Saturday, 23 November 2013

Carbon Tax vs. Cap-and-Trade

So I decided to educate myself on the basics of carbon taxation, only to come across a popular argument of the costs and benefits of the two main market-based ‘polluter pays principle’ options to regulate GHG emissions: carbon tax and cap-and-trade. 

Figure 1. Self-explanatory? (Source)

What are they?

Cap-and-trade is a scheme popular among the politicians. The government sets an overall maximum emissions limit – a cap (HowStuffWorks), consisting of allowances to distribute among oil, coal, and natural gas producers and importers. Initially, the government allocates the allowances to companies without cost (Avi-Yonah, 2009), while in later stages, auctioning takes place. A fossil fuel company that runs out of allowances has two options: to reduce their carbon emissions or to buy (trade) other companies’ spare credits. On the flipside, a company with ‘surplus’ allowance can either sell it or bank it for future use (HowStuffWorks).  

Figure 2. 'Cap' & 'Trade'
Source: FirstCarbonSolutions

Carbon taxation is a bit more straightforward - a tax is imposed at X pounds/tonne of carbon content on the main sources of carbon dioxide emissions. The tax rate is based on the ‘social cost of carbon emission’. Companies with carbon sequestration programs also receive tax credits.

Now let’s examine the costs and benefits of each: 

  • Cap-and-trade makes politicians more popular, while taxing causes political resistance. 
  • There are many questions to answer in a CaT scheme: Where should we set the baseline emissions cap? How do we distribute the allowances? Free or auction? How much should each industry receive?
  • CaT: Governments also have a safety valve to distribute extra allowance when prices soar, which essentially means raising the cap, which essentially defeats its purpose. For example, the mandatory EU European Trading Scheme (ETS), which covers 12,000 factories in twenty-five countries, experienced a price collapse in 2006 when too many allowances were distributed.
  • CaT only generates one-off revenue (which goes to funding alternative energy research) from auction allowances, while tax produces a continuous flow.
  • In the early stages, CaT is cheaper for companies due to initial free allowances. Taxation, on the other hand, incurs an immediate cost (Avi-Yonah, 2009).
  • CaT schemes involve a complex, time-consuming system, while carbon taxation can be implemented immediately. In CaT, the government has to act like a bank, setting up accounts, trading units, enforcing trading penalties etc. They need to employ more people to operate this complex system, leading to a drain in funds. Wittneben calls the EU ETS out for ‘corruption’ and ‘deceit of the public’ – the scheme has been successful in transferring money from taxpayers and consumers to government, but has been unsuccessful in reducing emissions.
  • Taxation holds cost certainty (price = amount of tax, which wouldn’t change without national policy change), enabling businesses to plan ahead, while CaT prices fluctuate to supply/demand. There is also no upper limit to emission reduction, while a cap on emissions = a cap on emission reduction (Wittneben, 2009). 
This January, California established its own CaT, which will expire in 2020. It is the US’ first sub-national carbon market and the world’s second biggest, following EU ETS (Guardian).

Currently, Australia PM Tony Abbott wants to repeal the carbon tax (at $22.23/C tonne). In its place, he will set up ‘an emission reduction fund and market-based incentives for businesses’ (Reuters).  

As Wittneben puts it, the bottom line is ‘we want a system that lowers emissions at the lowest cost to society and provides environmental integrity’. Since the Kyoto Protocol, COP19 and other past climate conferences proved not too aggressive or effective, I believe we should cut past the long bureaucracy and policy ambiguity and implement a simple carbon tax. One proposed CaT bill was over three hundred pages long, while a carbon tax bill was seventeen (Ecosystem). You choose.



Wittneben, Bettina B.F.. "Exxon is right: Let us re-examine our choice for a cap-and-trade system over a carbon tax." Energy Policy. Smith School of Enterprise and the Environment, 20 Jan 2009. (Access through university database)

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