Wednesday, April 15, 2009

Carbon Tax vs. Cap and Trade

The carbon tax center, not surprisingly, is in favor of a carbon tax, rather than cap and trade. The cap-and-trade proposals are being discussed in Australia currently, and the mood is clearly against cap-and-trade as well. Even Tom Friedman seems to be against cap-and trade, though for different reasons. However, as MicroEconomics 101 tells us, you go for limits if you are (a) clear as to what the limit should be rather than the price (b) The limit is enforceable. I think both of these factors point to a well-designed cap-and-trade scheme rather than a carbon tax.

An additional factor that has not got much attention is the fact that, in the presence of offsets, (assuming they are allowed after Copenhagen), one could see the emergence of a global carbon price. If the offsets are cheaper than carbon permits in the domestic market, then the demand for carbon offsets would rise, increasing their price, and achieving an equilibrium with the different carbon markets around the world. This could lead to a lower cost of compliance, although this lower cost of compliance will likely benefit the producers rather than the consumers). I haven't seen an analysis of this effect, so I will be scouring the literature to see the effects.

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