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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

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.

Reducing emissions: Is a cap-and-trade system better at reducing carbon emissions than a carbon tax?


  • 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.
  • 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",, 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."


  • 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

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


  • 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.


  • 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."

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


  • 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.

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  • 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.

"Progressive"? Is a cap-and-trade system more "progressive" than a carbon tax, and would this be a good thing?


  • 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 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".

Fairness to producers: Is a cap-and-trade approach more fair to producers than a carbon tax?


  • 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.


  • 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.

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



  • 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.

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


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

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