Resident Scholar Kenneth P. Green

Policymakers wishing to restrain greenhouse gas emissions have a broad range of potential instruments available. They can criminalize emitting activities, they can regulate emissions via technology requirements or emission standards, or they can put a price on the activity via a tax or trading scheme.

There is widespread agreement among economists and public policy analysts that activity bans and regulations are highly inefficient approaches to managing environmental externalities, particularly those such as climate change, where polluting activities span nearly all aspects of human life; cross all jurisdictional borders; have high levels of uncertainty with regard to costs and benefit delivery; and impose asymmetric costs and benefits. Thus, emission pricing--through taxation or the establishment of a pseudo-market that trades in emission permits--has been widely favored (by analysts) over regulatory approaches for several decades. Both taxes and emission-trading (also called cap-and-trade) impose a price on emissions, but the two systems are very different.

Taxing greenhouse gas emissions accomplishes several desirable goals in one stroke: It creates an economy-wide incentive to reduce greenhouse gas emissions; it is largely transparent; it operates within preexisting institutional frameworks adept at fraud prevention; it minimizes the potential for rent seeking; it does not lead to wealth transfer between regions with different forms of economic activity; it produces revenue that can be used to reduce other taxes in order to offset the economic harm of higher energy prices; it is predictable, adjustable, and can thereby avoid price volatility; it shifts some revenue generation from production to consumption; and it can be harmonized internationally if desired.

Emission trading systems by contrast (particularly international systems) are virtually unenforceable; create massive incentives for fraudulent claims of prior emission estimates and emission reductions; lead to massive wealth redistribution; require new untested institutions that have performed poorly in pilot testing (the European Trading System is a prime example); create incentives for rent seeking; generate no revenue to offset the economic harm of higher energy prices; require complicated "safety valves" to prevent massive energy price volatility; and are largely nontransparent.

We recently estimated that a tax of fifteen dollars per ton of CO2-emitted levied on the carbon content of fossil fuels would produce an 11 percent reduction in greenhouse gas emissions while raising the costs of crude oil and natural gas modestly. The majority of the price increase would affect coal prices and hence coal-based electricity. This is entirely appropriate as that, to paraphrase bank robber Willy Sutton, is where the emissions are.

For these reasons, I believe that a revenue-neutral carbon tax is a superior policy alternative to emission trading, regulation, or activity bans if our goal is the cost-efficient reduction of greenhouse gas emissions.

Kenneth P. Green is a resident scholar at AEI.