Cap-and-trade protectionism? The danger of offsetting tariffs that could doom the global trading system.

• Author: Feldstein, Martin

There is a serious danger that the international adoption of cap-and-trade legislation to limit carbon dioxide emissions will trigger a new round of protectionist measures. While aimed at reducing long-term environmental damage, cap-and-trade policies could produce significant harmful economic effects in the near term that would continue into the future.

Scientific evidence appears to indicate that the accumulation of carbon dioxide in the atmosphere from the burning of fossil fuels (primarily coal, oil, and natural gas--mainly in electricity production, transportation, and various industrial processes--contributes to gradual global warming, with long-term adverse effects on living conditions around the world. It is with this in mind that representatives of more than 150 countries are scheduled to meet in Copenhagen in December to discuss ways to reduce carbon dioxide emissions.

A common suggestion is to impose a tax on all carbon dioxide emissions, which would be levied on companies that emit carbon dioxide in production, or that sell products like gasoline that cause carbon dioxide emissions when used. Such a tax would cause electricity companies and industrial firms to adopt techniques that reduce their carbon dioxide emissions, as long as the cost of doing so is less than the tax that they would otherwise have to pay.

The higher cost of production incurred to reduce emissions--and of any emissions tax still due--would, of course, be included in the price charged to consumers. Consumers would respond to the tax-induced increase in the cost of the emissions-intensive products by reducing their consumption of those goods and services in favor of goods and services that create smaller amounts of emissions.

A carbon tax causes each firm and household to respond to the same cost of adding carbon dioxide to the atmosphere. That uniform individual cost incentive allows total carbon dioxide to be reduced at a lower total cost than would be achieved by a variety of administrative requirements, such as automobile mileage standards, production technology standards that is, minimum renewable fuel inputs in electricity generation), and so forth.

Yet we do not see carbon taxes being adopted. Although governments levy taxes on gasoline, they are reluctant to impose a general carbon tax because of public opposition to any form of taxation. Governments have therefore focused on a cap-and-trade system as a way of increasing the cost of carbon...