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I was recently asked whether I supported a carbon tax or a global cap-and-trade system. I suggested that it really depended on what you thought was more realistic – Americans accepting a carbon tax or the developed and developing world agreeing on national allocations of global carbon emissions.
My response was by no means unique, but shared by a consensus of policy analysts, environmentalists and economists (read the NYTimes article from Sunday’s business section, 9/16/07). I discussed the four policy options for reducing carbon emissions below, commenting on the positives and negatives to explain the logic behind the question I posed.
- The Libertarian Scheme: markets reduce carbon through voluntary measures
Some of the early measures in the U.S. would fall into this category (i.e. voluntary Renewable Energy Credits and carbon offsets for households). This could be a viable long-term option if we were dealing with marginal carbon reductions and the consequences of failing to take serious action weren’t disastrous. In reality, however, we are talking about a reduction of 50-90% in the next 40 years to avoid runaway global warming and voluntary measures won’t cut it.
- The Kyoto/Acid Rain Style Cap-and-Trade Scheme: where permits are allocated freely
A cap-and-trade system works by capping the total carbon emissions for a state, country or group of countries and allocating permits to individual polluters for the right to emit a portion of the total. The scheme allows those who can reduce their carbon emissions cheaply (low “marginal cost of abatement”) to sell their permits to the companies for whom it is more expensive (high “marginal cost of abatement”). The idea is that through market mechanisms, the lowest cost of compliance will be sought and the regulating body need only to reduce the total cap overtime and watch the market adjust. Similar to other supply chain costs, the “cost of carbon” will be passed onto consumers through higher prices, which will disproportionately place the burden of reducing carbon on low-income families. If permits are allocated freely, as opposed to an auction where the government sells the rights to pollute, there is no revenue raised by the government to alleviate these effects.
- The Auction Cap-and-Trade Scheme: tax revenue is raised
Similar to the above approach, the only difference is that tax revenue is generated by the auctioning of permits for programs that alleviate the effects of higher prices for those in need. The most appealing component of this solution is that it allows the government to determine the quantity of carbon emissions and cap it, as opposed to a tax which attempts to estimate what increase in price would stimulate that reduction.
- A Carbon Tax
Using a carbon tax, the regulating body determines a marginal price of carbon emissions (i.e. something on the order of $8-25 per metric ton) and allows the market to incorporate it into decision making. Similar to cap-and-trade strategies, lower carbon emissions will result and the associated costs of compliance will be passed onto consumers in the form of higher prices. The most appealing component of this approach is that it lends itself to better international cooperation (countries can determine their own carbon tax) and avoid some of the geopolitical problems associated with determining national shares of a global cap on carbon emissions (i.e. are they allocated according to population or historical emissions).
The truth is, any of the last three options are better than a voluntary approach. A carbon tax or a cap-and-trade with auctions are the most complete, because they can raise the revenue necessary to alleviate the socio-economic consequences of higher energy costs. The question is about which approach is more realistic. Americans will balk at the word tax and the international community are in a stalemate over the logistics of a global cap-and-trade system.
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