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Climate Policy Memo #1: Cap and Trade vs. Taxes
Cap and trade and a carbon tax are two distinct policies aimed at reducing greenhouse gas (GHG) emissions. Each approach has its vocal supporters. Those in favor of cap and trade argue that it is the only approach that can guarantee that an environmental objective will be achieved, has been shown to effectively work to protect the environment at lower than expected costs, and is politically more attractive. Those supporting a carbon tax argue that it is a better approach because it is transparent, minimizes the involvement of government, and avoids the creation of new markets subject to manipulation. This note explores both the fundamental similarities between cap and trade and tax regimes, but also the important differences between them.
IMPORTANT SIMILARITIES BETWEEN CAP AND TRADE AND TAXES
Both correct a market failure. Both cap and trade and a tax have as their objective the correction of an existing market failure. Currently, sources responsible for GHG emissions do not have to pay for the damages they impose on society as a whole. The failure to internalize these costs leads to greater levels of emissions than would be socially optimal.
Both put a price on carbon. By placing a price on carbon, and thus correcting the market failure, both approaches create an incentive to develop and invest in energy-saving technologies. This will encourage the shift to a lower carbon economy.
Both take advantage of market efficiencies. Unlike direct regulations, both harness market forces to achieve the lowest cost reductions in GHG emissions.
Both can generate revenue. A tax by definition is designed to raise revenue, but a cap-and-trade system, to the extent that allowances are auctioned, can also raise similar amounts of revenue. How such revenues are used becomes an important issue in both systems. Some proposals rebate the revenue directly back to consumers, some use part of the revenues to ease the transition to a low carbon economy (e.g. for consumers, energy-intensive manufacturers, research development and deployments, etc.) and some combine both approaches.
Both impose a compliance obligation on a limited number of firms. Depending on who pays the tax or is responsible for holding allowances, the number of firms directly impacted by these systems can be large or small. Most proposals focus on a limited number of firms with the goal of maximizing emissions coverage and reducing administrative costs.
Both necessitate special provisions to minimize adverse impacts. By putting a price on carbon, both systems raise concerns about adverse impacts on energy-intensive firms and manufacturing states, and on workers and communities that historically have been dependent on fossil fuels. For example, both could result in large wealth transfers from coal and manufacturing states to other parts of the country. However, through special tax provisions or the use of allowance value, either can be designed in a way to mitigate adverse impacts on disadvantaged groups. Similarly, both systems would require special provisions to avoid imposing requirements on GHGs that are consumed as feedstocks or to provide credit for reductions that result from capturing and storing carbon or expanding carbon sinks.
Both require monitoring, reporting and verification. Both systems require similar data on emissions, reporting and verification of that data, and enforcement in the event of noncompliance.
Cost certainty v. environmental certainty. By setting a cap and issuing a corresponding number of allowances, a cap-and-trade system achieves a set environmental goal, but the cost of reaching that goal is determined by market forces. In contrast, a tax provides certainty about the costs of compliance, but the resulting reductions in GHG emissions are not predetermined and would result from market forces.
Compliance flexibility for firms. A tax requires a firm each year to decide how much to reduce its emissions and how much tax to pay. Under a cap-and-trade system, borrowing, banking and extended compliance periods allow firms the flexibility to make compliance planning decisions on a multi-year basis.
Impact of economic conditions. Changes in economic activity impact a firm’s behavior under either system. Under a cap-and-trade system, reduced economic growth would lower allowance prices. Under a tax, government action to lower the amount of the tax, not market forces, would be required to reduce the carbon price seen by firms. In times of economic expansion, the opposite would be true – under cap and trade, allowance prices would rise based on market forces, but taxes would remain the same unless adjusted through government action. In this sense, cap and trade can be seen as providing a self-adjusting price, high when the economy is doing well and low when the economy is in a downturn. A tax in contrast is not self-adjusting.
Linkage to other systems. Ideally, a global price for carbon would develop and allow cost efficiencies to be realized across borders. While we are a long way from a global system, several trading regimes are already operating, expanding, or are planned which could allow international linkages across systems in the future. Far fewer jurisdictions have either instituted or are considering carbon taxes and the notion of an international carbon tax has been considered but generally rejected as not realistic.
Experiences to date: Cap and trade has become the cornerstone of successful efforts to achieve low-cost reductions in sulfur dioxide emissions in the United States. For GHGs, this same approach is also being relied upon in the European Union (EU). The EU has implemented a GHG cap-and-trade program covering thousands of sources and has created a market with millions of transactions producing a market price for carbon determined through supply and demand. Following a trial period, during which a number of start-up challenges were encountered (e.g., lack of data, different approaches across Member States), the EU has succeeded in establishing the building blocks for a successful trading regime. Cap and trade is also being used in three regional trading programs in the United States and Canada. The use of taxes aimed at reducing GHG emissions has initially been used in several countries, including Norway, Sweden and Germany that are now relying increasingly on emissions trading. Carbon taxes have also been used in a few local governments in the United States and Canada. A carbon tax was considered by the Clinton Administration in 1992, but quickly became loaded down with special exemptions, was redirected away from carbon to be a BTU tax to avoid burdening coal, and was ultimately enacted as a few pennies tax on gasoline.
This review of cap and trade and taxes suggests that many of the longstanding myths about these approaches fail to recognize advances in design options aimed at addressing earlier concerns. While a tax regime sounds simpler in theory, history suggests that special provisions would be added, for example, to avoid adversely impacting specific regions, to exempt feedstocks and to mitigate competitiveness concerns. While a cap-and-trade regime doesn’t directly provide price certainty, recent proposals include temporal flexibility (e.g., banking, borrowing, and multi-year compliance periods) as well as floor prices and offset provisions that would dampen price volatility. In the end, history suggests that it is unlikely that a tax would result in a simpler system. The greater flexibility for firms and greater certainty that environmental objectives will be met appear to be the greatest strengths of a cap-and-trade policy.
This series was made possible through a generous grant from the Doris Duke Charitable Foundation, but the views expressed herein are solely those of the Pew Center on Global Climate Change and its staff.
How Much Would You Pay to Save the Planet? The American Press and the Economics of Climate Change
By Eric Pooley
Kalb Fellow, Shorenstein Center, Fall 2008
Contributor at Time Magazine
Eric Pooley, a former Fortune managing editor and Time chief political correspondent, recently published a discussion paper that examines media coverage of the federal climate policy debate.
In his paper, Pooley explores the question: "How is the press doing on the climate solutions story?” Specifically, his paper examines media coverage of climate change with a focus on reporting of the economic debate over the Lieberman-Warner Climate Security Act of 2008. Pooley argues that news organizations should devote greater attention to the climate policy story, and reporters must help fulfill a glaring need for public education about climate change with good explanatory journalism. He argues that there is an emerging consensus among economists that well-designed climate policy would not derail the U.S. economy, and that journalists have failed to report this consensus and have given undue attention to “doomsday forecasts” produced by opponents of climate action.
"This is the great political test, and the great story, of our time," writes Pooley. "But news organizations have not been treating it that way." He goes on to add, “It is time for editors to treat climate policy as a permanent, important beat: tracking a mobilization for the moral equivalent of war.”
The paper emphasizes the enormous complexities of the issue, and Pooley challenges reporters to devote the time required to grasp and explain them to readers in a straight, understandable way.
Pooley’s analysis is based on 40 print articles that examined the cost debate published between December 2007 and June 2008 in national and regional newspapers, wire services, and news magazines. Twenty-four stories are identified as works of journalistic stenography – or he said/she said pieces – and seven are one-sided articles. Pooley finds nine articles that attempt to explain the arguments and offer conclusions “with varying degrees of success.”
“It falls to the press to be an honest broker in this debate – sympathetic to the idea that change must come, yet rigorous in its analysis of competing claims,” he writes.
Pooley argues that reporters too often played the role of stenographer, presenting the give and take of the debate without questioning an argument’s validity. Instead of being stenographers, Pooley challenges journalists to act as referees of the climate debate, “keeping both sides honest by calling fouls and failures to play by the rules.” Playing referee carries greater responsibilities and requires more time and work to grapple with complex issues and present them in an understandable and compelling way. But the details of climate policy are greatly important, notes Pooley, and reporters who operate as honest referees serve a critical role in the debate.
To inform the climate change dialogue, the Center for Climate and Energy Solutions has produced a series of brief reports entitled Climate Change 101: Understanding and Responding to Global Climate Change, Updated January 2011.
These reports provide a reliable and understandable introduction to climate change. They cover climate science and impacts, climate adaptation, technological solutions, business solutions, international action, federal action, recent action in the U.S. states, and action taken by local governments. The overview serves as a summary and introduction to the series.
For more information, be sure to listen to our Climate Change 101 podcast series
The complete set of six reports plus the overview in one volume.
This overview summarizes the key points from each of the Climate Change 101 reports.
This report provides an overview of the most up-to-date scientific evidence and also explains the causes and projected impacts of climate change.
This report details how adaptation planning at the local, state and national levels can limit the damage caused by climate change.
This piece discusses the technological solutions both for mitigating its effects and reducing greenhouse gas emissions now and into the future.
This report discusses how corporate leaders are helping to shape solutions.
This report discusses what will be needed for an effective global effort, one calling for commitments from all the world's major economies.
This report discusses federal policy options that can put the country on the path toward a lower-carbon future.
This report highlights states' efforts as they respond to the challenges of implementing solutions to climate change.
This report describes the actions taken by cities and towns.
This report explains the details of cap and trade.
November 12-14, 2008
Marriott Wardman Park Hotel
The Pew Center on Global Climate Change and Point Carbon invite you to Carbon Market Insights Americas 2008, taking place in the heart of political decision making, the week following the U.S. presidential election.
The event will involve key decision makers in the forthcoming U.S. Administration and Congress and provide participants with a fresh analysis on climate policy and carbon markets in North America. It will offer key insights into how federal policy changes are likely to affect regional cap-and-trade schemes in North America, the global carbon market, and emissions trading around the world.
Click here to Register and to get more information about the conference.
News Release: For Immediate Release — July 28, 2008
Alexia Kelly, The Climate Trust, 541-514-3633
Tom Steinfeldt, Pew Center on Global Climate Change, 703-516-4146
NONPROFIT COALITION ISSUES RECOMMENDATIONS FOR
DESIGN OF GHG OFFSET PROGRAMS IN CAP-AND-TRADE SYSTEMS
Group Receives Major Grant from the Energy Foundation
PORTLAND and WASHINGTON, D.C. — The Offset Quality Initiative (OQI) will release a white paper today in San Diego at a briefing to be held before the opening of the Western Climate Initiative stakeholder meeting. Titled “Ensuring Offset Quality: Integrating High Quality Greenhouse Gas Offsets Into Cap-and-Trade Policy,” the document offers policymakers practical recommendations regarding the integration of greenhouse gas offsets into emerging regulatory systems at the state, regional and federal levels. OQI, a coalition of six leading non-profit organizations—The Climate Trust, Pew Center on Global Climate Change, California Climate Action Registry, Environmental Resources Trust, Greenhouse Gas Management Institute, and The Climate Group—was founded in November 2007 to provide leadership on GHG offset policy and best practices.
“The availability of high-quality offsets is key to containing the cost of climate policy while delivering real greenhouse gas emission reductions,” said Eileen Claussen, President of the Pew Center on Global Climate Change. “A rigorous and adaptable offset program design can ensure that offsets play a valuable role in an effective cap-and-trade system. OQI’s work will assist policymakers seeking to develop core components of a credible offsets program.”
In addition to regulatory design guidelines, the white paper addresses the key criteria for offset quality and discusses offset project types most appropriate for inclusion in emerging regulatory systems. OQI member organizations will discuss their recommendations with policymakers and other stakeholders over the next several weeks, beginning with today’s briefing in San Diego.
“Establishing confidence in the environmental integrity of offsets is critical for the successful launch and acceptance of future cap and trade regulatory systems. The goal of our paper is to provide policymakers with well-conceived and comprehensive recommendations for offset program design based on the collective knowledge and experience of the OQI members. Each nonprofit member of the coalition is a well-respected and established organization in climate change and brings valuable experience and knowledge to the group,” said Gary Gero, President of the California Climate Action Registry.
OQI recently received a one-year grant of $235,000 from the Energy Foundation to support its work. “We were excited and honored to receive the grant,” said Mike Burnett, Executive Director of The Climate Trust, which was awarded the grant on behalf of OQI. “This generous support from the Energy Foundation highlights the need for the unique work and perspective of OQI. We will use the funds to continue to advance sound greenhouse gas offset policy.”
For a copy of the white paper or for more information on the briefing, please visit www.offsetqualityinitiative.org.
About the Offset Quality Initiative
The Offset Quality Initiative (OQI) was founded in November 2007 to provide leadership on greenhouse gas offset policy and best practices. OQI is a collaborative, consensus-based effort that brings together the collective expertise of its six nonprofit member organizations: The Climate Trust, Pew Center on Global Climate Change, California Climate Action Registry, the Environmental Resources Trust, Greenhouse Gas Management Institute, and The Climate Group.
The four primary objectives of the Offset Quality Initiative are:
- To provide leadership, education, and expert analysis on the issues and challenges related to the design and use of offsets in climate change policy.
- To identify, articulate, and promote key principles that ensure the quality of greenhouse gas emission offsets.
- To advance the integration of those principles in emerging climate change policies at the state, regional, and federal levels.
- To serve as a source of credible information on greenhouse gas offsets, leveraging the diverse collective knowledge and experience of OQI members.
Ensuring Offset Quality: Integrating High Quality Greenhouse Gas Offsets Into North American Cap-and-Trade Policy
An Offset Quality Initiative White Paper
Download full paper (pdf)
This paper aims to provide policymakers with practical recommendations regarding the integration of greenhouse gas (GHG) offsets into emerging regulatory systems. Offsets have an important role to play in controlling the costs associated with regulating and reducing GHGs, and in driving technology transformation in sectors not mandated to reduce their GHG emissions. In order for offsets to deliver on their intended purpose — the achievement of a real and verifiable reduction in global GHG emission levels beyond what would have otherwise occurred —regulatory programs must be designed to ensure the quality and effectiveness of offsets used to meet GHG reduction requirements. Policymakers must also have a clear understanding of both the opportunities and challenges presented by the integration of offsets into GHG emission-reduction systems.
This document represents the consensus of the member organizations of the Offset Quality Initiative: The Climate Trust, Pew Center on Global Climate Change, California Climate Action Registry, Environmental Resources Trust, Greenhouse Gas Management Institute and The Climate Group. The GHG mitigation field is evolving at a rapid pace and will continue to do so over the next several years; this document will be updated over time to reflect any changes in the Offset Quality Initiative’s consensus positions.
The work of the Offset Quality Initiative is generously supported by the Energy Foundation.
The Economic Costs of a Market-based Climate Policy
June 2008 (updated version)
Download the full paper (pdf)
Effort to develop a mandatory climate policy is accelerating and it seems likely that a national market-based strategy for dealing with climate change is on the near term horizon. Key provisions are likely to include a cap on selected greenhouse gas (GHG) emissions, an institutional framework for creating a nationwide emissions permit market, a welcoming integration of abatement opportunities from external domestic and international sources, and recognition of a broad range of features designed to soften economic impacts or promote economic efficiency. Prompted by a national sense of urgency, businesses, states and regions also are actively engaged in designing and implementing their own variations on these themes. Together, it is clear that there is growing support for a market-based complement to the technology orientation that characterizes current U.S. policy.
Models only provide a simplified view of our economy. In the case of the Lieberman-Warner Climate Security Act (S.2191), models can capture many of the key policy elements (e.g., the impacts of targets, timing, and offsets) but cannot incorporate all of them.
This In-Brief examines some of the models that have been used to assess the economic impacts of the Lieberman-Warner Climate Security Act (as reported out of Committee in December 2007) and puts them in context for consumers of this modeling information.
Download the In-Brief (PDF)
- Primer on Liberman-Warner Climate Security Act (S.2191) - As Reported out of Senate EPW Committee (PDF)
Vicki Arroyo, Director of Domestic Policy Analysis, Pew Center on Global Climate Change
- Insights from Modeling Analyses of the Lieberman-Warner Climate Security Act (S.2191) (PDF)
Janet Peace, Director for Markets & Business Strategy & Senior Economist, Pew Center on Global Climate Change
In this paper:
- Download Full In Brief
- Press Release
- Further Reading: Insights Not Numbers: The Appropriate Use of Economic Models
May 21, 2008
Contact: Tom Steinfeldt, (703) 516-4146
Click here to access the study.
ECONOMIC INSIGHTS OF THE LIEBERMAN-WARNER CLIMATE SECURITY ACT
Review of Six Economic Modeling Analyses Reveals Important Policy Insights
WASHINGTON, DC -- The Pew Center on Global Climate Change today releases a new study that provides critical insights regarding economic analyses of the Lieberman-Warner Climate Security Act (S. 2191). The study analyzes six major economic modeling exercises conducted to assess costs of this legislation. The Pew Center’s analysis puts the modeling results in context to provide a clear understanding of what models can - and cannot - reveal about the costs of climate policy.
The Pew Center examines the following economic modeling analyses of the Lieberman-Warner bill to derive insights about the drivers of key results and to inform effective policies.
- Energy Information Administration
- Clean Air Task Force
- American Council for Capital Formation/National Association of Manufacturers
- Massachusetts Institute of Technology
- Environmental Protection Agency
- CRA International
Key insights drawn from these modeling analyses and outlined in the Pew Center brief include the following:
- Availability of advanced, low-carbon technology is crucial to minimizing the costs of achieving greenhouse gas reductions;
- Flexibility in the timing of greenhouse gas reductions and allowing banking and borrowing of emission allowances lowers costs;
- The more offsets available, the lower the costs;
- Energy efficiency provisions reduce costs; and
- Robust economic growth is still achieved with climate policies in place.
“Stepping back from the details, all of these modeling efforts show the importance of policies that provide flexibility - like banking and offsets - and promote advanced low-carbon technologies and efficiency,” said Pew Center President Eileen Claussen. “This study delivers critical insights and demonstrates that cost-effective approaches to address climate change can be achieved with sensible policies.”
While the models offer valuable insights, they do not tell the complete story. They reveal long-term assumptions are at best only approximations. For example, accurately predicting the availability and cost of technologies 50 years in the future is nearly impossible. The models do not fully represent the Lieberman-Warner bill, often omitting potential cost-savings provisions including certain energy efficiency inducements and the Carbon Market Efficiency Board’s role in regulating allowances. The models also fail to consider the costs of inaction, and any credible analysis finds that unabated climate change will cost far more than reasonable climate policy.
As a companion to this study, a recent Pew Center paper describes the advantages and limitations of economic models for evaluating policy options. Insights Not Numbers: The Appropriate Use of Economic Models explains that economic modeling cannot predict future events or produce precise projections of the consequences of specific policies. Instead, model results are more appropriately used to provide insights into key economic relationships, to explore the impact of alternative policy designs, and to produce ranges of results based on plausible assumptions and reliable data.
For more information about global climate change and the activities of the Pew Center, visit www.c2es.org.
The Pew Center was established in May 1998 as a non-profit, non-partisan, and independent organization dedicated to providing credible information, straight answers, and innovative solutions in the effort to address global climate change. The Pew Center is led by Eileen Claussen, the former U.S. Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs.