Monday, March 31, 2008

Cap and Trade versus Taxes

From and economic point of view Cap and Trade is not seen as much different than taxation. The only difference is that in one case you start by limiting supply which drives up price. In the other you start by driving up price itself. Either way that should push down demand. But as Dan Ariely demonstrates in his new book, Predictably Irrational, price changes do not produce a stable response. Consumers accommodate to price changes over time. That makes for a big difference in the policy effectiveness of Cap and Trade versus taxation. In contrast to a Cap and Trade program, the effectiveness of taxation will diminish over time and require ever increasing taxes to maintain stable carbon output levels. So in the one case, you only have to fight a one time political battle. In the other, it is an ongoing war.

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