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Tax or Cap? Clear Thinking About Carbon Solutions
noticed. However, to cut emissions by, say, 50%, the price of reality, tax revenues are likely to be spent, and spending all the revenue
permits – the effective tax rate – will have to become quite noticeable. would raise the cost by about £100 billion. However, caps and taxes by
Then, when the price doubles, a political backlash seems more than themselves are cheap and effective.
likely. This problem will only be compounded by reports of speculators
making a killing (quite by accident) as a permit price bubble drives up Back to the Global Picture
carbon taxes. Without global co-operation, either a US cap or a US tax will make little
difference. However, to achieve global co-operation we must
understand why Kyoto-style international caps were rejected by
Many claim that because the
developing countries. Consider the most recent and reasonable of the
market sets the tax rate, the rate
capping proposals.
will be optimal. However, if the US Climate Envoy Todd Stern’s trend-line caps would cap India at half
government sets a tight cap, the
the per capita emissions level of the US in 1880 – not 1980. How
should the Indian government explain to its people that because we
market will set a high tax rate.
emit so much they must emit so little? Also, had China accepted such
a cap from Stern in 2000, China would have been buying £60–90
billion worth of carbon permits on the international market right now.
How would they explain to their citizens that because they are lessEither Can Be Cheap
There is another way that caps and taxes can be twins. If all the permits poor, and now make glass and steel for the rich countries, they must
are auctioned, a cap will collect the same revenue as a tax, and of buy pollution permits from abroad?
course that money can be spent in exactly the same way as tax
revenues. However, a more interesting possibility is to just give the We need an international climate commitment that allows developing
money back. One way is to use carbon revenues to reduce some other countries to avoid caps and allows industrialised nations to use cap and
tax, such as income tax. However, a simpler approach teaches a most trade. In other words, at the international level the answer to the cap
important lesson. or tax question must be ‘either is fine’. Fortunately, both work by
pricing carbon.
To give the money back, just divide the carbon revenues by the US
population and send everyone equal cheques. This is fair, because it is So, countries should commit not to a cap but rather to a global carbon
just the same as giving everyone an equal property right to pollute the price target. US domestic policy should support such a commitment. If
atmosphere and letting those who wish to emit more buy rights from the global price target is £20 per ton, the US should make sure that its
those willing to emit less. This is individual cap and trade. However, let cap or tax, or some combination of the two, meets that commitment.
us return to tax and refund – it has the same effect, and it is vastly This could be achieved with pure cap and trade, but given the erratic
simpler. Alaska returns about US$1,000 per year in oil tax revenues by nature of permit prices, a price floor and price ceiling seem highly
sending out equal-per-person cheques each year in June. desirable if not absolutely necessary.
Because emitting less does not reduce an individual’s refund, the
refunds do not diminish the incentives of a carbon tax. So, it appears
that with 100% refunds, we get emission reductions at no cost to the
Countries should commit not to
country. In fact, it seems that the tax and refund could be raised to any
level to accomplish any reduction at no net social cost. a cap but rather to a global
carbon price target.
That is too good to be true. The hidden cost comes from businesses
and consumers spending to cut emissions. However, this cost is strictly
limited. There is no use in spending £100 to save £20 in taxes. In fact,
since there are some cheap ways to cut emissions, the average cost is
only £10 per ton when the price of emitting is £20 per ton. That is the Fortunately, the need for more price stability to meet our commitment
standard economic approximation used by the US Environmental to a global price target coincides with the need to reduce the domestic
Protection Agency. political risks of price volatility under a pure cap. Besides curbing price
volatility, the other key to long-term political acceptability is to keep
The cost of cutting emissions by 20% with a £20 carbon tax works out carbon pricing cheap and to make that clear. The best way to do that
to be about £12 billion, or about £0.10 per person per day. That is why is to avoid spending revenues on handouts and subsidies, and nothing
every economic analysis of cap and trade says it is cheap: the economic would make that as clear as seeing all the cap or tax revenues returned
models build in a fully refunded carbon tax. The problem is that in each year with an Alaskan-style cheque in the post. n
1. Mark Lynas, How do I know China wrecked the Copenhagen 2. Stephen Collinson (AFP), Chaos greets new climate pact, 18 Financial Times, 29 December 2009. Available at:
deal? I was in the room, Guardian, 22 December 2009. December 2009. Available at: www.google.com/hostednews/ www.ft.com/cms/s/0/7b06d220-f493-11de-9cba-
Available at: www.guardian.co.uk/environment/2009/ afp/article/ALeqM5gHb77YA9Gn1q8QwopmdlPEITMjUA 00144feab49a.html
dec/22/copenhagen-climate-change-mark-lynas 3. Andrew Ward, EU in cold as climate deal redefines relations,
MODERN ENERGY REVIEW VOLUME 2 ISSUE 1
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