4.6 Transaction costs, efficiency and incidence of costs
In a carbon dioxide market among importers and extractors, transaction costs could arise from five sources. Transaction costs are a problem because they mean some firms do not trade efficiently and thus overall costs are increased. They are a direct use of resources. They also may bias against some firms that are less able to trade and hence face higher costs of compliance.
One obvious transaction cost would occur if there were expensive administrative procedures that must be followed to have trades approved and to make trades. In this case, players would only trade when they could make a significant gain.
Second, both a tax and a permit system involve some cost of optimising. That is, it is costly for businesses to identify their static marginal cost curves. The difference with a permit system is that it is possible to bank permits, so businesses must also predict their future marginal cost curves in order to make good permit-banking decisions. Firms under either a tax or a permit system need to predict their future costs to make optimal investment decisions in any case.
Third, there are costs of finding the market distribution of prices and then finding a partner. These can be minimized by creating an anonymous centralized trading mechanism where aggregate price (including the distribution of prices) and quantity information is periodically released and buyers are matched to sellers. The traders would have to have the confidence of the players. They would have to provide information on trading to the government (though not necessarily price information) for monitoring and enforcement purposes but this function would not need to be carried out by government. Large traders may prefer to negotiate directly when they have identified possible trading partners.
Fourth, if there is concern about the validity of the rights being traded, transaction costs are created. This is unnecessary and can be avoided by accurate registration of rights in real time (i.e. as they are traded) so that buyers can check claims of ownership at low cost.
Fifth, negotiation costs between trading partners will depend on the liquidity of the market. If many players become involved in speculating on rights and creating rights (e.g., from forestry) the market will be liquid and a market price will emerge. If the market is illiquid, large trades will involve negotiation and bargaining, which could be expensive. However, trades will tend to be repeated between the same partners and as trading patterns and prices become established, costs of negotiation will fall.
4.6.1 International trading and efficiency of permit market
Transactions costs will be heavily affected by the presence or absence of international trading of permits. If trading occurs within a liquid international permit market, transactions costs for domestic agents are likely to be very low; if the permit market is limited to New Zealand, participants will be much fewer and transactions costs could potentially be a great deal higher. Without an international permit market, fewer derivatives are likely to develop, trading will be lumpier, the price will be more volatile, and market power may be possible in very specific circumstances.
4.7 Design issues specific to taxes
A range of issues are specific to the design of an emission tax system. Unlike permit prices, a tax rate must be adjusted administratively over time. A tax system is likely to raise more money than a permit system in which some permits are grand-parented, and thus the question of what to do with the money raised becomes even more pertinent. Finally, additional government intervention may be required to achieve international compliance under a tax system.
