Geoscience Reference
In-Depth Information
giving strong incentives to consumers and fi rms to reduce emissions by
raising the price of carbon emissions.
The similarity can be seen with the following example. Assume
that uncontrolled emissions for the United States are 5 billion tons of
CO
2
per year. Then the United States passes cap-and-trade legislation
that limits emissions to 4 billion tons. This is done by auctioning off
emissions allowances for 4 billion tons. (These are the real-world equiv-
alent of the little cartoon in Figure 34.) Allowances are then traded so
that the reductions are undertaken in the most economical manner.
Because it is costly to reduce emissions, the price of an allowance would
rise to the cost of reducing the last ton. Assume that the cost of the last
ton removed is $25 per ton of CO
2
. The price of allowances would then
rise to $25 per ton because that is the price at which emitters are indif-
ferent between incurring the cost of abatement and buying an allow-
ance. From the point of view of a fi rm doing business, it would cost $25
to buy the right to emit a ton of CO
2
.
Now assume instead that the United States imposed a tax of $25 per
ton of CO
2
. At that tax rate, fi rms would fi nd it economical to reduce
emissions by 1 billion tons. From the ground view of individual fi rms,
in both cases the price of adding a ton of CO
2
to the atmosphere is $25
per ton, so fi rms will behave identically in both situations. In one case,
they pay a tax of $25 to emit a ton; in the other case, they buy a permit
for $25 a ton. The quantity of emissions and the price of CO
2
are exactly
the same for the cap-and-trade regime as for the carbon tax. The only
difference is that in the one case government employs a market-based
“quantity” regulation, while in the other case government uses a “price”
regulation in the form of taxes.
In the end, fi rms pay $100 billion (4 billion tons
$25 per ton) to
emit the 4 billion tons of CO
2
. In one case it is $100 billion of taxes; in
the other case, it is $100 billion for allowances. The government gets
$100 billion of revenues in either case. Cap and trade operates just like
a tax on pollution.
×
