The NGO Carbon Market reported last week that European businesses make billions from free carbon quotas. For the average European Joe, this must sound absurd and incomprehensible. Wasn’t the European Union Emission Trading scheme intended to make the polluter pay? Perhaps the question is: who is being paid, then? Other–bigger–polluters, so it seems.
The idea is that by putting a “cap” on carbon emissions, goods and services that rely on emitting carbon should become more scarce–at least until technology makes it possible to produce them with less emissions–which means more expensive, too, as the same number of consumers compete for a smaller supply. With the human factors of production (labor and capital), this higher price provides an incentive to increase supply, which will eventually bring the price down again. This is the called the “price mechanism.”
However, with natural scarcities such as land and government created scarcities such as permits, this cannot happen. Instead, they generate a flow of income called “economic rent.” Such income is called “unearned” because it does not reflect any kind of human effort. This is the economic mechanism through which European corporations are making big money out of carbon permits–for absolutely doing nothing.
Pollution permits, though a government created mechanism, reflect natural scarcity–the capacity of the earth to process waste and regenerate resources. Producing more waste causes harm to humans and other life, both now and in the future. Ignoring this harm allows businesses and individuals to “externalise” costs, meaning that the damage is paid for by someone else. This means that the price for some goods is artificially low, and thus, again because of the price mechanism, there is an oversupply of these goods. One way to deal with this problem is through so-called “Pigouvian taxes” (which should rather be called Pigouvian fees), which charge the true cost of pollution directly to the polluters. This fee serves as an incentive both to consume less of the polluting products and to create technology that avoids pollution in the long term.
These Pigouvian taxes require that we assign a fixed monetary value to the damage caused by pollution, which should be the price of repairing the damage. However, they provide little actual control over the amount of pollution produced, since it is possible for people to continue to produce an equal amount of waste but consume less of something else to compensate for the cost of Pigouvian taxes (i.e. the case of inelastic demand). Therefore, they don’t make sense as a solution when we lack the means to repair the damage but do have information about the maximum capacity of waste nature can absorb.
Putting caps on pollution through permits could offer a valid alternative. However, it would be essential that the economic rent of these permits be captured by the government. After all, each individual has a right to an equal share of natural resources, including the capacity of the Earth to absorb waste. This distribution can be accomplished by renting out the permits periodically to the highest bidder. A benefit of this system would be that the environmental cost would be set by the market and would decrease with development of technology to prevent pollution (because of lower demand).
Such a system would capture all of the unearned income paid for by consumers. The money collected should then be distributed equally to all citizens according to the rightful share of each. Those citizens that generate more waste than their fair would thereby compensate those that generate less. This system is socially justifiable because poor people pollute less in absolute terms and will thus benefit financially. The additional income could also be used to reduce taxes on the lowest incomes.
The European Union chose not to capture this economic rent, which would have resulted in a much more efficient allocation without generating unearned income. Under the current system, economic rent is “capitalized” into the selling value of the permits. This is intentional: supposedly, the incentive to buy and sell these permits will cause them to be allocated to the best use. The problem is that in a market of capitalized economic rent assets, there may also be speculation and actual under use of the assets, because as long as you can exclude others, full use is not required. If this isn’t bad enough, European governments actually gave away the valuable permits to large polluting businesses, a huge free handout on top of their historically externalised cost.
In these times of high public debt and slow economic growth, European citizens are constantly told they must suffer austerity and/or high taxes for their own benefit. It is time that the European population learns about economic rent and holds its representatives responsible for their lack of economic judgement in environmental policies.