Debate: Cap-and-trade versus carbon tax

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Is a cap-and-trade system preferable to a carbon tax in reducing carbon emissions?

Background and context

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Economics: Are cap-and-trade markets more economical than a carbon tax?

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Yes

• A cap-and-trade system incentivizes reductions in carbon emissions where it can be done most efficiently.
  • Portfolio.com (Conde Nast), "Why a Cap-And-Trade System Beats a Carbon Tax", 4/19/07 - "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.

• An effective cap-and-trade system helps reduce economic costs caused by carbon emissions. 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.

• Cap-and-trade is more flexible in the interconnected global economy. 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.

• A carbon tax would damage an economy.

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No

• The consensus among economists is that a carbon tax is the better approach.

• A cap-and-trade system is complicated and entails substantial administrative costs. 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 more predictable and less volatile than a cap-and-trade system. 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.

• The negative economic effects of a cap-and-trade system would be larger than its environmental benefits: Financial Times, "Carbon Markets Create a Muddle", 4/26/07 - "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 carbon tax would not damage an economy.

• A carbon tax would be more efficient.

• A carbon tax would better distribute the costs of carbon emissions.

• Cap-and-trade would cause job loss.

• A cap-and-trade system would be harder on government budgets.

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Reducing emissions: Is cap-and-trade better at reducing emissions?

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Yes

• A cap-and-trade system better encourages companies to cut their carbon emissions. 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.

• A cap-and-trade system is certain to reduce emissions, which is important in context of the global warming crisis: "Carbon tax vs. carbon market: who would win in a fight?", 9/15/06 - "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."

• The market does a better job of directing investments in the best green technologies: **Bill Chameides, Chief Scientist at Environmental Defense, "Cap-and-trade: more effective than a carbon tax", Grist.org, February 12, 2007 - "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."

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No

• Carbon trading schemes rely on bureaucratic processes to actually reduce 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.

• A carbon tax would add a clear cost to polluting and create a market incentive to pollute less.

• A carbon tax sends a serious and important message about the will to fight global warming.

• A carbon tax would shock consumers into needed behavioral changes.

• A carbon tax addresses carbon emissions in all industries: Carbon Tax Center, "Carbon Taxes vs. Cap and Trade" - "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."

• A carbon tax would create funds to support environmentally-friendly policies.

• A carbon tax provides better incentives for green innovation.

• A carbon tax can be implemented immediately. 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

• A cap-and-trade system is vulnerable to companies tricking the system by polluting heavily before the system begins: 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.

• A carbon tax obligates participation, whereas participating in a cap-and-trade system is largely optional: A carbon tax is an "opt-out" program, where all companies are obligated to participate unless taking specific steps to avoid it. A cap-and-trade system is an "opt-in" program, conversely, where companies are not obligated to participate unless they specifically take steps to "opt-in" and participate. This difference makes the carbon tax more imposing and likely to achieve results.

• A carbon tax can be easily adjusted over time to achieve desired emissions results.

• Cap-and-trade system don't ensure local area carbon emissions are reduced.

• The necessity of a cap-and-trade system depends on the case being made that the environment is seriously, catastrophically threatened.

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Feasibility: Is a market-based cap-and-trade system more feasible than a carbon tax?

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Yes

• A carbon tax is less popular and harder to achieve politically. 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.

• A carbon tax would also require complicated monitoring and enforcement mechanisms. 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.

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No

• The transparency and clarity of a carbon tax is attractive politically.

• The slow implementation of a cap-and-trade system may make it unpopular over time.

• A cap-and-trade system demands the creation of a large and highly complicated administrative bureaucracy. 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.

• A cap-and-trade system is more susceptible to corruption than a carbon tax: 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 within a cap-and-trade system have the incentive to "cheat": 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 cap-and-trade system is susceptible to distortion by lobby groups.

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"Progressive"? Is cap-and-trade more "progressive" than carbon tax?

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Yes

• A carbon tax is "regressive" 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.

• A cap-and-trade system is "progressive". TerraPass, "Carbon tax vs. carbon market: who would win in a fight?", 9/15/06 - "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."

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No

• A carbon tax is not really that "regressive", since the wealthy consume more energy and would be taxed more: 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.

• Carbon tax revenues create a basis for progressive "tax shifting": 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".

• A progressive approach could involve a carbon tax rebate.

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Fairness to producers: Is a cap-and-trade more fair to producers?

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Yes

• It is wrong to tax all carbon emissions, and call them all "bad": Carbon emitting energy industries emerged long ago, before anyone thought about the environmental impact of this industry. Is is wrong to suddenly consider all energy production that involves carbon emissions a social "bad", after decades of thinking to the contrary. Modern energy producers should not be punished for their participation in an industry whose emergence pre-dates concerns of global warming.

• A cap-and-trade system is "fair" because it rewards "efficient"-polluters while punishing "non-efficient" polluters: Given the above argument, this is a more reasonable approach to rewarding and punishing an industry whose emergence pre-dates the environmental concerns surrounding carbon emissions. Polluters should be rewarded for taking steps to be more "efficient", opposed to being efficient already.

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No

• A carbon tax fairly treats all carbon emissions as "bad": A carbon tax essentially considers all carbon emissions harmful to the environment, and warranting of equal punishment. A cap-and-trade system only punishes carbon emissions above a certain level, treating only certain kinds of emissions as "bad". A carbon tax, therefore, sends a strong message to polluters that all their emissions are harmful, that they should be phased out, and that they should invest in environmentally-friendly sources of energy. This dramatic message may be particularly important if we view global warming to be a serious crisis.

• Companies favor the predictability of a carbon tax: Companies are even willing to pay a premium for the stability provided by this system; the premium being the tax itself, and the lack of the potential for profit through the trading of carbon credits.

• It is easier for an energy supplier to understand a carbon tax than a cap-and-trade system

• Carbon taxes are more politically neutral toward different energy-producing sectors and companies.

• A cap-and-trade creates arbitrary base-lines.

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Fairness to consumers: Would a cap-and-trade system be more fair to energy consumers?

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Yes

• A carbon tax is more likely to result in the costs being passed on to consumers.

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No

• Carbon taxes would not cost consumers any more than a cap-and-trade system.

• It is ok for some of the costs of a carbon tax to be passed on to consumers because they are also responsible for carbon emissions: By consuming energy, consumers create demand for the production of energy and the burning of fossil fuels. In this way, consumers are partly responsible for carbon emissions, and should share the costs more equally with producers through a carbon tax.

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Democratic principles: Does cap-and-trade better uphold democratic principles?

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Yes

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No

• Carbon trading effectively turns the atmosphere into tradeable property.

• The Carbon trade will worsen existing global inequalities among nations.

• Carbon-trading can lead to the disproportionate polluting of poorer areas.

• Revenue from a carbon tax can be used to fund global aid programs.

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Case studies: What do the existing case studies suggest?

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Yes

• The EU Emissions Trading System is a success
  • Wikipedia: EU Emissions Trading System,
  • Official EU ETS website

• The EU cap-and-trade system is new and its difficulties simply need time to be worked out.

• US cap-and-trade systems:
  • The United States' cap-and-trade system in sulfur dioxide has proven a major success:
  • The Chicago Climate Exchange is a success:

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No

• Europe's attempt to create a cap-and-trade system has encountered major systemic problems.

Motions:

Market mechanisms are preferable to regulatory approaches in reducing carbon emissions.

In legislation, policy, and the real world:

See also

• The People Speak: Global Debate Format
• The People Speak: Global Debate Festival
• The People Speak: Global Debates: Debates at school
• Carbon Emissions: Market vs. Regulatory Approaches (Background)
• Debate: Market vs. regulatory approaches to cutting carbon emissions
• Actors:Carbon Emissions, Cap-and-trade versus Carbon Tax
• The People Speak: Global Debate (glossary of terms)
• The People Speak: Global Debate Translation Resources
• Debate: Carbon tax

External links and resources:

• Ronald Bailey, "Carbon Taxes Versus Carbon Markets: What’s the Best Way to Limit Emissions?", May 18, 2007.
• Ted Gayer, Georgetown University, "Market-based approaches to environmental regulation", 2006
• "Carbon taxes or cap-and-trade?", 4/7/07
• "Limiting Carbon Dioxide Emissions: Prices Versus Caps", Congressional Budget Office, 3/15/05
• Criticality, "Cap and trade versus carbon tax", 6/20/06
• Wall Street Journal, "Carbon Tax vs. Cap-and-Trade", 4/9/07
• TerraPass, "Carbon tax vs. carbon market. Who would win in a fight?", 9/15/06
• Felix Salmon, "Why a Cap-And-Trade System Beats a Carbon Tax" 4/19/2007
• Greg Mankiw, Harvard Economist, "The case against cap-and-trade" 4/11/07
• David Roberts, "Cap-and-trade: more effective than a carbon tax", 2/12/07

Books: