Global Warming: Carbon Tax or Cap and Trade?

Wonk's Anonymous is quite pleased to hear that John McCain has officially recognized that we have a problem with CO2 emissions that is likely causing a steady increase in global temperatures. Now that all major candidates are on the same page about this one we can actually start talking about what to do.

There are, as far as Wonks Anonymous knows, two major policy contenders in this area: Cap and Trade and the Carbon Tax. Both share the same basic economic mechanism: Both increase the cost of CO2 emissions to users of fossil fuels. In a world where all transactions are essentially free both can be shown to be equivalent - for more on this see the Wikipedia entry on Ronald Coase.

Cap and Trade allocates the right to emit a specified amount of CO2 emissions to manufacturers and others who use fossil fuels. They can use their allotment or sell it on commodity markets to others who need to emit more CO2. They may also be able to buy abatements on the same markets. These would represent newly planted forests or other ecological good deeds that absorb CO2. The total CO2 allotments would be set nationally. It would determine how quickly we slowed global warming.

The Carbon Tax would place a tax on all fossil fuels based on their carbon content, say $10 per ton of carbon contained in the fuel. The tax would have a greater impact on high carbon fuels like coal and heavy crude oil. It would increase the cost of all fuels that contain carbon.

Both plans increase the cost of producing CO2 emissions. Cap and Trade makes the right to emit CO2 a valuable commodity. In order to emit more than their allotment, producers will need to buy CO2 emission rights. If they emit less, producers can sell their excess rights. The Carbon Tax taxes the carbon in fuels directly. 

As the cost of emitting CO2 increases producers will emit less. Wonks Anonymous is a card carrying economist and he believes this to be true. There are, however, three major differences between the plans:

Administrative Costs for Cap and Trade are higher. The carbon content of fossil fuels is easy to measure and The Carbon Tax can be collected at the point of production or import. Producers and importers will pass it on to fossil fuel buyers who will pass it on to everyone else. Prices of high carbon products and activities will rise and behavior will change. The administrative burden of the Carbon Tax is low.

To enforce Cap and Trade the government will need to monitor CO2 emissions which may be a complex task. Some groups of emitters - automobile drivers for example - may escape caps because enforcement costs will simply be too great. Society will face further costs to administer carbon markets, trade CO2 emission rights and verify that the abatements sold really represented newly planted forests. Cap and Trade will be much more costly to administer.

Cap and Trade presents far greater opportunities for legislative creativity. Which, depending on who you are, is not necessarily a bad thing. The legislature will no doubt be charged with setting CO2 emissions allotments. The senator from Texas will no doubt need to defend the position of the domestic oil refining industry while the representative from Kentucky will be forced to look after the position of coal. California's representatives may need to protect the CO2 emissions from the cooling systems of our vast server farms.

Because CO2 emissions allotments are themselves valuable, legislatures will be rewarded for this onerous work with campaign contributions.  Because the carbon tax is applied uniformly to all fossil fuels the legislature's task will be quite simple.

The Carbon Tax will provide additional government revenue. Again, depending on who you are, this is not necessarily a bad thing. If you want to "starve the beast" then a new tax will slow our inevitable progress to the utopia of national bankruptcy. If you would like to see continued government services and maybe even pension payments then this is a good choice.

Wonks Anonymous is not too clear on the Democratic candidates proposals for climate change since he has heard noises about both Cap and Trade and the Carbon Tax in the Democratic debates. If the candidates are still confused he proposes the following: Start with a low carbon tax - enough to raise the price of gas by ten cents a gallon say - and raise it by a small percentage every month. A slow but steady rise in the cost of using fossil fuels would reduce emissions without serious economic disruption.


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  • 5/13/2008 10:54 PM Kimberly wrote:
    Thanks for a comprehensive and sensible explanation here. It does my heart good to see a nice, tidy recommendation at the end of a discussion of economic policy.

    I'm also enjoying the boldface for easy scanning. But then, I'm a design geek; these things make me happy.
    Reply to this
    1. 5/14/2008 8:14 AM Chris Martin wrote:
      You know what they say about economists: If you laid all the economists in the world end to end they still wouldn't come to a conclusion.

      I love praise but I have entirely too many positive comments on this blog. Does anyone out there hate my guts or even mildly disagree? Please feel free to register your disapproval. Note that obscenities will be bleeped.

      Reply to this
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