Comparing carbon pricing options

Each of the two carbon pricing systems have advantages and disadvantages. Some advantages and disadvantages -- based on peer-reviewed and other literature -- are listed below. Also, below is a video clip of a debate between John Doggett and Jim Nolan of McCoombs School of Business at the University of Texas at Austin.

 

And, on February 23, 2015, Price Carbon Now, ON!, along with Canadian Society for Ecological Economics and Citizens' Climate Lobby - NCR, organized a discussion panel, which included David Chernushenko (Councillor, Capital Ward), Nathalie Chalifour (Social Justice Professor, UOttawa), Nic Rivers (Canada Research Chair in Climate and Energy Policy, UOttawa), Dave Sawyer (Economic Advisor and CEO, EnviroEcoonomics), and Alex Wood (Senior Director, Policy and Markets, Sustainable Prosperity, UOttawa) to discuss the merits and demerits of different carbon pricing options. The panelists discussed these as they related to: Achieving the required emissions reductions, Ensuring stability of price of emission reduction, Achieving economic efficiency, Mitigating negative effect on competitiveness of industries, Making sure it is simple and transparent (and if it matters), Addressing fairness for low- and middle-income families (mitigating regressive effects), Ability to get public and stakeholder support, and Longevity (Ensuring that it survives over time).

 

Here are the clips from the discussion panel:

 

Emissions and price certainty

 
Economic efficiency and industrial competitiveness
 
Design simplicity
 
Fairness and equity
 
Political saleabilty and longevity

 

Advantages of cap and trade (CAT):

  • Puts limits on total emissions resulting in clear goals and firm reduction targets

  • Can provide cost-effectiveness; could deliver emissions reduction at the lowest cost to the economy by providing flexibility to choose lowest cost reduction method available; potential source of income to companies that can inexpensively reduce emissions.

  • Built-in responsiveness to inflation, cost changes and recessions

  • Different CAT systems can be linked to create a single global carbon market

  • Banking and borrowing of permits may reduce certainty in the short run, but could maintain certainty of overall emissions reduction

  • Tightening cap over time is appealing to many environmental groups

  • Cap and trade with auctioned permits is more transparent and simpler than free allocation of permits, and protects real incomes, and generates revenue

  • Politically more palatable; unanimity in decision making not required

 

Disadvantages of cap and trade:

  • It is a complex system that includes setting up of mechanism for permits, monitoring, and trading

  • Initial design and development can be time consuming often requiring new institutions to be set up; requiring many policy decisions regarding quantity, scope, point of regulation and distribution of permits

  • Requires emissions monitoring

  • May lead to price volatility, which may discourage investment and make business planning more difficult, making it unpopular with businesses and policy makers; requires price containment measures to decrease volatility in permit prices.

  • Long-term signals less powerful

  • In theory, the rationale for yearly quantity control is weak since only atmospheric stock of GHG gases matter not annual emissions.

  • Fails to take advantage of low-cost opportunities to cut more emissions

  • It may be likened to a tax

  • Repeatedly reducing permits can be politically challenging.

  • If offsets are used, it would benefit a few and fosters the perception that the system was designed to exploit a trading market.

  • Offsets are more complicated than tax credits and exemptions

  • Allowances are associated with many tax implications.

  • Costs, including administrative and legal costs, could be higher.

  • Challenges of setting up baseline for reduction targets, offsets and complex cost containment measures

  • In the event of linkage with other cap and trade systems, exchanging allowances increases enforcement challenges, which will need to be monitored and verified.

  • Linking with other jurisdictions' systems may result in outward flow of capital if other jurisdictions are setting their caps low to influence these flows.

 

 

Advantages of carbon tax:

  • Predictability in carbon prices i.e. price certainty, which supports critical business decision making, planning

  • Ease and quickness of implementation since systems for collecting fees already exist, leading to faster emissions reduction

  • Simpler to administer, and has low administrative costs

  • Simpler to adjust prices

  • Transparent, with clear indication of amount of revenue; process of enacting tax exemptions more visible and transparent than permit allocation in cap and trade (CAT)

  • It is easy to see the beneficiaries of tax breaks unlike entities who receive grandfathered permits in CAT

  • Since taxes are only collected and are not deductible, there are fewer tax implications

  • Ease of coordination – fees can be collected on imports and/or rebated on exports

  • Compliance costs could be lower since fees can be incorporated within the activities of a company's existing tax department

  • Less susceptible to corruption than cap and dividend since emissions permits create a potential for profit for those who control them. Also, does not create artificial scarcities and monopolies.

  • No historical base year of CO2 required.

  • Where distribution of revenues is incorporated into the tax, as in a revenue-neutral carbon fee, it protects real incomes of majority of families, enables households with smaller than average carbon footprint to derive net benefits, promotes common ownership of system, avoids some political obstacles, ensures sustainability of system.

  • Provides economic stimulus

 

 

Disadvantages of carbon tax:

  • Challenges in estimating practical effect of a fee; no emissions certainty, risk of falling short of targets

  • Setting optimal tax rate difficult; price setting vulnerable to political manipulation and rent-seeking (lobbying)

  • Tax rate may need to be adjusted based on economic conditions

  • Low political palatability for taxes; increasing tax rate each year requires overcoming opposition, since unanimity may be required for raising tax rate

  • Some businesses may oppose carbon fee

  • Lack of support from some environmental groups because of the lack of emissions reduction target

  • Some difficulties in linking to international carbon markets, potentially increasing cost of emissions reduction

  • Difficulties with developing appropriate methodology for combining different taxes into one overall carbon fee

 

 

 

References:

1. Deep Reductions, Strong Growth: An economic analysis showing that Canada can prosper economically while doing its share to prevent dangerous climate change. David Suzuki Found. at http://www.davidsuzuki.org/publications/reports/2008/deep-reductions-str...

2. Avi-Yonah, R. & Uhlmann, D. Combating Global Climate Change: Why a Carbon Tax is a Better Response to Global Warming than Cap and Trade. (Social Science Research Network, 2009). at http://papers.ssrn.com/abstract=1333673

3. National Round Table on the Environment and the Economy. Achieving 2050: A Carbon Pricing Policy for Canada – Technical Report. (Ottawa, 2008). at http://collectionscanada.gc.ca/webarchives2/20130322143407/http://nrtee-...

4. Kunkel, C. M. & Kammen, D. M. Design and implementation of carbon cap and dividend policies. Energy Policy 39, 477–486 (2011).

5. Boyce, J. K. & Riddle, M. Cap and dividend: A state-by-state analysis. (Political Economy Research Institute, 2009). at http://www.e3network.org/papers/CAP_DIVIDEND_states.pdf

6. Boyce, J. K. & Riddle, M. Keeping the Government Whole: The Impact of a Cap-and-Dividend Policy for Curbing Global Warming on Government Revenue and Expenditure. (Political Economy Research Institute, 2008). at http://www.peri.umass.edu/236/hash/2d535cd8b5/publication/328/

7. Stavins, R. A Meaningful U.S. Cap-and-Trade System to Address Climate Change. (Social Science Research Network, 2008). at http://papers.ssrn.com/abstract=1281518

8. Boyce, J. & Riddle, M. Cap and Dividend: How to Curb Global Warming While Protecting the Incomes Of American Families. PERI Work. Pap. (2007). at http://scholarworks.umass.edu/peri_workingpapers/108

9. Pricewatercoopers. Carbon taxes vs carbon trading. Pros, cons and the case for a hybrid approach. (Pricewatercoopers, 2009). at http://www.timun.net/media/userfiles/file/PWCCarbontaxesandtrading-final-March2009.pdf

10. Aldy, J. The Promise and Problems of Pricing Carbon: Theory and Experience. J. Environ. Dev. 21, 152–180 (2012).

11. Pizer, W. A. in RFF Guide Clim. Change Econ. Policy (Routledge, 2001).

12. Hsu, S.-L. The Case for a Carbon Tax: Getting Past Our Hang-ups to Effective Climate Policy. at http://islandpress.org/ip/books/book/islandpress/C/bo8079222.html

13. Burtraw, D. & Parry, I. Options for Returning the Value of CO2 Emissions Allowances to Households. (Social Science Research Network, 2011). at http://papers.ssrn.com/abstract=1767411

14. CBO | Policy Options for Reducing CO2 Emissions. at http://www.cbo.gov/publication/41663

15. Yale Environment 360. Putting a Price on Carbon: An Emissions Cap or a Tax? (2009). at http://e360.yale.edu/feature/putting_a_price_on_carbon_an_emissions_cap_...

16. Hansen, J. The People vs. Cap-and-Tax. James Hansen (2010). at http://fromjameshansen.blogspot.ca/2010/01/people-vs-cap-and-tax.html

17. Hovi, J. & Holtsmark, B. Cap-and-trade or carbon taxes? The feasibility of enforcement and the effects of non-compliance. Int. Environ. Agreem. Polit. Law Econ. 6, 137–155 (2006).

18. Hovi, J. & Holtsmark, B. Cap-and-Trade or Carbon Taxes? The Feasibility of Enforcement and the Effects of Non-Compliance. (Research Department of Statistics Norway, 2005). at http://ideas.repec.org/p/ssb/dispap/436.html

19. Revelle, E. Cap-and-Trade Versus Carbon Tax: Two Approaches to Curbing Greenhouse Gas Emissions. (League of Women Voters, 2009). at http://www.lwv.org/content/cap-and-trade-versus-carbon-tax-two-approaches-curbing-greenhouse-gas-emissions

20. Sustainable Prosperity. British Columbia Carbon Tax Review. (Sustainable Prosperity, 2012). at http://www.sustainableprosperity.ca/article3085