A Deeper Look at Tradeable Allowances

Since the passage of the Clean Air Act, SO2 emissions have decreased by 35%. Part of this is due to tradable allowances, which created a market solution to the external costs of SO2 emissions. In this video, we look at the lessons of tradable allowances for SO2 and see if a similar market-based solution could work to decrease other pollutants, such as CO2.

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- [Alex] Tradable permits are
a kind of combination

of costs and command and control.

We covered the essential idea
in the previous video.

In this video, I just want
to underline a few key points.

Let's get started.

The Clean Air Act
was very successful.

Under the act,
SO₂ emissions have fallen

over time, and at the same time,

electricity generation has
continued to increase.

So the market has
been able to discover

low cost ways of reducing pollution.

An important consequence
of the tradable allowance system

is that firms that generate
electricity from clean sources --

they can make money
by selling allowances.

On the other hand,
firms that generate electricity

from dirty sources --
they have to buy allowances.

The result is that clean energy is
subsidized, and not by taxpayers.

At the same time,
dirty energy is taxed.

So a tradable allowance system,
implicitly within that system,

is a way of encouraging clean energy
and discouraging dirty energy.

A very interesting aspect
of these markets is

that anyone can participate,
not just generators of electricity.

So Tyler Cowen and I, in fact,
purchased the right to emit

30 pounds of sulfur dioxide
into the atmosphere.

Now we didn't want to do that.
So what did we do?

Well, we tore it up. Why?

Well, when we tore up that right
to emit 30 pounds of sulfur dioxide

into the atmosphere,
we made the air cleaner.

Nobody else had that right.
So by tearing it up,

that's 30 fewer pounds
of sulfur dioxide

which were allowed to be emitted
into the atmosphere.

In fact, under
the tradable permits plan,

environmental groups are free
to buy up permits, tear them up,

and reduce pollution in that way.

If they think that
the government, for example,

set the pollution permits too high,

they're free to buy pollution
permits and tear them up.

So it's a very efficient way of
reducing the amount of pollution.

Let's briefly compare tradable
allowances with Pigouvian taxes.

They're actually
quite similar economically.

If the tax is set equal
to the level of the external cost,

and the number of allowances is
equal to the efficient quantity,

then they're basically
the same economically.

Politically however,
they're quite different.

And the key question is,
who gets the initial allowances?

Now some people argue
that pollution allowances are

the same as corrective
or Pigouvian taxes

plus a little bit
of corporate welfare.

You're giving away
the right to pollute.

Now that's really not the best way
to look at the issue, however.

First of all, we don't have
to give the allowances away.

They could be auctioned off,

generating revenue
for the government.

In this case, then politically
and economically,

the two systems would be very similar.

Most importantly, however,

is if the allowances are given
to the firms initially,

pollution control is more likely

to be accepted
by the large energy firms.

If you just come at the large
energy firms and say,

"We're going to tax you,"

of course, they're going
to lobby against those taxes.

If on the other end you say,
"We're going to have

a tradable allowance system
in which you guys are given

some right to pollute at, say,
historical levels," they're going

to be much more willing
to accept the program politically.

In any case, that's
the main difference, politics.

Tradable allowances
have worked very well

for controlling sulfur dioxide.

Could a similar system be used
to combat global climate change

and the problem of carbon dioxide
and carbon emissions more generally?

In theory, the answer
is definitely yes.

All of the advantages of tradable
allowances for sulfur dioxide would

hold for carbon dioxide as well.

The main difference is
that global climate change

is a global problem.

The externalities involved
in sulfur dioxide

the acidification of lakes,
were primarily national.

So all we needed was
a national plan in order

to control sulfur dioxide.

But to control carbon dioxide,
we need a global plan,

and it's going to be much
more difficult to get

all the nations of the world
to agree to either

a Pigouvian tax system
or a tradable allowance system

than it is just to get
one country to agree.

The externalities are international
making the problem

much more difficult to solve.

At the same time, economics is
going to be very important

for solving these problems,
because what we've just seen

is that both Pigouvian taxes
and tradable allowances give us

the most bang for our buck.

They give us the most pollution
control at the lowest cost.

And if we can lower the cost
of pollution control

or carbon dioxide emissions,
we're much more likely

to get reductions
in carbon emissions.

The lower the cost of solving
the problem, the more likely

we are to solve the problem --
and that's one reason

why understanding economics
and the economics of Pigouvian taxes

and tradable allowances
is extremely important.

- [Narrator] If you want to test
yourself click, "Practice questions."

Or, if you're ready to move on,
just click, "Next video."

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