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Carbon Taxes vs Emissions Trading Schemes

28 Apr

I had been planning to write a post explaining the logic behind a Carbon Tax or an Emissions Trading Scheme. The schemes are almost equivalent, and the way they work to reduce pollution is like this : by making it more expensive to pollute, people pollute less. If you make the cost of pollution equal to the damage pollution causes, then people only pollute when it’s actually worth their while to do so.

Think about Carbon pollution, for example. Carbon Dioxide pollution will cause damage. This damage can be measured, at least in part, in terms of dollars and cents. Notwithstanding rhetoric like “how can you place a value on a human life,” people regularly do in fact place a monetary value on human lives – even their own life. Every time you decide whether to pay for new running shoes, for example, or whether or not to renew your gym membership.

I’ll write in more detail later about how this works. For now, let me point out that Steve Landsburg, in a series of posts, has been addressing the question of whether Cap and Trade is better or worse than an Emissions Tax.

Read the post, and the other linked posts. Then read a comment I wrote on his first post, which I have edited and reproduced below.

For any cap, there exists an equivalent tax, and vice-versa. This is still true if you allow the tax and cap to be functions of time, or of the demand curve.

A cap allows you to specify with certainty how much pollution will be emitted, but you can’t be sure of the price. A tax allows you to be certain how much polluters are charged per ton, but you can’t be certain how much pollution will be reduced.

The “correct” tax rate is equal to the present value of the marginal amount of damage caused by one ton of pollution. However, even if we could perfectly compute the damage from CO2 pollution and agreed on a discount rate, the marginal amount of damage pollution would be a function of the total amount of pollution – which depends on our cap.

Since we don’t know what effective cap arises from any particular tax, we can’t ever be sure we’ve got the tax exactly right. The same argument shows we can never be sure we’ve got the cap exactly right – even if we had perfect knowledge of climate science and its economic effects and the discount rate we should apply to future costs.

A bit technical, I know. And please note that the uncertainty is not an excuse to do nothing. It is almost certainly true that a tax of, say, $20 per tonne is better than a tax of $0 per tonne or $1000 per tonne. Doing nothing about Carbon pollution is only sensible if extra atmospheric CO2 has no damaging effect. Almost no climate scientist would say that the expected damage from our pollution is zero.

 

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