Cap-and-tax vs carbon trading

The Congressional Budget Office reported recently on its comparison of a cap-and-trade program to a carbon tax program. The one-line conclusion is that carbon taxes are cheaper and simpler, but caps give more certainty.

  • Cheaper: The advantage of a tax is that it does what economists love to do and prices the cost of emissions. That allows the emitters to reduce their emissions, not only in their preferred fashion, but also at their preferred time. Since the cost of reducing emissions fluctuates, it is costly to be forced to reduce emissions by the same amount in each period. Caps force this, but taxes dont, hence taxes are the cheaper way to go about things.
  • Simpler: Caps can go some way towards replicating the tax’s efficiency gains, but not all the way, and it ends up significantly increasing the complexity of the system. Price ceilings, banking credits etc All these things are far more complex than the more efficient mechanism of a tax. Not only that, but the allocation mechanism for credits that gets used by governments rarely seems to look anything like the auction that most economists appear to favour.
  • Certainty: Scientists don’t say that the cost to the Earth of another tonne of carbon is US$20, they say “…more than x tonnes of carbon is not sustainable for this ecosystem.” Caps ensure that only x tonnes are emitted. Taxes only ensure that if you get the tax right, and getting the tax right is not trivial. Of course the tax can be adjusted in the future, but so might the marginal social cost of emissions change. Caps give us the certainty that we won’t over-pollute.

    For a lengthy and detailed commentary supporting taxes, check out Common Tragedies. Environmental Economics supports a cap on pragmatic, political grounds but also seems to set up the strawman that economists prefer the status quo over a system of caps! Felix Salmon is persuaded by the uncertainty of a taxation system to support caps.

    • I found your site on technorati and read a few of your other posts. Keep up the good work. I just added your RSS feed to my Google News Reader. Looking forward to reading more from you.

      Mike Harmon

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