5 Reasons Why Cap and Trade is Better than a Carbon Tax

| by NRDC

By Andy Stevenson

It is often asserted that a carbon tax would be simpler, more transparent, and have fewer special provisions, accommodations, or loopholes than a cap and trade system.  The fallacy, however, is to compare a "real-world" cap and trade design with an idealized carbon tax design.

Indeed, every pressure for special accommodations seen in the legislative process for developing a cap and trade system would be present in the legislative process for adopting a carbon tax.  The following is a list of five reasons why cap and trade is preferable to implementing a carbon tax as a means to achieving our expressed goal of an 80% or greater reduction in greenhouse gases by 2050:

1) Guarantees Emission Reduction
If the goal is to reduce the amount of greenhouse gases in the atmosphere by 80% or more, a cap and trade program that gradually reduces the amount of CO2 permits available to emitters over a 40 year horizon is far more effective at achieving this goal than a tax. A carbon tax can only attempt to change consumer behavior and is therefore one or more steps removed from actually affecting the desired emission reductions within an acceptable timeframe. In other words, a cap directly regulates the quantity of dangerous pollution, whereas the emission results of a tax are less certain.

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2) Creates Better Economic Certainty for Investment
In order to make the investments in clean energy needed to achieve our goals, investors need a clear price signal. Cap and trade provides a 40yr framework of economic certainty that will allow investors to base their investments on what industry thinks the price of carbon is today and will be far into the future. A carbon tax would only offer what government thinks a carbon tax rates needs to be on a year by year basis in order to best attempt to affect the desired emissions reductions.

3) Program Costs are Countercyclical
The price of carbon under cap and trade legislation will fall as the CO2 output from the economy slows and will rise as the CO2 output from the economy accelerates. In other words, carbon prices are countercyclical and wouldn't provide an undue burden on the economy during periods of economic stress. This makes cap and trade far more effective than a carbon tax, which needs to take into account how much progress the carbon tax has made historically before it can decide whether or not to provide economic relief during an economic slowdown.

4) Less subject to Political Intervention
While the regulation of a cap and trade market for CO2 is likely to be reviewed every five years, the program itself will be designed for nearly four decades and will not be subject to the intense political pressure that a carbon tax during periods of economic stress. As it is politically advantageous to under-estimate the amount of tax needed to affect a certain change in behavior, it is likely that a carbon tax program would be persistently behind on its reduction targets and constantly confronted with calls to either reform or abandon the program. Further, during periods of nascent economy growth, politicians will constantly struggle to determine the amount of increase in carbon taxes needed to avoid derailing the recovery.

5) Better Advances Goals of Complementary Standards
Under a carbon tax, innovation in one area isn't rewarded as predictably as it is under cap and trade program, as carbon taxes don't directly affect emissions reductions but rather consumer behavior. This makes cap and trade more effective at stimulating investments in complimentary standards which measure their economic value based on known carbon prices.

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See the Opposing Views debate on Carbon Trading by clicking here.