How to Price Carbon? Cap-and-Trade vs. Carbon Tax
Humans are the leading cause of the world’s quickly changing climate. The increase in greenhouse gas emissions due to people are trapping heat in the earth’s atmosphere and rapidly contributing to global warming. According to the International Panel on Climate Change, greenhouse gases have “increased to levels unprecedented in at least the last 800,000 years.” This is true considering carbon dioxide emissions have risen by 40% since pre-industrial times (Denchak, 2017).
Carbon dioxide is the greenhouse gas most often produced by humans and is responsible for 64% of man-made global warming (European Commission, 2020). This can be attributed to factors like burning coal, oil, and natural gas that release carbon dioxide and nitrous oxide into the atmosphere. When talking about how to reduce these emissions, phasing out incentives to burn coal and oil may seem like an easy alternative but have proven to be just the opposite. Coal is cheap and abundant. Although coal use in the United States, China, and the EU has started to become limited, it is still used and fast-growing economies in south Asia and southeast Asia are rapidly building new coal-fired plants (Schwartz, 2019). In order to lower greenhouse gas emissions, countries would need to phase out the use of coal and lower their carbon emissions.
Carbon taxes and cap-and-trade programs are both great ways to put a price on carbon and incentivize countries to use greener, cleaner practices to obtain energy. Under a carbon tax system, firms are charged for every unit of carbon they emit. The price of the carbon is determined by assessing the cost of damage associated with each unit of pollution and the cost of controlling that pollution (Grantham Research Institute, 2013). The key to carbon taxes is knowing just how high or low to set the tax. If it’s too low, firms may decide it’s cheaper to pollute and pay the tax. If it’s too high though, then it becomes more expensive than it is to control pollution, impacting jobs and the economy.
Carbon taxes have been proven to work in countries like Sweden, where firms are charged $140 per tonne of carbon emitted. Sweden has reduced its carbon dioxide emissions by an additional 20% since 1991 because of the carbon tax (David Suzuki Foundation, 2020). British Columbia adopted a carbon tax in 2008 and has so far reduced gasoline and natural gas use by 7% per capita and used the revenue to decrease income taxes and invest in green technology. The United Kingdom adopted its carbon tax in 2001, and as of 2018, 6% of the country’s electricity comes from coal, compared to 36% in 2012. Tokyo was the first city to put a price on carbon in 2010, and by 2013 over 70% of buildings had met their emissions goal for 2020 (Frank, 2019). Carbon taxes are a quick and efficient way to reduce carbon dioxide emissions and provide an incentive to use cleaner energy.
Another way to reduce carbon dioxide emissions is through cap-and-trade programs. Cap-and-trade works by setting a limit on how much carbon dioxide can be emitted overall by industry and allotting emissions permits, or units, to firms. Firms can purchase units from other firms to emit more carbon or sell their units to profit off of emitting less carbon than their allotment. The price of the units fluctuate with the market with prices being higher when the economy is growing and lower when the economy is struggling or in a recession. In this way, there is a ‘cap’ on how much carbon can be emitted and firms can ‘trade’ their carbon units for profit. Ideally, the cap decreases each year, and the end result is less carbon dioxide emissions overall. Cap-and-trade has successfully been used in the United States to reduce sulfur dioxide and nitrous oxide and as a result has reduced acid rain formations by half since the 1980s. Tokyo implemented cap-and-trade in 2010 with a goal to reduce its carbon emissions by 25% by 2020. The EU implemented its cap-and-trade system in 2005 to reduce their carbon emissions from 10,000 industrial emitters in the Union (David Suzuki Foundation, 2020).
Carbon taxes and cap-and-trade are ways to price carbon, but they both have some key differences. With cap-and-trade, units of carbon are initially given out for free, meaning there is no upfront cost to firms. With a carbon tax, there is an immediate cost to firms for polluting. Although cap-and-trade is the most cost-efficient option for firms, more revenue from a carbon tax system can be used by the government to fund spending or reduce other taxes. The two systems also differ because choosing between the two could come down to a matter of which performs better under uncertainty. If the cost to lower pollution is more sensitive than the environmental damage itself, a carbon tax system may be the better route to go because of the ability to set the tax and collect more revenue. If damage to the environment is more sensitive than how much it would cost to lower pollution, a cap-and-trade system is more efficient because there is a set limit on how much pollution can be emitted overall. So overall, if raising money is more important than mitigating immediate damage to the environment, a carbon tax is the way to go.
Carbon taxes may also be a better option when it comes to addressing climate justice. Cap-and-trade programs can actually increase pollution in disadvantaged communities. Since the introduction of California’s cap-and-trade program in 2013, carbon emissions have increased for many cement plants, power plants, and oil and gas producers. These toxic facilities are predominantly placed in low-income communities of color and are more likely to buy credits to pollute (Naik, 2018). When we think about carbon emissions and global warming in general, it’s important to note who will be most impacted by it and how legislation will impact these folx. On the other hand, carbon taxes can benefit disadvantaged communities. Chile’s 2014 carbon tax charged $5 per ton of carbon dioxide emitted and raised $143 million dollars by 2017. Chile raised taxes for big businesses but lowered taxes for consumers. British Columbia implemented a carbon tax in 2008 and returned $962 million dollars to citizens in 2017 in the form of tax rebates. Lower class households are better off with the carbon tax than without (Mountford, McGregor, 2018). Whenever environmental legislation is passed, climate justice needs to be at the forefront to avoid situations where the environment is benefitted but vulnerable communities become worse-off.
When it comes to policy, carbon taxes have been implemented more often than cap-and-trade programs. According to the Grantham Research Institute, “Climate change depends on the stock of greenhouse gases in the atmosphere, and in each year the increase in that stock due to new emissions is small, so the environment is probably not that sensitive to the uncertainty about the level of emissions brought about by choosing a tax, at least over a year or two.” Additionally, it is more expensive for companies to completely switch over to cleaner ways to emit energy than to be taxed for polluting (Grantham Research Institute, 2013). In the long term though, this may be non-beneficial because small increases in carbon emissions over time can have a huge impact on the environment. In this way, cap-and-trade reduces the uncertainty of the benefit of implementing a system like this first place (Frank, 2014).
Depending on incentives and economic need, both cap-and-trade and carbon tax can be effective ways to price carbon. If combined, hybrid models have the potential to mitigate the disadvantages of both. With a cap-and-trade system, there is a possibility for firms to exaggerate the cost to trade units. When this happens, the cost of abatement exceeds the benefit of abatement (Frank, 2014). One way a hybrid model can fix this is to set a ceiling on how high firms can sell carbon units. Additionally, if the reserve is large enough, firms can choose whether to trade units or to pay a tax. Both ways get the goal of reducing emissions overall done. California has implemented both with setting an overall cap on carbon emissions across the state but allowing firms to either trade ‘purchasing allowances’ or pay a tax for over-polluting. California has the fourth biggest carbon-trading-program in the world and has succeeded in lowering emissions statewide (Ahmed, 2018).
Climate change is the most pressing issue of the 21st century. Without major international action to stop our planet from overheating, there will be serious consequences in the decades to come. Cutting carbon emissions is one way to slow the process of global warming. Carbon dioxide traps heat in the earth’s atmosphere and, as a result, warms the globe. It’s the responsibility of major corporations to mitigate the effects of global warming and for governments to regulate carbon emissions before it’s too late. Cap-and-trade and carbon taxes are just two ways to help slow down global warming.
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