This blog is to help those interested in understanding why there is a debate between these two alternative policy options for reducing greenhouse gas emissions. While at first a cap and trade scheme and a carbon tax appear to be different versions of the same thing, there are important differences. These differences explain the push from big business for a carbon tax.
First, we must recognise that a tax is simply a reallocation of funds between economic agents – from individuals and companies, to the government. Thus a carbon tax, a cigarette tax, an alcohol tax and a GST all generate government revenue. We know from my previous blogs that all consumption is equal (in resource terms). If governments do not spend this extra tax revenue, they will reduce other taxes, but the total economic production will be the same afterwards, as will the total consumption by all economic agents. Therefore a carbon tax will not reduce carbon emissions.
One quite interesting discussion I had earlier this year with ECOS magazine editor James Porteous led me to a paper by Barney Foran, entitled Powerful choices: Options for Australia’s transition to a low-carbon economy. Foran suggests that revenues raised from a carbon tax can be allocated to a future fund, which is basically an offshore investment vehicle. I think he fails to understand that this investment itself has serious carbon implications (This translates as “let’s stop climate change by taxing Aussies and investing in Chinese production”).
A cap and trade scheme on the other hand is actually a restriction on the amount of emissions – a ban on emissions once they hit a given level. This will guarantee emissions reductions (at least within Australia). Unfortunately, we know that to be effective, environmental policy must come at an economic cost – and this scheme will limit Australia’s total production, and limit its international competitiveness.
Without getting too political, the 5% target recently announced for the cap and trade scheme to be adopted in Australia in 2010 is infinitely greater than any carbon tax that could have been proposed to seek wide public approval. Intriguingly, I would suggest that the current governments popularity with green groups would increase with the proposal of a "large" carbon tax, even though it would be less effective at reducing emissions.
Well explained - I wonder how many people know that?!
ReplyDeleteAlthough, it would be interesting to see how much it will cost big business. I would have thought with the economic slowdown, 5% would be a do-nothing scenario!
I'm not afraid to get political and say, well done for a cap-&-trade system, but harden up when dealing with 'big' business and stick to your promises!
Actually, the biggest industries, such as GE, are pushing for a cap and trade. Big industry has more control over manipulating markets than escaping taxes.
ReplyDeleteYou are missing the key ingredient, which is that industry responds to the bottom line - costs and profits. They will do a calcuation on how much it costs to purchase permits (cap and trade) or pay carbon taxes compared to profits for the increased production and choose. When the cost (and projections/certainty) of the two systems (cap and trade vs carbon taxes) match up, their decisions will be the same.
There is a wealth of information available on the web, so there is no need to post wrong arguments on this important topic.
Thanks for the comments. Just to clarify for you ch, the key difference between the two systems is the cap and trade is a quantity restriction, while the carbon tax is a price control. If there was no word ‘trade’ in cap and trade, you wouldn’t call it a tax. Just like you wouldn’t call any other pollution or safety standard. An analogous system would be tradeable development rights. Presently, town planning height limits are fixed to the specific property. Under the tradeable system, one land owner can sell there development rights to others, given the system the necessary cap and trade qualities. Surely this is not a tax!
ReplyDeleteYes ch, I agree that companies will react in similar ways to either measure. But from the view of the whole economy, things look very different. In the case of the carbon tax, the revenues will get recycled through the economy and increase aggregate demand, which accommodates the higher prices caused by the tax. Economists term the gains from the use of this tax the double dividend hypothesis. The only way I see to avoid most this offsetting effect is to spend the revenue on carbon sequestration efforts.
In the case of a cap and trade, even if revenues are raised by auctioning the permits, when the funds are recycled through the economy they cannot buy more fossil fuels. We will be forced to substitute towards other resources.
As far as the corporate support for cap and trade, I assume you are referring to the USCAP. Interestingly, Thanks for the comments. Just to clarify for you ch, the key difference between the two systems is the cap and trade is a quantity restriction, while the carbon tax is a price control. If there was no word ‘trade’ in cap and trade, you wouldn’t call it a tax. Just like you wouldn’t call any other pollution or safety standard. An analogous system would be tradeable development rights. Presently, town planning height limits are fixed to the specific property. Under the tradeable system, one land owner can sell there development rights to others, given the system the necessary cap and trade qualities. Surely this is not a tax!
Yes ch, I agree that companies will react in similar ways to either measure. But from the view of the whole economy, things look very different. In the case of the carbon tax, the revenues will get recycled through the economy and increase aggregate demand, which accommodates the higher prices caused by the tax. Economists term the gains from the use of this tax the 'double dividend hypothesis'. The only way I see to avoid most this offsetting effect is to spend the revenue on carbon sequestration efforts.
In the case of a cap and trade, even if revenues are raised by auctioning the permits, when the funds are recycled through the economy they cannot buy more fossil fuels. We will be forced to substitute towards other resources.
As far as the corporate support for cap and trade, I assume you are referring to the USCAP. Interestingly, others do not see the bright side of their proposal.
Am I right that a simple carbon TAX just gives money to the government to spend at their discretion. Meaning they could spend it on carbon producing things. I think that is what you are saying. I think you are also saying that the cap & trade means that it becomes a system within itself producing carbon reduction as an outcome?
ReplyDeleteYes, I am saying a carbon tax simply gives the government money to spend.
ReplyDeleteThe cap and trade provides a limit, so that even when funds are raised from auctioning the permits, when spent, they do not stimulate increased carbon emissions, since the carbon emissions limit is set.
I haven't read this in detail yet, but it appears this proposal for green buildings is a cap & trade system....
ReplyDeletehttp://www.lendlease.com/sustainability/pdf/EfficientBuildingScheme.pdf
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