Cap & Trade vs Carbon Tax for Emissions Reduction

A cap & trade carbon trading scheme isn’t the only possible route governments can take to try to reduce greenhouse gas emissions. Yet Australia isn’t alone in pursuing emissions trading to reach this end. The EU, Canada, New Zealand, Japan, and several US states are also engaged in, or developing, cap & trade systems. Some opponents of these trading schemes feel that a direct carbon tax would be more effective.

Let’s take a look at both cap & trade emissions trading schemes and the carbon tax to better understand why many countries are going the trade route.

Carbon Tax

In very simple terms, a carbon tax would involve the government taxing industries, companies, or individuals based on their carbon emissions. It would amount to a “pollute more; pay more” system.

This kind of system makes sense to some, who prefer the idea of making everyone pay for their pollution. Some believe this would be a fairer solution to carbon trading, where new programmes generally give more credits or permits to industries with high-polluting pasts.

A problem with this logic perhaps is the fact that it doesn’t account for the time and cost involved in developing lower emissions strategies. If carbon taxes were set too high, it could drive companies out of business, doing more economic harm than it might be doing to help with environmental concerns. There simply isn’t anything built into a carbon tax that helps companies off-set the costs of becoming more efficient.

Carbon Trading

Emissions trading, on the other hand, still includes a “pollute more; pay more” component. The big difference is that it adds another scenario – “pollute less; profit more.”

Companies who don’t use all of their carbon credits or permits will have the ability to sell those permits in a supply and demand-driven market. This gives companies a two-sided incentive to decreasing their pollution of greenhouse gases:

1. If they cut emissions, they can profit from selling extra permits, and
2. If they cut emissions, they can avoid having to pay out a lot of money in the after-market to purchase additional permits (where prices will rise as the available permits decline due to caps instituted by the government).

This makes carbon trading perhaps a less risky approach to decreasing a country’s emissions – companies don’t have to fear being put out of business from taxes with no way to off-set costs. Now costs can be off-set with the ability to sell those extra credits, and what they have to pay beyond that will be driven by market forces rather than regulations.

No matter what system is used, the overall goal remains the same – cut greenhouse gas emissions. The tax system would insist on every business cutting their own emissions, while a cap & trade system reduces overall emissions while allowing businesses to do so in as cost-effective a manner as possible.

Last updated 22 September 2008