Cap and Trade, Essay Example

“Reducing greenhouse gas emissions (Co2): Carbon tax or Cap-and-trade”

The recent scientific evidence of the occurrence of global warming has increased political awareness and interest in finding an efficient and cost-effective solution in the reduction of the release of greenhouse gases (GHGs) into the atmosphere. From an economic standpoint, there is an understanding that the environmental effects will not change or disregard the new policies on greenhouse gases.  In addition, it has been observed and widely accepted that the damages from greenhouse gases are irreversible and outweigh any type of economic cost.  (Pierce, 938) Two programs that have been proposed are a tax on Carbon Dioxide (CO₂) emissions or a cap-and-trade program. Both of the programs offer an incentive-type based option, as well as flexibility in how the emission reductions will occur; however, the two programs differ in certainty.  A tax program would reduce the cost of cutting emissions gases, but the amount of GHGs released into the atmosphere per year would be unknown.  A cap-and-trade, on the other hand, would reduce the amount of GHG emissions per year, but the cost would be uncertain.  Recent research has focused primarily economic efficiency instead of cost-effectiveness in comparisons of tax or cap-and-trade program.  In cost effective research, there was no significant difference between tax or cap-and-trade programs.  (Dinan, 535-536)  The current paper discusses each of the programs and analyzes which program would provide a more efficient and economically cost-effective approach to the reduction of GHGs into the atmosphere.

Since the benefits and the costs of decreasing emissions are not known, the need for choosing the right program is imperative to help the long-term environmental effects of greenhouse gas emissions.  Carbon taxes are taxes in which the burning of fossil fuels is taxed to facilities that release greenhouse gases.  This type of program does provide an easy method for countries to deal with the emissions issues.  In addition, this method results in large revenue from this tax, which can be used however the legislators decide.  (Aldy et al, 243)  Previous literature found that tax would lead to higher benefits when the reduction of emission gases is greater than expected; however, knowing that GHGs are a stock pollutant, the accumulation of GHGs over periods of time is uncertain and the need for large amounts of reductions is necessary, which would require a high cost.  In regard to economic efficiency, the uncertainty does not affect the outcome of either a tax or cap-and-trade program; the difference would only be dependent on the slope occurrence of the marginal benefits and cost which are estimated in dollars versus emissions reductions, as observed in Figure 1.  Other research, however, has found that the using the tax program would increase costs much larger than the cap because CO2 emissions increases and the advantage of a tax would decrease, favoring a cap-and-trade. (Dinan, 538) However, other research has illustrated advantages of the carbon tax program, such as the correction of tax distortion, setting the basis for measurable carbon content in fossil fuels, and increase revenue substantially.  (Pierce, 940)

In a cap-and-trade, the total amount of emissions is limited, which is considered the “cap”, and the number of allowances that can be either purchased or sold is considered the “trade’.  Each company or facility is then monitored and recorded for emissions and the number of allowances are tracked and provided to the government.  Therefore, a company can track its pollution at a marginal cost to equal the market price of the allowance.  This type of program suggests a cost-effective approach, reducing emissions at a low cost.  In addition, the cap-and-trade program can allow for companies to bank their allowances, meaning they can utilize them in the future or even borrow from future years.  Furthermore, the allowances are able to be freely distributed and/or sold at auctions, which is considered trading.  (Keohane, 1-2)

It is clear that each program achieves the overall purpose of reducing greenhouse gas emissions; however, the main issue when considering one of the programs is how the value of emissions will be allocated and if the policy will set the price and quantity of emissions for these companies.  In regard to carbon tax, tax on every ton of emissions would occur; thereby, providing the value of the entire emissions for the government.  With the cap-and-trade system, a portion of the emissions would be provided to industries in forms of allowances.  In addition, the cap-and-trade system offers flexibility, as it doesn’t require politicians to allocate the value of the emissions for a free value.  (Keohane, 3) Furthermore, the cap and trade system allows for domestic policies to be coordinated between countries, as the amount of global emissions is necessary in order to decrease the effects of global warming.  Cap and trade programs can be linked internationally with international trade allowances.  (Keohane, 9)

Overall, a tax or cap-and-trade program would facilitate the reduction of greenhouse gas emission, for environmental purposes.  The tax approach could offer an advantage over the cap-and-trade, such as producing high revenue; however, implementing a tax program results in the inability to maintain marginal benefits compared to the cap-and-trade.  The author, Dinan (535) indicates the following:  “If there were an accepted measure of the marginal benefit of reducing a ton of greenhouse gas emissions, a tax would clearly be advantageous from an efficiency perspective”.  The cap-and-trade program, however, offers a major benefit, such as the banking approach.  The banking approach allows the policymakers to maintain the emissions regulations and also allows companies to respond when necessary.  Also, the cap-and-trade program allows for the distribution of allowances to firms, in which they could sell if not needed for compliance issues.  More research must be conducted in order to look at the long term effects of either a tax or cap-and-trade program, as the accumulation of GHG’s over a period of decades is the major concern, not during short-term periods.

Figure 1.  Outcome Under a Tax and a Cap if MB does not Equal E[MB] (Dinan, 538)

Works Cited

Aldy, JE., Eduardo, L., Parry, I.  A Tax-Based Approach to Slowing Global Climate Change.  2008. National Tax Journal. Vol. LXI(3): 493-517.

Dinan, T.M.  Reducing Greenhouse Gas Emissions with a Tax or a Cap: Implications for Efficiency and Cost Effectiveness.  2009.  National Tax Journal. Vol. LX11 No. 3. Pages: 535-554.  Retrieved from: file:///C:/Users/owner/Downloads/main%20paper%201.pdf

Keohane, N.O.  Cap and Trade, Rehabilitated: Using Tradable Permits to Control U.S. Greenhouse Gases. 2009. Review of Environmental Economics and Policy Advance.  Retrieved from: file:///C:/Users/owner/Downloads/Rev%20Environ%20Econ%20Policy-2009-Keohane-reep_ren021%20(1).pdf

Pearce, D.  The Role of Carbon Taxes in Adjusting to Global Warming. July 1991. The Economic Journal, Vol. 101(407):938-948.