Tuesday, May 13, 2008

McCain vs Obama: Carbon Auctions

Any cap-and-trade system for carbon creates a valuable resource: the right to produce carbon. A key question in the design of the system is how those carbon allowances are allocated. Are they given out for free to power companies and other established carbon emitters? Or are they sold at auction so the revenue can be used to reduce government debt, fund public programs, or reduce distortionary taxation? If the allowances are sold, their price resembles a Pigovian tax, which readers of this blog will recognize as the optimal policy response.

In his speech yesterday, Senator McCain gave a nod to selling the carbon allowances:
Over time, an increasing fraction of permits for emissions could be supplied by auction, yielding federal revenues that can be put to good use.
Not bad, but the statement raises several questions. Why over time? Why not immediately? And how high would that fraction become?

Here was Senator Obama on this topic in a debate a few months ago:
I think cap-and-trade system makes more sense. That's why I proposed it because you can be very specific in terms of how we're going to reduce the greenhouse gases by a particular level. Now what you have to do is you have to combine it with a hundred percent auction.

The Pigou Club gives the edge to Obama.