A tax on carbon emissions isn’t the only way to “put a price on carbon” and provide incentives to reduce use of high-carbon fuels. A carbon cap-and-trade system is an alternative approach supported by some prominent politicians, corporations and mainstream environmental groups. Cap-and-trade was the structure embodied in the Waxman-Markey climate bill that passed the House in 2009 but died in the Senate. And cap-and-trade is the cornerstone of the European Union’s “Emissions Trading Scheme” (ETS).
Cap-and-trade systems can be effective under certain conditions. The U.S. sulfur dioxide cap-and-trade system instituted in the early 1990s efficiently reduced acid rain emissions from power plants. However, the scale of a carbon trading system — it would be up to 100 times larger than that for sulfur — combined with the lack of “technical fixes” for filtering or capturing CO2, rules out sulfur cap-and-trade as a model for carbon. Moreover, evidence from the EU’s ETS suggests that price volatility and gaming by market participants have undermined the effectiveness of this complex, opaque indirect method of pricing carbon pollution.
The Carbon Tax Center along with most economists regard a carbon tax as vastly superior and preferable to a carbon cap-and-trade system. Here’s why:
- Carbon taxes lend predictability to energy prices, whereas cap-and-trade systems exacerbate the price volatility that historically has discouraged investments in carbon-reducing energy efficiency and carbon-replacing renewable energy.
- Carbon taxes are transparent and understandable, making them more likely to elicit public support than an opaque and difficult to understand cap-and-trade system. The co-author of the U.S. Senate cap-and-trade bill, Sen. John Kerry (now Secretary of State) told a reporter in 2009, “I don’t know what ‘cap and trade’ means. I don’t think the average American does.”
- Carbon taxes can be implemented more quickly than complex permit-based cap-and-trade systems.
- Carbon taxes aren’t easily manipulable by special interests, whereas the complexity of cap-and-trade leaves it rife for exploitation by the financial industry.
- Carbon tax revenues can be more or less guaranteed and integrated into state or federal fiscal policy, owing to their predictability, whereas the price-volatility of cap-and-trade precludes its being counted on as a revenue source.
- Carbon taxes are replicable across borders, since the price “metric” embodied in a carbon tax is far more universal than the quantity-reduction metric underlying cap-and-trade.
- Perversely, cap-and-trade discourages voluntary/individual carbon reductions, since those cause a lowering of prices of emission permits which undercuts low-carbon investments; carbon taxes are free of this unintended negative consequence.
Politically, cap-and-trade has functioned as a “safe harbor” for politicians who grasp the need for pricing carbon emissions but cling to the need to “hide the price” to appease interest groups and/or ordinary citizens. But the point of carbon emissions pricing is to raise the price of emitting carbon. Better to make the price explicit, via a tax, and protect households by making the tax revenue-neutral.