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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  1. Turadg - August 19, 2006

    Wouldn’t a carbon tax credit eliminate the adverse impact on the poor?
    At the consumer level, are you proposing capping individuals? What happens if they’ve hit their limit and they need to drive to work? Doesn’t seem practical.

  2. Claire - August 26, 2006

    It seems to me that another key difference between the two methods is that everyone automatically participates in a carbon tax, making it an opt-out program where you’d automatically pay the tax unless you took specific action to avoid it. A carbon market, on the other hand, is an opt-in program where you’d have to learn about it and take some action to become involved. I think I have read that some other economically “good for you programs” like deferred compensation or 457K have found that the opting in system doesn’t seem to attract as many people as it should. I wonder how much education and marketing it would take to get widespread awareness and participation in a proactive program? I can see it working for corporations and wealthy individuals with financial advisors who are always looking for opportunities to profit. Hard to reach populations would take a lot of effort. What would happen with a combination program where you’d get some tax credit if you participate in the market, but be taxed in some standard way if you do not? It sounds like it could be regressive, too, unless you had a way to begin immediate participation at the point the taxes were being calculated. For example, if it were really just a swipe card used when purchasing gas, you could use your driver’s license. They now has magnetic tape on the back. You’d get a tax credit to sign up by following directions to “call or visit your drivers license bureau website or office and sign up, then enter your confirmation code on line 12b.”

  3. Tim - March 1, 2007

    I think this is an important issue that needs to be and is being addressed at a much larger, macro-level. The implications of large-scale efforts have a direct effect on a more individual approach that will follow.
    Cap and trade market schemes currently being discussed in congress target industry and large corporations first – i.e. those who contribute the greatest to pollution. Additionally, this approach reduces administrative costs by targeting large emitters rather than going after individuals. Look at the EU trading scheme – the transportation sector was initially left out but is now being slowly integrated – this will have more of a micro-level impact. As industry, namely utility companies and private power producers begin to integrate more renewable energy into the national power grid, consumers will not have to make the opt-in or out choice. It will become less and less of a “choice” to purchase renewable, clean energy.
    With regard to biofuels, namely the use of ethanol in automobiles, this has traditionally been and still is largely a consumer-level decision. Proper government incentives through tax breaks for consumers who buy hybrid or biofuel powered cars are essential as well as the creation of carbon credits for project developers aiming to create biofuel producing facilities. Simple economic theory suggests that as these fuels become more and more abundant, prices will lower and more people will make the decision to drive biofuel powered automobiles. Right now, the lowering of these costs must be facilitated by govt. incentives.
    The possibility of a carbon tax rather than cap and trade system is highly doubtful. The 3-4 bills that are currently floating through legislation mention nothing of a carbon tax. Cap and trade has been effective in other areas of the world and the US has a great benefit in its carbon reduction efforts as there is much to take away from the errors of the EU and Kyoto CDM schemes. California and the Northeast states have already signed on to cap and trade. It seems the most imporatant issue is not which system is better but rather “how do we formulate and effective and fair cap and trade system that creates additionality and has a positive envirionmental impact”.

  4. Tom Hayhoe - October 5, 2008

    I dont believe we should adopt a cap and trade system until we consider the complexities of our countries export industries. For example should a farmer have hit his limit of carbon credits. Would he be able to produce food for a country where they do not participate in a carbon market? Would exports for example from Canada of much needed humanitarian supplies be taxed when they are exported. Would there be a system in place to transferr the taxed credits to the reciever? Or what would happen if the recieving Country did not participate in a carbon market?