Carbon Taxes Versus Cap and Trade: A Critical Review

Abstract

We examine the relative attractions of a carbon tax, a "pure" cap-and-trade system, and a "hybrid" option (a cap-and-trade system with a price ceiling and/or price floor). We show that the various options are equivalent along more dimensions than often are recognized. In addition, we bring out important dimensions along which the approaches have very different impacts, including some dimensions that have received little attention in prior literature. Although no option dominates the others, a key finding is that exogenous emissions pricing (whether through a carbon tax or through the hybrid option) has a number of important attractions over pure cap and trade. Beyond helping prevent price volatility and reducing expected policy errors in the face of uncertainties, exogenous pricing helps avoid problematic interactions with other climate policies and helps avoid potential wealth transfers to oil-exporting countries.

Instrument Choice and Stranded Assets in the Transition to Clean Capital

“…Goulder and Schein (2013) note that the same result can be obtained with carefully-designed exemptions under a carbon tax. 4 We expand this literature by comparing carbon prices with alternative instruments: instead of offering compensation to the owners, standards and feebates avoid stranded assets and all their social impacts in the first place.…”

Climate Policies and Nationally Determined Contributions: Reconciling the Needed Ambition with the Political Economy

“…The price of fossil fuel is mainly derived from scarcity rents, which are net profits for fossil fuel exporters. If many fuel importers levy a tax on imported energy, the answer from fuel exporters will be to reduce the scarcity rent they charge on their exports (Goulder and Schein, 2013). For the governments in importing countries, this boils down to capturing part of the scarcity rent of exporters in their public coffers (Rozenberg et al, 2010).…”

“…Carbon pricing offe s a pote tial dou le di ide d p o idi g oth e i o e tal e efits a d the possi ilit of reducing those distortionary by recycling carbon revenues (Bovenberg, 1999;Carraro et al, 1996;Goulder, 2013). Many studies find that this effect alone can make carbon prices welfare improving, even if avoided climate change impacts are not accounted for , (Combet et al, 2010;Parry and Williams, 2010).…”

“…Under a carbon tax, a way to compensate the owners for stranded assets is with partial exemptions or rebates (Goulder and Schein, 2013). Cap-and-trade carbon markets can also be designed to compensate firms for stranded assets they may create: the owners of polluting firms may be fully compensated if a fraction of emissions allowances are grandfathered for free (Goulder et al, 2010).…”

“…A literature finds that ill-designed sectoral or local policies (for instance subsidies for renewable power decided at the municipal level) may dampen the efficiency of policies with a wider scope -geographical or sectoral (Bento et al, 2009;Böhringer and Behrens, 2015;Böhringer and Rosendahl, 2010;Goulder and Schein, 2013;Hood, 2013;Weigt et al, 2013) . The main danger is when the wider-scope policy is a quantity-based policy, typically a carbon market: for instance, renewable targets for the power sector in the UE will reduce the allowance price on the EU-ETS, and emission reductions achieved thanks to renewable power will be compensated by fewer reductions in another sector covered by the ETS.…”