Cap-and-Trade or Carbon-Tax (Part II)

from Flickr Creative Commons some rights reserved

Yesterday I profiled the merits of a cap-and-trade system for climate change mitigation. Today I will evaluate the cap-and trade-system against the alternative of a carbon tax. 

Carbon Tax Overview

A carbon tax is an environmental tax levied on the the production, distribution, or use of fossil fuels based on the carbon content of the fuel. Economists call it a Pigovian tax as it is used to make emitters pay the full social cost of their pollution. The tax is used to make emitters pay for the negative externality of their pollution. It works through the government choosing the price per ton of carbon and then converting this price into a tax to be placed on oil, natural gas, and electricity. The tax is generally placed on the transaction, for instance on the sale of gasoline. It makes dirty fuels more expensive and therefore encourages consumers to either use less of these fuels, or to switch their consumption to cleaner alternatives. 

Pros 

• Transparent and easily understandable, which is important for garnering public support.
• Stabilizes energy prices. 
• Easily implemented and can be done on municipal, provincial/state, national, or global levels. 
• Substantial revenues from the tax. 
• Little monitoring needed from government. 

Cons

• A regressive tax as low-income residents are affected disproportionately more than other income groups. 
• The total level of emissions cannot be restricted to a certain level, making it difficult to limit global emissions. 
• The demand for fuel is highly inelastic (doesn't respond much to price changes) and therefore the tax would have to be very high to reduce demand significantly. 
• Politically risky to implement a tax.

The Answer
I believe that a carbon tax is the better policy for climate change mitigation because it can be quickly implemented, does not require a global framework, and generates clear revenues for the government.

A carbon tax is much simpler to implement than a cap-and-trade system. Because of its simplicity, it can be implemented much quicker than a cap-and-trade system. For example,  British Columbia enacted and implemented a carbon tax in five months. By comparison, the only comparable carbon cap-and-trade system in North America (Northeastern U.S.), took five years of negotiation and rule-making.

Similarly, the carbon tax's simplicity aides it's feasibility as the tax can be effective on any level. A carbon tax is not inhibited by the need for a global or even national plan, it can be easily implemented on a regional level as in British Columbia. In 1997 the world's leaders convened in Kyoto to discuss developing a plan for Climate Change, and they decided to implement a global cap-and-trade system. Fourteen years later, the plan— overcome by erratic participation— has yet to amount to any decreases in emissions. 

The carbon tax also brings in a clear revenue stream. A cap-and-trade system that auctions permits could yield similar revenues; however, firms would likely bargain away these profits by demanding a free allocation of permits. 

I should note that a cap-and-trade system is an immense improvement over the do-nothing status quo, even if it’s second best to a carbon tax. If governments insist on cap-and-trade system (as the Obama administration has done), we should embrace the movement from the status quo even if it represents a second best choice.