One feature of both the Kerry-Lieberman and Cantwell-Collins cap and trade plans that I don’t understand is the so-called “hard collar”. This will put a price floor and ceiling in place. Here is how Yglesias describes it for Kerry-Leiberman:

The Senate bill modifies this idea by mandating that permit prices trade within a certain band. That starts as a floor of $12 and a ceiling of $25 per ton. The floor increases at 3%+CPI, the ceiling at 5%+CPI.

My question is, how to you set a price ceiling or floor in a market without getting a shortage or surplus? If Company A values a marginal pollution permit at $30 and Company B values it at $27, but the price ceiling is $25, how does this market allocate that marginal permit? I’m not sure how you make sure the permits are allocated efficiently without allowing the price to rise above the ceiling. Both bills may include very effective mechanisms that deal with this that I am just unaware of. If so I would be glad to be educated on this.

I am persuaded by Yglesias that the floor makes more sense as an insurance policy against the level of carbon permits being set too high, or the system being gamed by illegitimate carbon offsets:

What the floor does is let you assume the worst about the offsets—the regulation is super-lax, tons of stuff is offset, and much of it has little value—and still be left with essentially an escalating carbon tax in the event that the market price of permits crashes.

I do kind of agree with him here. But if this is a likely possibility for offsets, than should we allow them in the first place? My guess is that a whole lot of the rest of the meat in Kerry-Lieberman is designed to set the stage for just these sorts of wasteful offsets. Cantwell-Collins, while much simpler (the full bill is only around 40 pages long), seems to leave a lot of wiggle room for this type of stuff as well. Why not get offsets out of the bills altogether?

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