Potential Advantages of a Carbon Tax

This report examines four potential advantages of a carbon tax approach to controlling GHG emissions. These issues are discussed below. The Task Force finds, however, that the political momentum behind cap-and-trade makes its near term adoption much more likely.... [emphasis added]
Although a carbon tax would likely face more political obstacles than a cap-and-trade program, some of these obstacles may be based on misunderstandings regarding the differences between the two approaches or on assumptions that the tax would be set too low to be effective. Conclusions

Market-based mechanisms that limit greenhouse gas (GHG) emissions can be divided into two types: quantity control (e.g., cap-and-trade) and price control (e.g., carbon tax). To some extent, a carbon tax and cap-and-trade program would produce similar effects: Both would place a price on carbon, and both are estimated to increase the price of fossil fuels, which would ultimately be borne by energy users, particularly households. In an economically efficient market with perfect information, either a price (carbon tax) or quantity control instrument (cap-and-trade system) could be designed to achieve the same outcome. Because this market ideal does not exist, preference for a carbon tax or a cap-and-trade program ultimately depends on which variable one prefers to control—emissions or costs. Although there are several design mechanisms that could be included with either program that would blur the distinction, the gap between price control and quantity control can never be completely overcome. Moreover, with a set price, industry would have better information to guide investment decisions (e.g., energy efficiency improvements and/or equipment upgrades), unless the tax rate was subject to periodic adjustment to achieve GHG emission reduction goals. Economists often highlight the relative economic efficiency advantage of a carbon tax, but this advantage rests on assumptions about the expected costs and benefits of climate change mitigation, both of which contain considerable uncertainty and some controversy. Some contend that a carbon tax may provide implementation advantages, including greater transparency, reduced administrative burden, and relative ease of modification. The primary disadvantage of a carbon tax is that it would yield uncertain emissions. Some argue that the potential for irreversible climate change impacts necessitates the emissions certainty that is only available with a quantity-based instrument (e.g., cap-and-trade). Although it may present implementation challenges, policymakers could devise a tax program that yields only short-term emission fluctuations, as it progresses towards its long-term emission reduction objective. Proponents argue that short-term emission fluctuations would be preferable to price fluctuations that might be expected with a cap-and-trade system. For example, Congress could devise a cap-and-trade program that controls total costs and price volatility to some degree.
Market-based mechanisms that limit greenhouse gas (GHG) emissions can be divided into two types: quantity control (e.g., cap-and-trade) and price control (e.g., carbon tax or fee). To some extent, a carbon tax and a cap-and-trade program would produce similar effects: Both are estimated to increase the price of fossil fuels, which would ultimately be borne by consumers, particularly households. Although there are multiple tools available to policymakers that could control GHG emissions—including existing statutory authorities—this report focuses on a carbon tax approach and how it compares to its more frequently discussed counterpart: cap-and-trade.
If policymakers had perfect information regarding the market, either a price (carbon tax) or quantity control (cap-and-trade system) instrument could be designed to achieve the same outcome. Because this market ideal does not exist, preference for a carbon tax or a cap-and-trade program ultimately depends on which variable one wants to control—emissions or costs. Although there are several design mechanisms that could blur the distinction, the gap between price control and quantity control can never be completely overcome.
A carbon tax has several potential advantages. With a fixed price ceiling on emissions (or their inputs—for example, fossil fuels), a tax approach would not cause additional volatility in energy prices. A set price would provide industry with better information to guide investment decisions: e.g., efficiency improvements, equipment upgrades. Economists often highlight a relative economic efficiency advantage of a carbon tax, but this potential advantage rests on assumptions—about the expected costs and benefits of climate change mitigation—that are uncertain and controversial. Some contend that a carbon tax may provide implementation advantages: greater transparency, reduced administrative burden, and relative ease of modification.
The primary disadvantage of a carbon tax is that it would yield uncertain emission control. Some argue that the potential for irreversible climate change impacts necessitates the emissions certainty that is only available with a quantity-based instrument (e.g., cap-and-trade). Although it may present implementation challenges, policymakers could devise a tax program that allows some short-term emission fluctuations, while progressing toward a long-term emission reduction objective. Proponents argue that short-term emission fluctuations would be preferable to the price volatility that might be expected with a cap-and-trade system.
Although a carbon tax could possibly face more political obstacles than a cap-and-trade program, some of these obstacles may be based on misunderstandings of the differences between the two approaches or on assumptions that the tax would be set too low to be effective. Carbon tax proponents could possibly address these issues to some degree, but there remains considerable political momentum for a cap-and-trade program.