Question

How would a carbon tax reduce the carbon footprint of someone and how would a cap and trade mechanism achieve the same result?

Answer 1

Unlike alternative approaches, carbon taxes and cap-and-trade schemes have many significant advantages. They minimize pollution by implementing the lowest-cost emission cuts, and they do so without anybody having to learn in advance when and where such emission reductions will happen. These strategies are enabling investors and business people to build new low-carbon technologies. So both policies raise government revenue, which can be used in productive ways (assuming carbon permits are auctioned under cap-and-trade).

There are clear variations between carbon taxes and cap-and-trade schemes, each with distinct benefits. The United States has pledged to the international community to reduce its annual greenhouse gas emissions by 26-28% below the rate of 2005 by 2025. A cap-and-trade program will increase the likelihood that emissions will fall below the fixed emission levels by setting an emission limit that declines over time.

Disadvantages of carbon taxes or cap-and-trade, but their claims are impersuasive when well-designed policies are in place. Although a carbon tax does not give the same degree of emission certainty as cap-and-trade, a tax may achieve adequate stringency by design elements such as a "ratcheting mechanism" which will change the tax upwards if the initial emission cuts are too low. In any case, as we show in the brief question, if technological developments continue to reduce renewable energy costs and availability, a carbon tax is likely to cause emissions to fall faster than expected by the simulation models that form our policy expectations.

Cap-and-trade points to issues faced by existing cap-and-trade schemes such as the European Union Emissions Trading Plan and the National Greenhouse Gas Initiative, such as low emission limits, unpredictable emission allowance rates and overly generous emission allowance allocations to controlled organizations. But these are issues with the nature of a cap-and-trade system and each has a clear solution. Emissions limits can be set more stringently, price floors and ceilings to eliminate instability, and permits for emissions can be auctioned rather than given away.