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Safety Valves And Uncertainty

Blogging from the Aspen Ideas Festival, Matt Yglesias rejects the notion of having a cap-and-trade emissions scheme with a "safety valve," which would allow companies to buy emissions permits at a given price if the market price of for permits exceeds that price (in effect, setting a limit on how high the cost of carbon emissions can rise). Matt writes:

[A] safety valve is a great provision to add if you don't care at all about mitigating climate change. Call it "John McCain environmentalism"--you'd like to be associated with the climate change issue, but you also want to rake in huge dollars from polluters and you don't actually care accomplishing anything on the issue other than advancing your own political career.

This isn't quite right. It's true that if you set the safety valve low enough, it would simply be a cop-out: A working cap-and-trade scheme will inevitably cause the price of carbon emissions to rise. But, if I remember correctly from economics class (any economists out there can correct me if I'm wrong), the idea behind a safety valve is to compensate for the uncertainty involved in emissions reduction: We don't really know exactly what the socially optimal level of emissions is, so chances are with any reduction scheme we'll miss either on the high side or the low side. But missing high and missing low aren't necessarily equally harmful; that depends on the shape of the cost and benefit curves for emissions reduction (see here for a helpful explanation). Most economists seem to believe that in the short run, the marginal cost curve is relatively steep and the marginal benefit curve is relatively flat, since emitting a little too much for a period of a year or two isn't that big a deal.

Under those circumstances, it's better to set the cost of emissions and let the quantity fluctuate to reach equilibrium--i.e., to have a carbon tax, rather than a cap-and-trade scheme (which sets the quantity and allows the cost to fluctuate). The idea behind a safety valve is to make cap-and-trade (which is more politically palatable than a carbon tax) act like a carbon tax in the event that the price of emissions rises more than we anticipate. So while I'm sure Matt's right that the oil and gas industry would like to use a safety valve just to render cap-and-trade practically useless (by setting the trigger too low), in the right hands, a safety valve is a useful tool for crafting an optimal emissions-reduction regime.

--Josh Patashnik