Why Cap-and-Trade Schemes Are Little More Than a Cash Grab

04/13/2015 08:54 pm ET | Updated Jun 13, 2015

Ontario's move to join Quebec and California in a cap-and-trade pact for carbon emissions may seem like an environmental win, but whether it's actually a meaningful step towards battling climate change or just a cash grab by the province, well, you can be the judge.

Cap-and-trade schemes create a market for emission credits that allow a fixed amount of carbon to go into the atmosphere. If an emitter wants to go over its allotment, it can buy surplus credits through an open trading market.

In this case, the market will be sizeable. Together, Ontario and Quebec account for more than half of Canada's economy. Such clout, at least on the surface, would seem to offer a nice offset to the lack of federal government action on carbon emissions. Throw in California's mega-economy, the eighth largest in the world, and the cross-border agreement appears to be a bold step in the right direction. Unfortunately, the picture becomes less rosy once you look at how the market for credits actually works.

Cap-and-trade systems have a nasty habit of turning into cap-and-fade. Emissions prices, which even at inception are generally modest, typically fall within a few years to a fraction of their original level. The reason is hardly a great mystery.

Just as printing more money lowers the value of existing bank notes, the more credits a government issues, the less valuable they become. Credits on the European Climate Exchange (ECX), for example, once traded for as much as €30 per ton. Today, the price is down to €7 per ton. Similarly, California's trading system, which Ontario is poised to join, has seen the price of emissions halved from $23 a ton in 2011 to slightly more than $12.

What exactly do those types of emissions prices accomplish, aside from providing billions in new revenues to cash-strapped governments? I wonder if California governor Jerry Brown, who has just implemented a 25 percent cut to water usage due to a state-wide drought, thinks $12 a ton is enough as he looks at the vanishing snow pack in the Sierra Nevada mountains. Similarly, what impact does German Chancellor Angela Merkel think a €7 charge on emissions is having on coal usage, which is booming in her country as a response to shuttered nuclear plants.

If such costs aren't already low enough, consider that some large emitters are exempt from paying even those token rates. Quebec's system, for instance, provides free emissions credits to two oil refineries, as well as the province's aluminum plants. Ontario premier Kathleen Wynne will no doubt seek exemptions for own pet industries, such as the auto sector.

Politicians claim that key industries need to be exempt from paying for emissions or they'll risk losing ground to competitors. Instead, the practice of exempting some industries while forcing others to comply is a sure-fired path to create economic distortions that do anything but bolster competitiveness.

Ontarians would do well to question why their premier has chosen to join a costly and complex cap-and-trade system instead of opting for a simpler B.C.-style carbon tax. A straightforward $30 a ton tax, which is offset by lower personal income taxes and hence is revenue neutral, shifts the tax base in B.C. from income to carbon fuels. It's precisely the direction tax policy must go if we're to stabilize the already dangerous levels of greenhouse gasses in the atmosphere.

Why didn't Ontario choose that route? The answer is simple -- the two alternatives serve different purposes. Carbon taxes work to reduce emissions while being fiscally neutral at the same time. Cap-and-trade schemes, in contrast, are designed to foster a perception that emissions are going lower without actually doing much environmental good. At the end of the day, the main beneficiary is the provincial treasury. For a premier looking to paint a new source of revenue in greenwash, it's a perfect choice.