24 October, 2018

Cap-and-trade vs Carbon tax: What’s the difference?

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In today’s world it’s widely agreed that human induced carbon emissions are directly responsible for climate change.


Overwhelming scientific evidence suggests that we need to reduce these emissions if we’re to prevent this looming crisis, with the latest Intergovernmental Panel on Climate Change (IPCC) report concluding that we now need rapid, unprecedented action.


One of the key tools available that can help us successfully manage and lower our carbon emissions is carbon pricing, which typically comes in two different forms.


-       A Carbon Tax – In which an emitter must pay a fee per tonne of carbon emissions they produce


-       A Cap-and-Trade System – Whereby a quota is set at a country or regional level for the total amount of carbon emissions which can be produced. Permits are then allocated or auctioned to emitters, with each permit allowing a set amount of carbon emissions. Any emitter subsequently found to be producing more carbon emissions than their permits budget for will be fined for non-compliance.


However, which is the right approach? Does it matter?



Cap-and-trade vs Carbon tax


Both approaches to carbon pricing are designed to assign a cost to carbon emissions. By attaching a financial price to emissions, emitters are incentivised to not only limit their emissions but are also encouraged to work at reducing them.


Where the two begin to stand apart are in terms of complexity and ‘certainty’.


Compared to a cap-and-trade system, a carbon tax is relatively simple. When implemented by a government it could potentially be attached to an existing administrative body, and launched within just a few months. The price of a carbon tax is also ‘certain’ which provides confidence to emitters; it’s fixed at a set level, and emitters know exactly how much they’re going to have to pay in line with their emissions.


However, what a carbon tax doesn’t do is provide ‘certainty’ regarding reduction of emissions. In theory, if emitters were content to pay the price for their emissions they could produce as much as they desired, and our level of carbon emissions would not decrease.


This is where cap-and-trade has an advantage. While slightly more complicated to implement, a cap-and-trade system sets a fixed limit on emissions and therefore provides ‘certainty’ that the total carbon emissions will be reduced. Emitters can only emit as much as they are allowed to by the permits they’ve purchased, and in the event that any exceed their permitted limit they will face a fine for non-compliance (which exceeds the carbon price, and thus acts as a strong incentive to comply).


By revising over time the total quota of allowable emissions, and reducing the number of available permits in line with this, a cap-and-trade system allows a more direct, ‘certain’ management of carbon emissions.


One perceived disadvantage of a cap-and-trade system is that unlike a carbon tax it fails to provide ‘certainty’ around the carbon price, which isn’t fixed and is instead determined by market demand. In a world in which carbon reduction is vital though, this could actually be a blessing. For example, if new technology is discovered which significantly reduces carbon emitting activities and therefore makes it easier to meet carbon limits, the carbon price naturally lowers. If, on the other hand, carbon emissions are not reduced as quickly as hoped and the limits are harder to meet, the carbon price increases accordingly (as the demand is higher) which in turn provides further incentives to emitters to reduce emissions.


While possible with a cap-and-trade system, the benefit of a responsive carbon price isn’t typically easy to achieve with a carbon tax; any revision to the rate of carbon tax would need to be calculated and approved which, especially if the tax was implemented and overseen by a governmental body, could take considerable time.



What’s the logical conclusion?


At present, given the current status of global emissions, all the scientific evidence, and the increasing urgency with which action is being deemed necessary, emmi strongly believes that a cap-and-trade system is the better approach to take.


If we, as a global community, had more time then perhaps a simple carbon tax (which we had ample opportunity to tweak and fine-tune in order to reach the correct amount of emission reductions) would be sufficient. However, it’s becoming increasingly clear that time is of the essence, and reducing carbon emissions to the required levels quickly and effectively is the overwhelming priority. As such, a cap-and-trade system which provides ‘certainty’ around carbon management takes precedence.


In addition, again considering the limited time we have available to work at preventing climate change, emmi believes we must look for a solution outside of governmental purview. Historically, the nature of politics has meant that governments have been slow to act, with decades of inaction allowing climate change to progress to its current, critical state. Unfortunately, we no longer have the luxury of time with which to indulge this, though thankfully with the blockchain at our disposal we have an alternative; a decentralised, scalable platform, which can provide trust, transparency, and incorruptibility.



Time may be running out, but it’s still not too late to take meaningful, significant action in reducing carbon emissions. Together, we can still share a cleaner future.