Carbon Tax or Carbon Trading: Which Will Be More Effective?

In recent days, the price of carbon in the European markets has fallen dramatically. Analysts say various factors are at play, including the trading system’s ‘design flaws’. Surprisingly, no one blames US politicians for their plans to institute a carbon tax. But the tax will definitely be an issue to be reckoned with. World Resources Institute has a good discussion on the benefits and challenges of a carbon tax vs. a carbon trading scheme.

It’s increasingly clear that it’s going to be a matter of either/or. So, having heard at length about carbon trading nightmares and delights (for an overview of which plans and realized platforms are in the running, check out this link), it’s time now to focus on the carbon tax. What’s the deal here?

Getting a Carbon Tax Passed

Last month, we saw the issue of the latest carbon tax bill, proposed by Representative Pete Stark (D-CA). For the time being, it’s the only proposal that’s officially doing the rounds, but at least one other bill is being drawn up, and various experts offer their ideas.

Stark proposes that companies be initially taxed $10 per ton of fossil fuels they use. The taxation would be doubled in the second year, and subsequent years would see an increase of $10 per ton every year. Stark promised that once emissions are below 80% of their 1990 levels, the tax would be leveled out. The proposal is designed to prevent businesses from ‘gaming the system’—Stark’s words.

Consumers might be quite enamored at first glance with the carbon tax. That’s because of two magic words that are repeated again and again when all things Carbon Tax are discussed—‘revenue neutral’. The carbon tax must be revenue neutral, say its proponents, meaning that what the government takes with one hand, it gives back with the other. In the case of Stark’s plans, this means that income tax is lowered while consumers pay more for various pollution-intensive products (mostly energy and transport).

You might wonder how this makes sense. How can the macro-economic environment equation work out as a freebie at the end of the day? If you are interested in the in depth logistics of this, listen to this interesting by Kenneth Green, a resident scholar at the American Enterprise Institute. He gives a clear insight into the sums involved (as well as reasons to consider rejecting cap-and-trade ideas).

The long and the short of Green’s plan is that imposing a $15 carbon tax could be made revenue neutral by lowering income tax by as much as 13%. The carbon tax itself generates $80 billion in revenues for the government. Green does not say how CO2 reductions are to be achieved but assumes the money is enough to cut carbon emissions by 11% annually. In return for the lowered income tax, consumers will be paying 83% more for coal, 11% more for oil, and 9% more for natural gas, and they’d pay 14 cents more per gallon of gasoline at the pump.

These sums are pretty much similar to those Stark is doing. Aside from revenue neutrality, all carbon tax plans have in common that they propose to slap hefty penalties on pollution producers. Some will double the price of coal and oil (read: energy prices for the consumer), while others propose taxes that will raise the price of energy by at least 80%.

Pricing Carbon

Whether that proves to be the right price remains to be seen. The estimates of the net cost of carbon emissions, also known as the social cost of carbon (SCC), were around $12 per tonne of carbon dioxide for 2005, but the range around this mean is broad. According to Wikipedia, in a survey of 100 estimates, the price varied from $–3 per tonne to $95 per tonne of carbon dioxide.

Whatever turns out to be ‘right’ here probably won’t matter all that much. The main motivating factor for pricing carbon is getting producers to switch to more environmentally friendly alternatives for coal and oil. Whether this will work is a bit of a gamble. In some cities or regions, alternatives will be very easy to come by. California, for instance, has very easy access to natural gas. But other areas will be hard pressed to find alternatives.

Studies show that replacing a coal-fired power plant of 100 megawatts requires 300 to 400 wind generators (assuming they operate at 2 to 2.5 MW each). The authors of the article conclude that renewables should be seen as a supplement at most, not as something we can solely rely on with any amount of realistic confidence. That’s gloomy news.

And then there’s the international angle to all this. The global situation is more frequently cited in connection with carbon trading, but it will have a real dimension in relation to the carbon tax too. Ralph Nader explains this in a lengthy piece in the Wall Street Journal. He speculated on what Chinese leaders might well be thinking by now if they’ve read the US newspapers about the proposed climate change bill (something that is 99% a given – the one percent accounting for those days that they manage to block all internet access to the West).

Nader said that the most reasonable conclusion is that what’s being orchestrated in the US at this very moment equates to an intense effort at the sort of protectionism that globalization euphemistically heralds. Big deal, you might think. But hey-ho – think again. For carbon trading to be successful, it needs the participation of all the major international parties. And a person like Green already argues that companies don’t need environmental standards so long as they’re taxed, something that strikes me as at least overly optimistic; that corporations suddenly will ‘know’ how to produce without emitting carbon dioxide and, at worst, an effort to appease ill tempers.

In the near future you might expect to see Stark’s carbon tax bill seeing competition from one that’s being drawn up by Rep. John Larson (D-Conn.). He is also advocating to offset payroll taxes. “We can have middle-income tax relief while serving the purpose of cleaning up the environment,” Larson said at a briefing last week. His plans have the support of the Environmental and Energy Study Institute, Carbon Tax Center, the Climate Crisis Coalition, Friends Committee on National Legislation, and Friends of the Earth.