Home > Carbon emissions, Energy & Environmental Economics > A carbon state taxes and a nations cap-and-trade hybrid

A carbon state taxes and a nations cap-and-trade hybrid

Carbon taxes and a cap-and-trade scheme have been cited as measures to curb greenhouse gas emissions. The carbon tax is a price measure which affixes a price of carbon into goods and services, while the cap-and-trade scheme is a quantity measure limiting the amount of emissions. In this scheme, producers emitting carbon are given a cap quota for the total amount of carbon emissions in a certain phase period. If this cap is exceeded, they have to buy from the open market emission rights. On the other hand, if their total emissions are below this cap, they are able to sell in the open market the balance in the open market. The existing European Trading Scheme (ETS) is an example of a cap-and-trade scheme. The first phase was from 2005 Jan -2007 Dec while the second is from 2008 Jan -2012 Dec. Additional features in the scheme like banking and borrowing allow them to carry over or bring forward the emissions rights from the next phase.

Economists have generally agreed that carbon tax is a more feasible and economical way to regulate the greenhouse emissions.  Firstly a tax affixes a fixed price to carbon, whilst in a cap-and-trade scheme, prices are more volatile. Reduced price volatility allows for more decisive actions into clean technology investments. Quoting Caterpillar’s CEO in a Bloomberg article: “We are calling for a definitive price on carbon that will help drive the choice of individuals to reduce the amount of carbon consumed in this country, and also creates a revenue source to help fund incentives to insulate homes, to improve the energy grid,”

Nowhere is price volatility more undesirably seen in October 2009, where fraudulent trades overstated volume by 40% in the Europe ETS. This inflated carbon prices, and when the trades were discovered, the prices fell 22% overnight.  In this fraud, carousel traders bought permits in countries other than the EU countries they were based in without VAT. These permits in turn were sold in their EU countries, and VAT collected for their benefit.

Some may point out cap-and-trade does a better job of price discovery than a fixed tax. It also draws in much-needed capital from investment banks. This is a fallacy. Thus far, 4 years of trading on the ETS has not resulted in reduced carbon emissions. Further, climate science has not matured enough to determine the level of carbon dioxide concentration correlating with temperature changes. It will be easier to determine the carbon taxes rate than to let the market fluctuate and set a price for carbon.

A carbon tax is also easier to implement administratively than cap-and-trade since a tax system is already existent in all countries. Some argue that a cap-and-trade scheme allows for integration amongst different countries. A global market will allow for greater efficiency in taking advantage of lower abatement costs in developing countries. This is however subject to corruption and fraud, especially in developing countries, where monitoring can be difficult. Even domestically in the US, the Waxman –Markey Bill will give away about 85% of all allowances to emit gases, which is not much of a disincentive. Companies which produce LNG are also excluded from these allowances, presumably as they are mostly in Republican states, and the Bill is pushed forward by the Democrats.

A hybrid system that combines taxes and cap-and-trade appears apt. At the level of the states, a tax system is used to internalises the price of carbon into goods and services. On an international level or a more marco level, countries are allowed to trade their permits in intermediate phases under a ratified accord. For example, suppose they commit to 30% reduction of 2005 levels by 2020, and overshot their monthly intermediate targets, they may buy permits from countries that have excess permits. This retains the benefits of global market integration, and also removes the risks of excess volatility as the trading players are sovereign nations that do not trade that frequently. It further incentivises nations to adhere to their commitment targets, with a stick-and-carrot approach.


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