Carbon tax V Cap and trade

This blog is to help those interested in understanding why there is a debate between these two alternative policy options for reducing greenhouse gas emissions. While at first a cap and trade scheme and a carbon tax appear to be different versions of the same thing, there are important differences. These differences explain the push from big business for a carbon tax.

First, we must recognise that a tax is simply a reallocation of funds between economic agents – from individuals and companies, to the government. Thus a carbon tax, a cigarette tax, an alcohol tax and a GST all generate government revenue. We know from my previous blogs that all consumption is equal (in resource terms). If governments do not spend this extra tax revenue, they will reduce other taxes, but the total economic production will be the same afterwards, as will the total consumption by all economic agents. Therefore a carbon tax will not reduce carbon emissions.

One quite interesting discussion I had earlier this year with ECOS magazine editor James Porteous led me to a paper by Barney Foran, entitled Powerful choices: Options for Australia’s transition to a low-carbon economy. Foran suggests that revenues raised from a carbon tax can be allocated to a future fund, which is basically an offshore investment vehicle. I think he fails to understand that this investment itself has serious carbon implications (This translates as “let’s stop climate change by taxing Aussies and investing in Chinese production”).

A cap and trade scheme on the other hand is actually a restriction on the amount of emissions – a ban on emissions once they hit a given level. This will guarantee emissions reductions (at least within Australia). Unfortunately, we know that to be effective, environmental policy must come at an economic cost – and this scheme will limit Australia’s total production, and limit its international competitiveness.

Without getting too political, the 5% target recently announced for the cap and trade scheme to be adopted in Australia in 2010 is infinitely greater than any carbon tax that could have been proposed to seek wide public approval. Intriguingly, I would suggest that the current governments popularity with green groups would increase with the proposal of a "large" carbon tax, even though it would be less effective at reducing emissions.