Shortly after United States President Barack Obama introduced a budgetary plan for an emissions cap and trade system, some journalists and politicians were calling it a ‘tax’ on carbon. You may have read that this would be a tax that anyone who drives a car would have to pay. Yet trading emissions under a cap and trade system is designed specifically not to be a tax. It’s only a tax in as much as any added cost to a business is a tax. Mostly it’s dubbed that as political shorthand by critics opposed to cap and trade.
But a true carbon tax has been proposed by economists as a policy intervention. It’s a different approach than cap and trade. So, how would a carbon tax be different and what might the environmental outcomes be?
A carbon tax would be a fixed price based on the carbon dioxide content of fossil fuels. It would most likely be assessed against the coal, petroleum, and natural gas used in energy generation, transportation, heating and cooling, industrial manufacturing and processing. It is likely that a carbon tax would be applied ‘upstream’ with the primary industries involved in fuel extraction and combustion. The cost would then be transferred ‘downstream’ in the form of higher energy costs and probably higher prices for energy-intensive goods and services.
Proponents of a carbon tax favor it because it would set a fixed price for carbon. This would add certainty and some reliability (as taxes are harder to impose and to change) around an often volatile and moving target — the price of carbon. And that could be advantageous for industry to plan emissions strategies. A carbon tax could be targeted at specific industries and could be levied on imported fossil fuels as a means to address competitiveness when foreign countries choose not to adopt more rigorous reductions targets.
However, a carbon tax offers no guarantee on the amount of emissions that will be reduced. So while the price is certain, the environmental outcome is not. With cap and trade, the amount of emissions are fixed, thus the environmental outcomes (in terms of greenhouse gases emitted) are certain, although the price is variable.
With both approaches, the revenues from the systems could be used to lower other taxes (such as income), to invest in low-carbon technology, or to offer some form of relief for vulnerable industries, businesses or households.
The most critical element to a carbon tax is setting the price. This is also a major complication. Predicting a value will likely be educated guesswork. We do not know how many emissions reductions will be achieved at $10 per ton of carbon dioxide, any more than we can predict the mitigation at $25 or $75 or $100 per ton.
Let’s recall that the goal is to reduce global warming by reducing emissions of greenhouse gases (GHG) in the atmosphere. And it’s the amount of GHGs that determine how much global temperatures will increase. If a carbon tax is not priced correctly, the necessary emissions cuts don’t happen. Establishing certainty on emissions cuts seems more important than price, which is why cap and trade is probably the more effective tool.