Question

In a newly published article in the scientific journal “International Economic Review”, some authors study how carbon taxation could help reducing the climate change problem. They find that:

Carbon taxation is mostly studied in social planner or infinitely‐lived‐agent models, which obscure carbon taxation's potential to produce a generational win win. This paper's large‐scale, dynamic 55‐period, overlapping generations model calculates the carbon‐tax policy delivering the highest uniform welfare gain to all current and future generations. Our model features coal, oil, and gas, increasing extraction costs, clean energy, technical and demographic change, and Nordhaus' (2017) carbon/temperature/damage functions. Assuming high‐end carbon damages, the optimal carbon tax is $70, rising annually at 1.5 percent. This policy raises all generations' welfare by almost 5 percent. However, doing so requires major intergenerational redistribution.

f.An alternative solution to the carbon tax is a cap-and-trade system. Explain how such a system works and the outcome of it compared to a tax.

Answer 1

Under Cap and Trade system a limit is placed on the amount of green house gases and other harmful pollutants that can be emitted by the industrial sector of a country.These are called environmental permits given by government. The industry by emitting lesser amount of pollutants in comparison to the given limit can then sell their remaining permits to other industrial units. The permit is reduced overtime thus, making it more and more expensive to emit such gases which then incentivices the industries to look for cleaner alternatives for their production and reduce emission of pollutants overtime.

The provision of limit over emissions reduces total amount of pollutants in the environment to a very large extent and gradual upgradation to greener alternatives reduces pressure of increasing production costs that could have been caused if businesses had to reduce emissions suddenly.

Both carbon tax program and cap and trade has resulted in effective reduction of pollutants in the environment . Cap and trade makes it easier to evaluate the amount of emission reduction in the environment whereas carbon tax provides information over the cost of emission while reduction in emissions will remain difficult to understand. Both the policies will work only when they are effectively implemented to realise the goal of reduced amount of carbon dioxide gas emissions in the environment .