Carbon tax vs Cap and Trade

[Imperialism Inc.]

A while back I posted an article comparing the carbon emission reduction plans of Obama and McCain. Though Obama's is certainly better (McCain just gives the permits away for free to the biggest polluters), I point out that some experts think just using a tax would be better. It is far more difficult to game a tax system than it is to game a trading system. The story below is about a month old but I just came across it and it provides and example of how cap and trade systems can be exploited.

Class Tests Carbon Trading, With Troubling Results
(snip)

He and Bushnell predicted California's energy crisis. They were ignored at the time. But in the classroom, it becomes clear as students put in a position to manipulate the market do so all on their own.

The professors updated the simulation to account for carbon trading. So after a first round of straight-up power trading, the teams have to reduce their carbon output by 10 percent and trade permits.

"Now, in Game A, these guys bought up most of the credits, and they announced 'We're tearing up half the credits, and so you got to pay a high price if you want to get carbon credits from us.' Was anybody surprised by this? … You guys were? Yeah, you guys were kind of upset, as I recall," Bushnell explains as students laugh.

The lesson? In any market, social concerns — even broader economic stability — take a back seat to making money as efficiently as possible.

Borenstein says it's critical to stress-test your market design before you ring the opening bell.
"What's going to happen in the real world when some people are out to make as much money as they can?" he asks.

(more)