The debate between cap-and-trade and carbon taxes is very prominent. As concerns have arisen about global climate change and human greenhouse gas emissions, the question has arisen, what should be done? Many say that the most important avenue for cutting carbon emissions is market systems and incentives. Cap-and-trade and carbon taxes are two of the most prominent approaches to creating such market incentives to cut emissions. Both place a price on carbon emissions from businesses, giving them an incentive to emit less. A carbon tax places a straightforward tax on all carbon emissions. All emitted carbon is treated the same, under such a system, carrying the same price for a business. Under a cap-and-trade system, caps are set for businesses, requiring that they emit less than their caps. If they succeed, they receive carbon credits in proportion to how far below their cap they have reduced emissions. These credits can then be sold for a profit to companies that have failed to reduce emissions below their cap and whom are subsequently required to buy credits to make of the difference. In the United States, the debate has been particularly contentious over the years. The Obama administration planned on implementing a cap-and-trade system. Yet, the debate continues.
“The efficiency [of a cap-and-trade system] comes with the “trade” part. Let’s say you have two power plants, each emitting 100 tons of carbon per hour. The first can reduce its emissions by 20 tons at a cost of $5 per ton, and the second can reduce its emissions by only 10 tons, at a cost of $30 per ton. Clearly the efficient thing to do is to make the former reduction rather than the latter, with the owner of the second plant paying the owner of the first plant to offset the first owner’s extra costs [by buying carbon credits and the “right” to pollute from the first plant].” This allows effective emissions reductions to occur at the lowest cost.
One of the strongest pieces of evidence supporting this argument is the United States sulfur dioxide cap-and-trade system, in which the economic costs of acid rain damage was dramatically reduced.
A cap-and-trade system is more flexible in the global economy. Nations that adopt a cap-and-trade system can later link that system into other cap-and-trade systems around the world. It would not be as easy for a carbon tax to achieve this. This is important in today’s global economy, where multinational companies exist across borders.
This is also important because it would make it easier to combat the problem of “carbon leakage”, which probably requires and international solution.
The costs of establishing and administering a cap-and-trade system could be substantial. It demands that a cap be set, monitored, and enforced. This is a highly complicated process, given the size of the energy market, and would demand substantial administrative oversight.
A carbon tax is predictable, as are most simple tax systems. A cap-and-trade system, on the other hand, is subject to market fluctuations, speculation, and volatility. This could have a bad effect on energy prices.
“Getting the amount of emissions a little bit wrong in any year [through a carbon tax] would hardly upset the global climate. But excessive volatility or unduly high prices of quotas on carbon emissions [as a result of a cap-and-trade system] might disrupt the economy severely.”
A cap-and-trade system provides companies with credits if they are able to reduce their emissions below an established level. They can then sell these credits for a profit. So, if a company takes action to reduce its carbon emissions below the designated level, than it can make a profit. This is a powerful market incentive that is more likely to cause companies to invest money in finding ways to reduce their carbon emissions. A carbon tax, conversely, only provides the incentive of cutting costs, and does not offer this important profit motive.
“In a cap-and-trade carbon market, total emissions are guaranteed to go down. The cap is the cap, and assuming some reasonably effective enforcement mechanism, not a pound more carbon can be emitted. A carbon tax, on the other hand, merely encourages people to emit less by making it more expensive to do so. And in the case of fossil fuels, people seem perversely resistant to financial incentives.”
A post made on economist Greg Mankiw’s Blog 4/11/07 – “With the cap-and-trade system, there will be a definite decrease in emissions, while with the tax, the decrease depends on whether the cost of cutting emissions is lower than the potential tax. If it is, emissions decrease, if not, there is no effect.”
“Subsidizing one or two targeted technologies with a carbon tax would discourage investment in others that may turn out to be more effective. Which technologies should receive these tax dollars? No one has a crystal ball that can determine for sure which will turn out to be most useful. History has shown that the marketplace does a better job of developing new technologies, and a tax takes money out of the marketplace. The solution is cap-and-trade. A cap-and-trade strategy provides the incentive for all segments of the economy to compete to discover the best ways to cut emissions.”
Tax schemes direct the power of market forces towards reducing emissions, rather than merely reducing the price of emissions. Market mechanisms will work far faster.
“Carbon taxes address emissions of carbon from every sector, whereas cap-and-trade systems have only targeted the electricity industry, which accounts for less than 40% of emissions.”
While a cap-and-trade system may take a long time to take effect, a carbon tax can be implemented immediately. Due to the urgency of the Global Warming problem, the rapid results of a carbon tax are very important
The main problem is that baseline emission allowances for companies are based on their past emissions. For this reason, a company has the incentive to emit as much as possible when these baselines are being set so that the baseline is above or at what the company is already emitting. If a company successfully tricks the system in this way, they will be able to emit carbon as they had before, with no reductions being achieved.
The basic problem is that a carbon tax would be a new tax on the public. New taxes are typically unpopular. This makes it hard for politicians to support a carbon tax, as they are beholden to their constituents, and their likely desires to avoid such a tax.
In a carbon tax, emitters would pay a tax for every ton of carbon emitted. This requires that the government know precisely how much carbon is being emitted by energy producers. This is not easy to determine, and requires that a government put in place monitoring mechanisms. Deploying these mechanisms universally would be very complicated, expensive, and require much administration. Then, ensuring that all these monitoring devices operate properly and that all energy producers comply with the tax would also involve a substantial administrative burden. This would be equally as complicated as a cap-and-trade system. However part of the monitoring cost could be absorbed privately by companies who wish to sell their credits, as high price is in their interest.
A cap-and-trade system demands that the government determine the emissions baselines for companies, the allocation of carbon credits, and the monitoring and enforcement of this all. This is a major administrative burden. A carbon tax would be simpler and require less oversight.
The complexity of a cap-and-trade system would make it easier for companies to cheat. This is largely because the enforcement of this system would be difficult.
Governments have the incentive to establish conditions favorable to the performance of their own national companies. They can do so by, for example, offering more carbon credits than they should to the companies of their country. The EU’s emissions trading system is the primary example of this occurring.
A “regressive” tax is one that disproportionately burdens poorer groups. Energy consumption generally makes up a larger portion of the personal budgets of poorer groups. Because energy consumption would be taxed equally across social groups with a carbon tax (it’s a “flat tax”), the costs of the tax would disproportionately affect poor groups.
“Tradeable carbon credits, on the other hand, could conceivably result in a net transfer of wealth to the poor. Although the poor spend a bigger proportion of their income on energy, the wealthy consume a far greater amount of carbon in absolute terms. So under a cap-and-trade regime, we would expect the poor (and the energy thrifty) to have excess credits to sell to their more profligate neighbors.”
A progressive tax is one that places a heavier burden on the wealthy. While the carbon tax would be “flat”, some point out that wealthier people consumer more energy and emit more carbon — they drive and fly more, have bigger (and sometimes multiple) houses, and buy more products that require energy to manufacture and use. Most carbon tax revenues will, therefore, come from families of above-average means, as well as corporations and government.
The revenue generated from a carbon tax, which will largely be from wealthier groups, could allow a government to then cut certain “regressive” taxes – such as the payroll tax (at the federal level) and the sales tax (at the state level) – in a way that benefits poorer groups. This is called “progressive tax-shifting”.