by Erik Markusson

Created on: May 30, 2009

A crucial part in the effort to reduce carbon emissions is putting a price on those emissions. This is the only way to provide economic incentives for this reduction. Economic incentives are more effective than any other kind of incentives. Putting a price on carbon emissions could be done through either a cap-and-trade system or a carbon tax.

In a cap-and-trade system large scale emitters have a limit on the amount of carbon they can emit. This is the cap. The reduction target is achieved by emission limits becoming stricter over time. These limits are enforceable because every emitter is required to purchase a permit for each ton of carbon they emit. The emitters who need to exceed the cap can purchase unused permits from those emitters who are under the cap. This is the trade. The trade acts as an incentive to emitters not to exceed the cap because they can earn extra revenue. It also acts as a deterrent to emitters from exceeding the cap because it will cost them financially to do so.

On the other hand a carbon tax is a more straightforward approach to limiting carbon emissions. It is essentially a pollution tax imposed for emitting carbon. The amount of tax collected is dependent on both the amount of carbon emitted and the carbon content of a particular fuel. For example, coal would be taxed more heavily than natural gas because the carbon content is higher in coal than it is in natural gas. A manufactured product containing carbon such as plastic that isn't burned wouldn't be taxed. Carbon that's sequestered instead of released to the atmosphere wouldn't be taxed either.

Both approaches bring in revenue. In a cap-and-trade system this revenue comes from the government auctioning emission permits. With a carbon tax the revenue comes directly from the tax. The revenue could be used to invest in renewable energy and related infrastructure. The economic effects on lower and middle income consumers could be mitigated through dividends or progressive tax-shifting.

The EU already has a cap-and-trade system in place. In some ways the EU system has been successful in that it covers 45% of the emissions in Europe, 10 thousand companies, and 27 EU countries. On the other hand there have been some unintended consequences like companies that can't stay open because of high energy price, increases in electric bills of up to 25%, and threats of unemployment caused by countries that don't have cap and trade systems. Opinions vary widely about its

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