Climate Policy Blog

The cost and environmental efficacy of either a cap-and-trade program or an emission tax will depend on several important design issues: the point of regulation; the coverage of emission sources; “complementary” programs; and possible hybrid policies that integrate elements of both approaches.

Point of regulation. It would be infeasible to regulate all greenhouse gas emissions at the very point where they enter the atmosphere – monitors will not be placed on every car and truck tailpipe, every home that heats with natural gas or heating oil, as well as every smokestack in the industrial and electricity sectors. One approach – often referred to as upstream regulation – would impose the emission tax or the requirement to hold permits on energy suppliers, such as at coal mines, natural gas wellheads, petroleum product refineries and importers. The carbon content of all fossil fuels that enter the U.S. energy system would be covered by this approach. This approach would be administratively simple and straightforward because it accounts for almost all U.S. CO2 emissions (more than 98 percent) by focusing on a relatively small number of firms; incorporates existing monitoring and measurement of fuel supplies; and takes advantage of the fundamental molecular properties of fossil fuels that allow for precise measurement of emissions based on the physical amounts of these fuels. (more…)

Building on my previous posts in this series providing an overview of cap-and-trade and emission taxes and a discussion of their similarities, this post illustrates some of the differences between cap-and-trade and an emission tax: the trade-off between cost certainty and emissions certainty, incentives for R&D, and revenue generation.

Cost certainty versus emissions certainty. In an uncertain world, it is impossible to design a policy that simultaneously guarantees an emissions outcome at a certain cost. An emission tax provides cost certainty – the incremental increase in energy prices is transparent and fixed under a tax – while cap-and-trade provides emissions certainty by capping aggregate emissions. Under a tax, emissions in aggregate can vary depending on the realized costs of abatement (that cannot be predicted ex ante with certainty), economic growth, relative changes in energy prices unrelated to a carbon policy, etc. These factors can likewise drive the variation in costs under a cap-and-trade program. (more…)

Cap-and-trade programs and emission taxes share several important similarities, including incentives for cost-effective mitigation, increasing energy prices, and raising revenues (assuming an auction in the cap-and-trade program).

Cost-Effective Mitigation. Cap-and-trade programs and emission taxes promote cost-effective emission mitigation by ensuring that every source of emissions faces the same marginal cost of abatement. Under an emission tax, firms should abate emissions until the last ton of abatement is equal to the tax. If they abate less than this amount, then they would make tax payments on some tons of emissions in excess of what it would have cost to abate those tons. If they abate more than this amount, then it would have cost more to abate some of those tons than it would by paying taxes on them. In a similar fashion under cap-and-trade, covered firms would make abatement decisions based on the clearing price of allowances in the market. If they can abate more tons for less than the current market price, then they would do so and sell any excess allowances. If they cannot, then they would buy additional allowances from the market at a lower cost than the emissions abatement would have cost. (more…)

As interest mounts for a federal policy to mitigate greenhouse gas emissions, two policy options have received substantial attention: a cap-and-trade system and an emission tax.

A cap-and-trade system would limit greenhouse gas emissions by setting an aggregate quantitative cap (e.g., over the entire economy or a specific sector, such as electric utilities). This cap is then allocated to regulated firms – either through an auction or for free – in the form of emission allowances. An allowance would give a firm the right to emit a given amount of greenhouse gases (e.g., one metric ton). Firms are allowed to buy and sell allowances among themselves, in effect creating an allowance market. Firms with high costs of abating their emissions may prefer to buy allowances from firms with low abatement costs. At the end of every regulatory period, firms would submit allowances the government to cover their greenhouse emissions during that period. (more…)

By Garrett Gruener and Daniel M. Kammen

It is now painfully obvious that the oil-addicted United States must take action to stop global warming — and equally obvious, after President Bush’s anemic State of the Union Address, that sensible energy action will have to come from Congress, the American people and the business community. Piecemeal approaches won’t work. What we need are market-based incentives that make it attractive to stop emitting the carbon that causes global warming – and quickly.

The longer we wait, the more global warming will cost us the long run. So it makes sense to adopt a tax on carbon emissions now. The trick is to design a “global cooling fee” that a majority of Americans will want to pay. We propose a tax that will hit energy hogs hardest. But under our scheme, whether you use a little or a lot, you will be able to invest your tax dollars directly in technologies that will clean up the environment now and lower your energy bills. (more…)