Tuesday, May 19, 2009

Comparative Advantage at Work II – Cap and Trade

I like cap and trade.  Under cap and trade, a mandated aggregate reduction in emissions is established, and those emitters who can reduce their emissions most cheaply reduce them, while everyone else pays the reducers for doing so. 

Cap and trade puts the law of diminishing returns – usually an unhappy fact of life – to good use by seeing to it that the low-hanging fruit do in fact get picked first.  It does this by encouraging the emitters with the lowest hanging fruit to do the picking.  Since one way of describing the situation is that the emitters who can best afford to reduce emissions have a comparative advantage in emission reduction vis á vis those emitters who will pay for the privilege of not reducing their emissions, cap and trade explains comparative advantage as the harnessing of the law of diminishing returns to serve the imperative of self-interest.

Cap and trade is being attacked now as a “tax.”  So what?  Raising taxes can have a suppressive effect on economic activity, but imposing “a tax” is not the same thing as “raising taxes.”  If Congress imposes a cost via cap and trade, it can offset that cost by lowering taxes or subsidizing the emitters.  I’m not saying that Congress will do that, only that standing alone, the imposition of any given cost is not necessarily recessionary.

The other objection to cap and trade is that we don’t need to reduce our emissions or that doing so won’t matter if the Chinese don’t.  I’m not going to get into that.  I just think that if we’re going to reduce emissions, cap and trade is the way to do it.

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