Pricing Carbon: Tax vs. Cap and Trade

Addressing a Market Failure: the costs of emissions to US health and welfare are paid by the public.

A Market Solution puts the costs of emissions on the emission, not on the consumer. Two solutions are Cap and Trade and a Carbon Tax.

The ways pricing carbon by either mechanism are similar

  • Harnesses market forces to achieve the lowest cost reductions in green house gas emissions
  • Imposes compliance obligations on targeted industries
  • Requires monitoring, reporting and verification
  • Can have adverse impact on high emitting states and communities

A comparison of the differences

Cap and Trade

Emission Certainty

  • Allowed emission are set
  • The costs vary as market forces affect technologies and financing


Cost Certainty

  • The tax is set by Congress. Since it requires a vote of Congress, rate changes are not expected to be frequent, although they are expected to respond to major shifts in the economy
  • Emissions reduction harder to predict since some companies will pay the tax rather than reduce emissions

Permits for emissions

  • Sets a maximum level of pollution, distributing emissions permits among firms that produce emissions
  • Companies can obtain permits either through an initial allocation or auction, or through trading with other firms

Tax on emissions

  • Imposes a tax on each unit of greenhouse gas emissions
  • Gives firms an incentive to reduce pollution whenever doing so would cost less than paying the tax

Complying with the cap

  • Company decides how to meet emissions reduction through investments in carbon reducing activities, such as installing new equipment or buying offsets
  • Can purchase offset from company that has emissions below their allowable cap

Complying with the tax

  • Company decides how to balance costs of taxes against installing emissions reductions
  • Can not trade reductions with another firm

Indirect costs to consumer

  • Indirectly affects consumer as costs integrated into capital costs through long term investment, loans and other financing

Direct costs to consumer

  • Can directly affects consumer as a tax tends to impact cost of goods

More complexity

  • Continuing government involvement in administrating a complex system that measures current emissions against the cap, predicts emission reductions from installed new technologies or upgrades, and balances the trade of offsets from one company to another

More transparency

  • Less government involvement, as tax is levied against verified emissions yearly


  • Market sets pricing
  • In a good economy, market will tend toward higher pricing of offsets and technologies, and vice-versa
  • Companies can use long term strategies to finance projects that reduce emissions


  • Government sets tax rate
  • It takes an act of Congress to change that rate
  • Companies set policy on a yearly basis as they asses the impact of the tax
  • Long term planning affected by the potential for congressional changes in future years

Slow impact

  • Cap rises over time, so slower impact on business

Fast impact

  • Tax hits at the same time, so faster impact on business

Extensive global implementation experience

  • In the US and Europe

Limited global implementation experience

  • Taxes on the supply side -- fuels -- have been very successful
  • Some failures, as in Australia where voters demanded an end due to increases in electricty costs

Higher preference among Progressives

  • Greater assurance of carbon reductions
  • Revenue goes towards supports for research and development of technologies that lower green house gases 


Higher preference among Conservatives

  • Taxes the problem -- the externality -- rather than income
  • Can be revenue neutral: that is dollars are returned to the tax payer 

Potential Best Use

  • Large industrial plants and utilities

Potential Best Use

  • Transportation, heating and cooling


Gratefully acknowledge the following sources. However, all errors are the responsibility of The Green Economy.

  1. Center for Climate and Energy Solutions
  2. Brookings Institute
    Author:  Charles Frank, Nonresident Senior Fellow - Global Economy and Development
  3. The Guardian
    Authors: Luca Taschini, Simon Dietz and Naomi Hicks of the
    Grantham Research Institute on Climate Change and the Environment at LSE in collaboration with the Guardian

See also: Towards a Cleaner World in this magazine.