Carbon trading is an attractive idea, but it will not work as well as a consistent tax on carbon emissionsby Richard Barry / July 28, 2007 / Leave a comment
Efforts to control emissions of carbon dioxide in Britain are in a muddle. Until we sort this out, it will be needlessly difficult to meet our national goal of a 60 per cent cut in emissions by 2050.
Almost everybody accepts that a financial penalty must be attached to CO2 emissions, because mere exhortation is not proving to be enough. There are two main ways of attaching that penalty: the direct way, through taxation, where the emitter pays a tax for each tonne of CO2 emitted, and the indirect way—the so-called “cap and trade” approach.
Under a cap and trade system, the government (in our case Brussels because it’s an EU-wide scheme) sets the cap—the maximum overall tonnage of CO2 (and other greenhouse gases) that can be emitted in any given period. The cap is then divided into permits, each allowing the bearer to emit one tonne of CO2. The permits are then distributed to each country in the EU, and the countries then allocate them to their main emitting companies. Any company not needing all of its allocation is free to sell its surplus to a company that needs more. The emissions trading scheme (ETS) provides the marketplace for the trade of these permits.
Politicians like the cap and trade system because it spares them having to impose yet more taxes. Economists like it because it is economically efficient. Those companies that can reduce emissions easily will do so, and profit from selling surplus permits. Companies for whom cutting emissions would be expensive can buy those permits. Overall, the cap is met at the lowest economic cost.
The system has two key features. First, it sets the overall tonnage that may be emitted but lets the price of a permit fluctuate according to market demand. Second, the initial allocation process is highly discretionary. Permits are valuable things, and the importance of successful lobbying at company and country level cannot be overestimated. By way of illustration, Poland and the Czech Republic have recently announced that they are planning to sue the European commission for increased allowances. (The common fisheries policy shares this discretionary feature. Each year, the scientists’ warning of the maximum sustainable catch is largely ignored in a frenzy of lobbying for increased national quotas.)
By contrast, the tax system fixes the price of CO2 emissions—a tax of…