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Carbon tax vs. carbon market: who would win in a fight?

taxcut.jpgIn response to the post about Britain’s flirtation with personal carbon credits, several readers wrote in wondering whether a carbon tax could achieve the same ends in a much more straightforward fashion.

It’s a worthwhile question, and although I don’t have a definitive answer, a few points to consider:

The first point is that 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. Years ago, it was predicted that gas prices of $2.50 would be the breaking point at which we finally ditched our gas guzzlers in favor of fuel sippers. Well, we’ve blown past that milestone and mostly what we see is consumers spending more and more of their income on energy.

A second point is that carbon taxes are regressive — they hit the poor the hardest — which makes them politically and morally problematic. Gas is simply a much bigger percentage of a poor person’s budget.

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.

These theoretical benefits do need to be weighed against the complexity of administering a carbon market. But carbon taxes and markets are different beasts, and it’s interesting to explore the policy implications of each.

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