Greenhouse gas emissions (GHGs) are one of the most commonly
cited examples of a negative externality: when prices in a competitive market
do not reflect the full cost of producing a product or service. The days of
freely emitting greenhouse gas emissions are numbered and government
institutions are in the process of determining the best way to price carbon
emissions. Among the plethora of options, carbon taxation, a pricing
instrument, and emissions trading, a fixed quantity model, remain the two
economically efficient policies.
Putting a price on carbon dioxide is an attractive
alternative to providing expensive subsidies to the renewable energy sector.
Since carbon pricing increases the price of fossil-fuel based energy sources,
the price of renewable energy becomes more competitive in comparison. What’s
more, carbon taxation provides organizations with an incentive to invest in
greener technologies. In fact, executives of oilsands’ companies have expressed their support for carbon pricing.
The leading proposal in the United States and globally is to
create an emissions trading system, also known as cap-and-trade. Cap and trade systems place a limit on the amount
of pollution that can be emitted. Therefore, firms must pay for each unit of
pollution in the form of a permit. The price of these permits varies depending
on supply and demand. Firms that can reduce greenhouse gas emission inexpensively
can sell their permits to other organizations. The widespread acceptance of cap
and trade is no surprise as the system benefits almost all stakeholders. For
governments, cap and trade offers the opportunity to take action to combat
climate without the negative perception of an added tax. For environmentalists,
emissions trading systems ensure governments commit to a fixed reduction in
greenhouse gas emissions. Cap and trade systems can work effectively as
evidenced by the sulphur dioxide allowance-trading program that was established
under the 1990 Clean Air Act Amendments (CAAA). The goal of the program was to reduce S02 emissions by ten million tons relative to 1980. The program was immensely successful; sulphur dioxide emissions declined by 43%, despite electricity generation from coal-fired power plants increasing by over 26% between 1990 and 2007.
Despite being positioned as a market-based approach to curb
greenhouse gas emissions, cap and trade systems are not the best tool to combat
climate change. First, cap and trade systems can take years to implement
because of delays associated with policy implementation. Given the uncertainty
over the price of carbon dioxide emissions, in the event that the price of
carbon rises, there will be pressure on the government to relax the carbon cap,
thereby reducing the overall efficacy of the policy.
A carbon tax levies a tax on each unit of greenhouse gas
emissions and provides incentives for organizations to reduce pollution. Carbon
taxes are easier to implement than cap and trade systems and can be adjusted if
the resulting changes are too strong or too weak. Carbon taxes are supported by
economists on the left and right because they are a market instrument that does
not require substantial government involvement: change the price and let the market
work its magic.
Carbon taxes carry limitations as well. Perhaps the biggest
obstacle is the challenge of instituting an additional tax. There are many
psychological reasons why people oppose things like carbon taxes. For one, the
endowment effect—when peoples' willingness to accept compensation for a good is
greater than their willingness to pay once their property right is established—is
one reason why taxes are hard to accept. While both pricing systems increase energy
prices, cap and trade is often more viable politically because it is not
labelled as a tax. Finally, there is a temptation that politicians will use carbon
taxes as a revenue source rather than a neutral tax. Remember that carbon taxes
are intended drive down consumption of fossil-fuel based energy source (see
British Columbia's revenue neutral carbon tax as a case in point: http://www.fin.gov.bc.ca/tbs/tp/climate/carbon_tax.htm).
Both pricing models achieve the outcome of increasing energy
costs and reducing greenhouse gas emissions.
The challenge is that while carbon taxation is a more holistic solution,
it is less appealing to voters due to the negative perception associated with
an added tax. In short, carbon taxation is a remarkably system that allows governments
to reduce spending (particularly on supporting renewable energy), lower our dependence
on foreign oil, reduce pollution, and correct a market failure.
By Trevor S.
