Carbon tax or cap-and-trade? Oh, my ass gets sore sitting on this particular fence. Each has its pros and cons, and for each the Devil is in the details of implementation. And maybe it does not have to be either-or.
With data now telling us that things (like arctic ice cover) are worse than the most pessimistic scenarios of a few years ago, serious efforts to reduce total GHG emissions are in order and will likely need to be 90-95% reductions by 2050. So anything that gets us along the right path is worth a long, hard look, but we want to get it right so that we do not waste a decade fiddling. My lenses are attuned to the distributional impacts of such measures, and it seems to me that either carbon tax or cap-and-trade could be regressive (they would have a bigger hit for lower income families). But suitably designed they could reduce inequality, too: we need to pay close attention to who gets the proceeds and how that money is spent.
Both carbon taxation and cap-and-trade systems are variants on carbon pricing, which is based on the principle that the external costs associated with emissions be internalized into market prices. All mitigation costs will ultimately be borne by households through higher prices, or changes in employment income or corporate profits. The appeal of market-based measures is a capacity to resolve millions of individual decisions on the consumer and producer sides of the market. Carbon taxes affect the price and let the market determine the quantity of emissions; cap-and-trade systems set the quantity of emissions and let the market determine the price, through trading or auctions.
Both pose a degree of uncertainly. With a carbon tax we would know the price but we would not have a good handle on exactly how this will affect the total quantity of emissions. From the estimates I have seen the price would have to be pretty high (above $100 per tonne; in the political arena, the Greens are calling for a tax of $25 per tonne) for there to be a change in behaviour, although the fact that there will be a schedule of rising prices over time will encourage behavioural change at lower levels of the tax.
With cap-and-trade we set the quantity of emissions but do not know what the resulting price of carbon would be. One concern I have for cap-and-trade systems is if everyone expects to purchase credits to cover their shortfalls. Governments are pushing to widen the potential market for making such purchases, such as BC’s decision to join the Western Climate Initiative (with five US states) and the EU emissions trading regime, on the presumption that we will miss our industrial targets and will need to buy the difference. But if everyone, or the major players, assume the same strategy, then the market price will be extremely high, and the market could fail in that there is not enough trade to meet the predetermined cap.
Cap-and-trade systems also have distributional issues that critically depend on how the initial rights are allocated. In the European trading system, the worst polluters were given the most credits. Alternatively, rights to emit CO2 could be allocated as equal per capita amounts. On this basis, redistribution is inherent in the model, as intensive emitters (the carbon rich) would effectively have to pay low emitters (the carbon poor) in order to emit more than their allocated share. Such schemes may in fact be necessary in order to achieve the objective of sustainability – shared sacrifice, rather than individual choices on the margin, may be a prerequisite to getting people to accept radical change. A historical precursor is the widespread acceptance of rationing during World War II.
More fundamentally, cap-and-trade also has enforcement issues and is more susceptible to cheating on the part of polluters. These options are not necessarily black and white, and there may be some combination of the two (for example, carbon taxes on major consumer items, but cap-and-trade for industry) that is most effective or efficient. A carbon tax would be the easiest to administer, though equity considerations also need some thinking through. Thus, some or all of the proceeds of a carbon tax can be used to (i) reduce other taxes (“tax shifting”), or (ii) provide a direct income transfer to low-income households (for example, building on the GST refundable tax credit), or (iii) make direct expenditures on, for example, public transit, home retrofits and basic research on alternative technologies.
Because of the cultivated antipathy towards taxes and the public sector these days, most carbon tax proponents package it with tax cuts elsewhere (option i), though I do not see what this need be the case. I prefer some combination of (ii) and (iii), though there is some modelling that needs to be done around this. There is ample evidence from Nordic countries that regressive taxes can lead to progressive outcomes – if the proceeds are spent in a progressive manner. In other words, a carbon tax, with progressive spending of revenues, could become a Nordic-type strategic bargain that addresses both ecology and equity.
I’m not sure I’ve talked myself off the fence yet. But it is important to consider that markets can have shortcomings, and one important one is a failure to account for a fair distribution. And some fairness in how the burden is shared will be needed to maintain the political momentum for change. Market prices are inherently about determining who is willing to pay for a scarce good, meaning the poorest (and perhaps a sizable share of the population) could get priced out. So either carbon tax or cap-and-trade may worsen inequality if unaccompanied by deliberate measures or policy design that address distribution.
- CGE models and carbon tax incidence (November 24th, 2014)
- Absolving our Carbon Sins: the Case of the Pacific Carbon Trust (April 2nd, 2013)
- Carbon bubbles and fossil fuel divestment (March 26th, 2013)
- GHG Cap & Trade (January 21st, 2013)
- What’s next for BC’s carbon tax? (January 14th, 2013)