A cap-and-trade system with freely allocated permits is equivalent to a carbon tax in which the tax revenue is given to stockholders.
The American Clean Energy and Security Act of 2009, a bill co-authored by Congressmen Henry A. Waxman and Edward J. Markey, may soon come to the House floor for a vote. The bill details an expansive greenhouse gas reduction agenda, including the establishment of a cap-and-trade system.
Under cap and trade, American firms must have a permit for each ton of greenhouse gases that they emit. The permits are tradable, meaning that firms may buy and sell them. By limiting the quantity of emissions permits, the federal government controls the total quantity of greenhouse gases emitted. The Waxman-Markey bill requires that America’s economy-wide emissions be reduced to 17 percent of 2005 levels by 2050.
In simple economic models, a cap-and-trade system can be identical to a carbon tax. If the government sells all of the permits to firms at auction, it raises the same revenue as if it had imposed a tax on carbon. Like a carbon tax, a cap-and-trade system is a market-based regulatory mechanism to reduce carbon emissions. These mechanisms impose a cost on carbon emissions by requiring emitters to either pay a tax or obtain a permit. Ideally, this cost should be equal to the environmental damage caused by emissions. Market-based solutions tend to be the most efficient regulatory approach for correcting environmental externalities because producers and consumers are left free to choose the most cost-effective way to reduce emissions. This efficiency can be lost under regulatory systems that dictate particular ways to reduce emissions.
The best policy option would be to use the revenues from cap and trade or from a carbon tax to decrease the marginal tax rates of other distortionary taxes.
Continue reading… Alan Viard
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