Eleutherian

I've been following the carbon abatement issue for a few years now, and in the debate between a carbon tax (tax on price) and cap-and-trade (tax on quantity), Terry Dinan, the Congressional Budget Office (CBO)'s Senior Advisor for Climate Policy, has been the clearest, most reasoned voice. This post will cover her finding in my favorite paper on the issue, available at the CBO website.

I will be speaking largely from the table below (click to enlarge):


If a cap-and-trade system (hereon more accurately referred to as a "carbon quota") were implemented in the United States, the level of emissions would be completely arbitrary. No scientist knows the level of carbon dioxide at which the atmosphere become irreversibly unstable. Without knowing the upper limit, any restriction in quantity will necessarily be made through guesswork (or, even worse, through politics - i.e. what sounds politically popular).

Having stated that, the CBO recognizes that if the government somehow managed to guess the correct carbon quota to match the actual cost of reducing the carbon, then there is zero difference between a carbon tax and a carbon quota (in terms of reduced emissions and cost). This is illustrated in the "Expected Outcomes" column on the table.

It is far more likely that the government will guess incorrectly. If the cost is higher than expected, a carbon tax will reduce less carbon than a carbon quota, but the carbon tax will provide the greater net benefit as the emission reductions were achieved at a lower total cost.

If the cost of reducing carbon is lower than expected, a carbon tax will reduce more carbon than a carbon quota and do so at a greater net benefit. This illustrates an obvious limitation of a carbon quota. Even if the price level would encourage greater reductions, a carbon quota will always reduce carbon by the same amount.