What’s the difference between a carbon tax and “cap-and-trade” system for reducing greenhouse gas emissions?

Dear EarthTalk: What’s the difference between a carbon tax and “cap-and-trade” system for reducing greenhouse gas emissions?
– Marina Brown, New York, NY

Most of us can agree that reducing greenhouse gas emissions is a must given the rapid warming of the planet; just how to do it best is another question entirely. The two leading market strategies are a carbon tax, whereby polluters are simply taxed for the carbon dioxide and other greenhouse gases they spew, and “cap-and-trade,” whereby government sets an overall cap on the amount of greenhouse gases that each industry or sector can emit without penalty and issues permits or allowances accordingly that companies can buy and sell to each other based on their own business and sustainability priorities. Each approach been shown to effectively cut down emissions, but many nations are now weighing which way to go as they prepare to make new commitments as part of the potentially decisive international climate talks (COP21) coming up in Paris in December 2015.

Cap-and-trade allows affected businesses to choose how much pollution reduction they can tolerate and then leverage market forces to buy or sell allowances accordingly. Such systems effectively penalize polluters who exceed allowable limits (those who therefore must “buy” credits) while rewarding those who not just meet emissions target levels but get down below them (the difference being what they can then “sell”). Cap-and-trade markets are designed to encourage flexibility in allowing companies to decide how they want to meet emissions reduction targets.

Of course, cap-and-trade isn’t a new concept. The first national cap-and-trade market limited emissions of sulfur dioxide and nitrogen oxide that were causing acid rain in 1990s. The European Union later launched the first major market in greenhouse gas emissions trading in 2005 in order to meet commitments made under the Kyoto Protocol, the first international treaty to limit carbon emissions. In North America, three regional carbon cap-and-trade plans have been in place since the mid-2000s (the Regional Greenhouse Gas Initiative, Midwest Greenhouse Gas Reduction Accord, and Western Climate Initiative), but there hasn’t been enough political will at the federal level yet to support a nationwide carbon emissions market.

Not everyone thinks cap-and-trade is the way to go to reduce emissions. Carbon tax proponents argue that cap-and-trade scenarios can cause unnecessary price volatility to energy prices, are overly complicated, and are easily manipulated by those that learn to game such systems to their advantage without reducing greenhouse gas output. “Carbon taxes will lend predictability to energy prices, whereas cap-and-trade systems will aggravate the price volatility that historically has discouraged investments in less carbon-intensive electricity generation, carbon-reducing energy efficiency and carbon-replacing renewable energy,” reports the Carbon Tax Center.

Critics counter, however, that it’s easier for companies to pass the costs of a carbon tax onto consumers by raising prices—and that lower income households bear a disproportionate amount of those economic costs. Perhaps the world’s biggest experiment in carbon taxation ended last year when Australians voted to repeal their carbon tax due to rising costs of living, saving the average household more than $500 a year. Meanwhile, a recent analysis of Norway’s carbon tax—the highest in the world on a percentage basis—found that emissions reductions there were negligible over the first decade of implementation.

While both systems have their pros and cons, either can be effective in reducing emissions if there is enough political will behind it. A key component to the upcoming COP21 Paris climate talks is flexibility in allowing participating nations to choose how they want to reduce emissions. Environmental leaders are keeping their fingers crossed that whether through cap-and-trade or taxation, the nations of the world will finally agree on enough greenhouse gas cuts to finally stem the still surging tide of global warming.

CONTACTS: COP21, www.cop21.gouv.fr/; Carbon Tax Center, www.carbontax.org.

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