Argument: A carbon tax is less volatile than a cap-and-trade system

Issue Report: Cap-and-trade versus carbon tax


Carbon Tax Center. “Carbon Taxes vs. Cap-and-Trade”: “Carbon taxes will lend predictability to energy prices, whereas cap-and-trade systems will aggravate the price volatility that historically has discouraged investments in less carbon-intensive electricity generation, carbon-reducing energy efficiency and carbon-replacing renewable energy.”

The Economist. “Duffing the Cap”. 15 June 2007: “taxes deal more efficiently than do permits with the uncertainty surrounding carbon control. In the neat world of economic theory, carbon reduction makes sense until the marginal cost of cutting carbon emissions is equal to the marginal benefit of cutting carbon emissions. If policymakers knew the exact shape of these cost and benefit curves, it would matter little whether they reached this optimal level by targeting the quantity of emissions (through a cap) or setting the price (through a tax). But in the real world, politicians are fumbling in the dark. And that fumbling favours a tax. If policymakers set a carbon tax too low, too much carbon will be emitted. But since the environmental effect of greenhouse gases builds up over time, a temporary excess will make little difference to the overall path of global warming. Before much damage is done to the environment, the carbon tax can be raised. Misjudging the number of permits, in contrast, could send permit prices either skywards or through the floor, with immediate, and costly, economic consequences. Worse, a fixed allotment of permits makes no adjustment for the business cycle (firms produce and pollute less during a recession). Cap-and-trade schemes cause unnecessary economic damage because the price of permits can be volatile. Both big cap-and-trade schemes in existence today—Europe’s Emissions-Trading Scheme for carbon and America’s market for trading sulphur-dioxide permits (to reduce acid rain)— suggest this volatility can be acute. America has had tradable permits for SO2 since the mid-1990s. Their price has varied, on average, by more than 40% a year. Given carbon’s importance in the economy, similar fluctuations could significantly affect everything from inflation to consumer spending. Extreme price volatility might also deter people from investing in green technology.”

Congressional Budget Office. “Limiting Carbon Dioxide Emissions: Prices Versus Caps”. 15 Mar. 2005: “Analysts generally conclude that uncertainty about the cost of controlling carbon dioxide emissions makes price instruments [such as a carbon tax] preferable to quantity instruments [such as a cap-and-trade system] because they are much more likely to minimize the adverse consequences (excess costs or forgone benefits) of choosing the wrong level of control…The less information policymakers have about the cost of meeting a particular emission cap, the greater the advantage offered by an emission price [carbon tax]. The cost of meeting a given cap on carbon emissions is likely to be difficult to estimate for at least three reasons. First, the cost of meeting a future cap would vary significantly with the amount of growth in carbon emissions in the interim. Those emissions are difficult to predict: they are a function of numerous factors, including population trends, economic growth, and energy prices. Second, policymakers have less information about the cost of controlling emissions than do the firms that create them. Third, the cost of meeting the future cap will depend on the technologies that are developed to reduce carbon dioxide emissions and the economic consequences of adopting those technologies–neither of which can be predicted with certainty.” see the CBO article for a substantive expansion on this argument

Carl Pope, Sierra Club executive director: “It [a carbon tax] will be more effective [than a cap-and-trade system] if people know that in year ‘X’ they will pay this much. Companies are highly motivated by costs.”[1]