains, thus costing an additional $500,000 per year. The railroad management does not want to spend the money because they want higher profit.
5. Now assume that once a year one of the trains using the cheap brakes sends off a spark and that results in a corn field burning down, all 40 acres, all $2 million dollars.
6. Now the farmer sues the railroad and gets his $2 million plus costs back, albeit with some transactions costs and time.
7. The railroad must increase its rates to it passengers to reimburse the farmer. It would have been better off with the better brakes.
8. In the end the passenger pays the costs.
Now this is cap and trade, in some simple manner. The sparks are the negative externalities of Mankiw, really the corn field fire is, the sparks are only the proximate cause. The court is the clearing mechanism, the offend gets to pay ex post facto. Yet the offender knows the risks ab initio but does not accurately calculate the frequency of occurrence.
Yet as we discussed in HR 2454 the House in its glorious wisdom placed the dog catcher, the hot dog vendors, the hat seller, and every other special interest group in the middle of this process. Instead of the courts being the sole arbitrator, as in the train example, and in an auction cap and trade a simple auction process, they have distributed the process across a wide set of special interest groups. I refer you again to the older blog entry.
Mankiw says:
"How much does it matter? For the purpose of efficiently allocating the carbon rights, it doesn’t. Even if these rights are handed out on political rather than economic grounds, the “trade” part of “cap and trade” will take care of the rest. Those companies with the most need to emit carbon will buy carbon allowances on newly formed exchanges. Those without such pressing needs will sell whatever allowances they are given and enjoy the profits that resulted from Congress’s largess.
The problem arises in how the climate policy interacts with the overall tax system. As the president pointed out, a cap-and-trade system is like a carbon tax. The price of carbon allowances will eventually be passed on to consumers in the form of higher prices for carbon-intensive products. But if most of those allowances are handed out rather than auctioned, the government won’t have the resources to cut other taxes and offset that price increase. The result is an increase in the effective tax rates facing most Americans, leading to lower real take-home wages, reduced work incentives and depressed economic activity. "
The problem is greater in a way. The HR 2454 proposal "gives" away credits to a plethora of special interest entities, Congressionally controlled. It makes the railroad analogy of one where each town hall mayor along the railway can get his share of the money for his goody bag of treats and political investments and the price that the railway is charged could become astronomical. Transparency would disappear. It would be akin to driving from New York to Miami in the 1950s and 1960s and being stopped for speeding in every town from Virginia to Georgia by every local sheriff and fined for driving while having your cylinders moving, the out of state definition of speeding.
Mankiw has a point but he should have dug deeper into what is hidden in HR 2454 a bit more.
Let us consider a simple example from the 19th century.
1. Let us assume that a railroad company builds a set of tracks from city A to city B and it is length 100 miles.
2. Let us assume that along the track between the two cities are 100 farms each a mile on both sides of the track, and each owned by a different farmer.
3. Let us assume further that each farmer grows corn, say each farmer grows 40 acres of corn and that the yield is 1,000 bushels per acre and that the farmer would get 40,000 bushels selling at $50 per bushel. That is $2 million per farm per year.
4. Now assume that the railroad has a choice of good brakes, namely ones which do not make any sparks, and bad brakes, those which make sparks. The cost difference is $500 per brake per year, a typical train has 100 brakes and would cost $50,000 per year and there are ten trains, thus costing an additional $500,000 per year. The railroad management does not want to spend the money because they want higher profit.
5. Now assume that once a year one of the trains using the cheap brakes sends off a spark and that results in a corn field burning down, all 40 acres, all $2 million dollars.
6. Now the farmer sues the railroad and gets his $2 million plus costs back, albeit with some transactions costs and time.
7. The railroad must increase its rates to it passengers to reimburse the farmer. It would have been better off with the better brakes.
8. In the end the passenger pays the costs.
Now this is cap and trade, in some simple manner. The sparks are the negative externalities of Mankiw, really the corn field fire is, the sparks are only the proximate cause. The court is the clearing mechanism, the offend gets to pay ex post facto. Yet the offender knows the risks ab initio but does not accurately calculate the frequency of occurrence.
Yet as we discussed in HR 2454 the House in its glorious wisdom placed the dog catcher, the hot dog vendors, the hat seller, and every other special interest group in the middle of this process. Instead of the courts being the sole arbitrator, as in the train example, and in an auction cap and trade a simple auction process, they have distributed the process across a wide set of special interest groups. I refer you again to the older blog entry.
Mankiw says:
"How much does it matter? For the purpose of efficiently allocating the carbon rights, it doesn’t. Even if these rights are handed out on political rather than economic grounds, the “trade” part of “cap and trade” will take care of the rest. Those companies with the most need to emit carbon will buy carbon allowances on newly formed exchanges. Those without such pressing needs will sell whatever allowances they are given and enjoy the profits that resulted from Congress’s largess.
The problem arises in how the climate policy interacts with the overall tax system. As the president pointed out, a cap-and-trade system is like a carbon tax. The price of carbon allowances will eventually be passed on to consumers in the form of higher prices for carbon-intensive products. But if most of those allowances are handed out rather than auctioned, the government won’t have the resources to cut other taxes and offset that price increase. The result is an increase in the effective tax rates facing most Americans, leading to lower real take-home wages, reduced work incentives and depressed economic activity. "
The problem is greater in a way. The HR 2454 proposal "gives" away credits to a plethora of special interest entities, Congressionally controlled. It makes the railroad analogy of one where each town hall mayor along the railway can get his share of the money for his goody bag of treats and political investments and the price that the railway is charged could become astronomical. Transparency would disappear. It would be akin to driving from New York to Miami in the 1950s and 1960s and being stopped for speeding in every town from Virginia to Georgia by every local sheriff and fined for driving while having your cylinders moving, the out of state definition of speeding.
Mankiw has a point but he should have dug deeper into what is hidden in HR 2454 a bit more.
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