The Cap and Trade System vs. Carbon Tax

Compares and contrasts the Cap and Trade System. Discusses which may be better at controlling and reducing greenhouse gases.

The idea of a market based Cap and Trade system to deal with CO2 pollution has been talked about in academia and politics for some time now. For those of you who aren't familiar with cap and trade it is a system in which the government issues emission permits to individual businesses. The permit allows the company to emit a certain amount of greenhouse gases. In effect the permit acts as a "pollution allowance" for each company, and if the company does not use it up, it is allowed to sell or "trade" its remaining allowance to other businesses who cannot operate without exceeding their permit. By creating a market for these permits it is hoped that gross polluters will be encouraged to reduce their emissions instead of having to purchase extra permits. This system was successfully implemented as part of the Clean Air Act of 1990, which reduced sulfur emissions that caused acid rain.

Despite that success some question if cap and trade is really the best option for reducing greenhouse gas emissions. Implementing cap and trade on a large scale does present technical and political problems. For example: How will the caps be determined? Will some industries have a higher cap than others? Will the size of the company matter? Will industry lobbying affect this process? Is our current technology capable of allowing companies to operate within their emission limits? How will the market for these permits be set up, and how will it be regulated? These are some tough questions, and cause for concern.

These concerns have caused some in academia and politics to propose the alternative of a carbon tax. The Carbon Tax Center ( a non-profit, non-governmental organization) regards carbon taxes as superior to carbon cap-and-trade systems for six fundamental reasons:

1. Carbon taxes 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.

2. Carbon taxes can be implemented much sooner than complex cap-and-trade systems. Because of the urgency of the climate crisis, we do not have the luxury of waiting while the details of a cap- and-trade system are resolved through lengthy negotiations.

3. Carbon taxes are transparent and easily understandable, making them more likely to elicit the necessary public support than an opaque and difficult to understand cap-and-trade system.

4. Carbon taxes can be implemented with far less opportunity for manipulation by special interests, while a cap-and-trade system’s complexity opens it to exploitation by special interests and perverse incentives that can undermine public confidence and undercut its effectiveness.

5. Carbon taxes address emissions of carbon from every sector, whereas some cap-and-trade systems discussed to date have only targeted the electricity industry, which accounts for less than 40% of emissions.

6. Carbon tax revenues would most likely be returned to the public through dividends or progressive tax- shifting, whereas revenues created through trading emission permits will likely go to market participants, lawyers and consultants.

These all seem like very valid points, but are they really? What do you think?

sources:

http://www.carbontax.org/issues/carbon-taxes-vs-cap-and-trade/

http://ndn.org/node/3761

http://www.americanprogress.org/issues/2008/01/capandtrade101.html

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Daniel Snyder
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Sergio Chaidez
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Daniel Snyder
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Posted on Feb 24, 2010