Putting a Price on Carbon: An Emissions Cap or A Tax?

- Opinion piece featured in Yale Environment 360 on May 7, 2009. -

Yale Environment 360
To read the entire piece and other responses, click here.

May 7, 2009  

The days of freely dumping greenhouse gases into the atmosphere are coming to an end, but how best to price carbon emissions remains in dispute. As the U.S. Congress debates the issue, Yale Environment 360 asked eight experts to discuss the merits of a cap-and-trade system versus a carbon tax.

A broad spectrum of people concerned about global warming and U.S. energy independence agree on one basic truth: Sooner or later, emitting planet-warming greenhouse gases is no longer going to be free. Whether it comes this year, or next, or in five years’ time, legislation imposing a price on burning fossil fuels seems all but inevitable.

Any law that places a price on carbon must achieve two basic and interrelated goals: discouraging — with increasingly painful economic consequences — the use of oil, coal, and natural gas, and encouraging the development of renewable sources of energy. Two paths to this end have been proposed. The first is a cap-and-trade system, which would place progressively stricter limits on fossil fuel use; require power plants, industries, and other major sources of greenhouse gases, to purchase permits to discharge carbon dioxide; and establish a market in those permits. The second is an outright tax on fossil fuels. Proponents of both methods say the economic hardship created by higher energy prices could be offset by rebates to taxpayers.

The cap-and-trade option has attracted far more attention and has many more supporters, including President Obama, key Congressional leaders, and an influential coalition of environmental groups and big businesses, including General Electric, Dow Chemical, Shell Oil, and Duke Energy. Congressional leaders say they hope to pass a cap-and-trade bill by year’s end, but whether they can achieve that goal remains a major question.

Supporters of cap-and-trade argue that it has two main strengths. It sets a steadily declining ceiling on carbon emissions, and, by creating a market that rewards companies for slashing CO2 (corporations that reduce emissions below their allotment can sell them on the open market), it uses the free enterprise system to wean the country off fossil fuels and onto renewable energy. Proponents of a carbon tax say their plan has one overriding benefit: Its simplicity. They contend that by imposing a predictable and steadily increasing levy on fossil fuels, the carbon tax will also drive development of alternative sources of energy.

Yale Environment 360 asked a number of environmentalists, economists, and academics to explain which approach – cap-and-trade or a carbon tax – they preferred. There was disagreement on many points, but on one issue most concurred. As Jeffrey D. Sachs, director of the Earth Institute at Columbia University, said, imposing some sort of price on fossil fuels “is a big improvement over the do-nothing status quo.”

Eileen Claussen's response:

An economy-wide greenhouse gas cap-and-trade system sets a clear limit on greenhouse gas emissions and minimizes the costs of achieving this target. Environmental integrity and cost-effectiveness are two critical advantages that make cap-and-trade the right policy mechanism to tackle climate change in an economically responsible manner. Complementary measures and incentives — including for coal, transportation, technology commercialization, and buildings and energy efficiency — are also necessary pieces of the climate solution.

Unlike traditional regulation, a cap-and-trade program constrains emissions but lets market forces set a price on emissions. Rather than mandating a specific technology, the flexibility afforded by emissions trading markets helps identify where emission reductions can be achieved most cost-effectively. Cap-and-trade stimulates the development of new technological solutions that can enable much deeper emissions cuts at lower cost in the future.

A carbon tax is often presented as a main alternative to cap and trade. A core difference between these approaches involves the issue of certainty. A tax provides cost certainty by setting a fixed cost on emissions, whereas cap-and-trade delivers emissions certainty by establishing a declining emissions limit based on an assessment of the reductions level required to protect the climate. In contrast to a cap-and-trade approach, a tax would not provide the same level of emissions certainty during any given compliance period.

An economy-wide cap-and-trade policy is supported by President Obama, by Congressional leaders drafting bills in the House and Senate, and by the 25 major corporations and 5 NGOs working together as the U.S. Climate Action Partnership. Greater flexibility to achieve emissions reductions in a cost-effective manner and greater certainty that environmental objectives will be met are key advantages of a cap-and-trade policy.