Industrial policy by any other name

In ancient times (a week ago), I went to a presentation at the Urban Institute by Douglas J. Holtz-Eakin, ex-Director of the CBO and currently John McCain's senior policy adviser. The purpose of the talk: to find out what that campaign had to say about tax policy.

Unfortunately, what I found out (and in quite the dramatic fashion as it came at the very, very end of the talk, which was otherwise going nicely given what can be expected from such an exercise) was a textbook example of a policy disaster waiting to happen: an instrument labeled as a global-warming-busting environmental policy whose implementation is unfortunately designed in such a way that it begs to be hijacked by special-interests and converted into the Mother of All Industrial Policies (and Granny to One Huge Redistribution). Very sad.

DHE is undoubtedly a smart economist, but above all he now is a political operator; as such, he handled the couple-of-hours worth of questions with outstanding professionalism, seamlessly mixing sound economics with political obfuscation... which made it oh-so-very-frustrating as it meant that each time we began to scratch the surface enough to know there was something interesting there, we veered into some politically-safe generic statement.

(Having said that, one could sort of tell, by the shifts in his tone and body language, when he was talking as DHE, the economist, and as DHE, the Candidate's Senior Policy Adviser.)

But what really gave me the evil goosebumps was when I asked him about the environmental policy. As you might know, McCain has declared that doing something to stop global warming is among his top priorities; as you might also know, he has chosen tradeable carbon permits over Pigouvian taxes. Oh well, nevermind: at least an argument can be made for their equivalence if the former are auctioned off. At least in principle (god knows how car-drivers would be equivalently-taxed, for example, but nevermind).

Now, what I wanted to know was this: since most of the discussion had been about balancing the budget, but the tax and expenditure measures discussed had not included any revenues from internalizing pollution externalities, was this revealing the campaign's true expectations about passing this reform?

The answer that I got came as a disappointment: it started well, presenting tradeable permits as the constrained-efficient option given all sorts of real-world implementation problems, including much more working knowledge on permit markets... and a greater ease to achieve political support (suspicion alarms warming up)... through transitional issues (alarms starting to fire as this is the time where special interests lay waste to the best laid plans)... which would all have still been fair and square within the realm of "they're still serious about it, they're just trying to also be realistic," until we find out that this will mean that not all permits will be auctioned off, but rather that what sounds like a sizable amount (most of them? it hasn't been decided) will be allocated based on... OMG: on issues such as trade competitiveness, strategic interests, etc!

And since giving out permits = subsidizing, this is, pure and simple, an undercover industrial policy waiting to happen.

Now, I'm not remotely trying to suggest that McCain (or DHE) are themselves planning to create a system they can then game for personal gain, but just think of the opportunity for all policy-makers involved to add a clause here and a special consideration there to end up with a Mutant Morphing Monster that achieves little-to-non of the intended environmental purposes, but instead acts as yet another channel to redistribute fiscal resources back to pet sectors while increasing economic distortions to a whole new level.

Another reason, methinks, to prefer a uniform, across-the-board, carbon-emissions tax. When will the Pigou club become a party?