It sounds like the possibility of a “carbon tax” is back on the table. We have written on the topic before – but it does not appear that we have laid out what I see as the primary costs and benefits of the different options. As a result, I will do that now. In the comments, feel free to add some costs and benefits:
Emissions trading scheme
- Quantity certainty: We can make sure that we meet our Kyoto liability. BENEFIT
- Price uncertainty: The cost of a credit is unknown. COST
- Quantity uncertainty: We do not know the future path of growth, especially in individual industries and technologies, so we do not know if the tax will be too high or too low to meet the liability. COST
- Price certainty: The cost of carbon is known by all participant ex-ante – as it is the tax. BENEFIT
The advantage of the ETS is that it ensures that the users of carbon DO pay the full cost of using it! The disadvantage is “uncertainty” which, because firms are risk averse, will lead to a sub-optimal level of investment.
The advantage of the Tax is that the cost of carbon is known, so if the tax is set at the right level we get efficient investment. The disadvantage is that we don’t know if the tax is at the right level, and so we may raise to much tax revenue (which will lead to “too little” activity in these industries) or keep the tax too low (which would mean that non-polluters have to pay some of the liability!).
As a result, the choice of scheme will depend on where we think the biggest inefficiencies will occur – will uncertainty from the ETS retard investment too much, or is the tax highly likely to be in the wrong place?