Carbon Tax vs. Cap-and-Trade System


The issue of reducing carbon emissions has become a major point of debate and discussion in various aspects of society including politics, economics, and international relations. Various suggestions and efforts have been put in place to reduce the amount of carbon emitted from human activity. Unlike other atmospheric pollutants, carbon dioxide affects the whole globe as opposed to the region where the pollutant is released; this has for a long time allowed business firms to engage in activities that emit tons of carbon into the atmosphere without feeling any of the cost of the harm of doing so (Ladislaw et al, 2009).

However, in the recent past, efforts have been put in place to make these businesses foot the environmental bills of their activities, therefore, acting as an incentive to reduce their emissions in order to reduce their production costs; this has resulted in the internalization of this externality in the respective markets. Some of these efforts include the carbon tax and the cap and trade system.

Reduction of Carbon Emission

Carbon tax

This is a tax levied on all activities that emit carbon into the atmosphere as a form of pollution; in effect, the tax penalizes the use of fossil fuels as a source of energy. Fossil fuels are hydrocarbons; the release of energy from these fuels involves combustion in the presence of oxygen with the breakage of the bonds to release energy and resulting in the production of carbon dioxide gas that is released into the atmosphere. These fuels include petroleum (and all its products), coal, and natural gas.

It is important to note that each of the fossil fuels has a known precise amount of carbon that can be objectively measured. Additionally, the amount of carbon dioxide released per unit of energy produced is known; as such coal is known to produce much more than petroleum and natural gas with the latter producing the least amount of carbon dioxide. Therefore, a carbon tax is applied according to the expected amount of carbon that the fuel will release upon combustion; and thus penalizing more pollutant fuels heavily and the less one relatively lightly.

It is important also to mention that (especially) petroleum products can be used for other purposes other than generation of energy; such include production of plastics and synthetic fabrics; since these products do not emit carbon dioxide into the atmosphere, they are exempt from this tax (Grossman, 2009).

Other sources of energy that do not involve the conversion of organic carbon to carbon dioxide and energy such as fusion energy (nuclear power) and wind energy (Ladislaw et al, 2009) are not taxed; or may be provided with tax incentives to increase their competitiveness in the face of cheap fuel energy. However, it is important to note that some non-heat energy, for example, electricity, can be traced back to fossil fuels that drive electric turbines powered by furnaces; this type of energy will be taxed accordingly since it is involved in carbon emission.

A carbon tax would involve the payment of a flat tax for emission; thus, such products will be penalized from the source, for example, a mining company will have to pay tax for the coal they put into the market thus raising the cost of this commodity in all the other levels of the market. This passing down of the cost of pollution makes other non-carbon sources of energy more competitive; thus having an overall effect of increasing investment and production of clean energy (Houser & Heilmayr, 2009; Ladislaw et al, 2009).

Cap- and Trade System

This is another approach to reducing the amount of carbon released by various human activities; in this case, the limit for emission is set by a central body, usually a government agency. Various companies are issued emissions permits that give them the permission to emit the amount of carbon stipulated in the permit per unit period. While some companies can reduce their carbon emissions to the stipulated levels while still remaining economically functional others cannot; consequently, a market has developed where the companies with unspent carbon credits can sell them to those who cannot meet such standards thus keeping the total emissions at the level set by the government (Grossman, 2009; USEAP, 2009).

This method of pollution control has been used successfully to reduce the emission of Sulfur dioxide (SO2) gas which caused acid rain in the United States (USEPA, 2009). The market can be adjusted by the government to make such regulations progressive and achieving more reduction in the long run. For example, the credits can be retired once they are traded; thus each time such trade occurs, the industry loses a number of credits that they can trade thus forcing them to reduce their emission further. Additionally, some systems are open to other players such as environmental conservation groups who can purchase such credits and retire them thus depriving industry players the allowance to emit carbon and driving up the cost of the remaining credits also forcing them to further control their emissions.

While the government sets the amount of carbon that the industries can emit, the individual ventures are free to choose the method they will use to effect such reduction. Therefore, the ventures that can reduce their emissions cheaply do so and they then sell their surplus allowances to others who cannot; the former thus get rewarded for being environmentally friendly (through the acquisition of income) and the latter get penalized for emitting above the cap thus having them pay for the effects of the pollution.


One might be tempted to ask why there is so much clamor to reduce the total amount of carbon emitted to the atmosphere. In order to get the whole picture, one must comprehend the effect of the release of carbon dioxide into the atmosphere. As mentioned before, all fossil fuels are hydrocarbons whose combustion to generate energy results in the formation of carbon dioxide, an innocuous gas. It is this gas that causes the Greenhouse effect and thus Global-warming.

The Greenhouse effect and Global-warming

The greenhouse effect is a natural occurrence and is an important factor in maintaining the more-or-less constant temperature of the globe. Greenhouse gasses that are naturally found in the earth’s atmosphere including carbon dioxide, ozone, methane, and water vapor act in the same way as greenhouse functions to trap the energy of the sun (Nabi & Qader, 2008). Solar energy passes through the atmosphere and reaches the earth’s surface; while some of it is reflected back into space, a good amount is retained as heat and is responsible for the optimum temperatures that maintain life on this planet.

Natural Greenhouse effect responsible for maintaining life on the planet.
Figure A; Natural Greenhouse effect responsible for maintaining life on the planet. Source: Nabi & Qader, 2008.

The number of greenhouse gasses in the atmosphere determines the amount of proportion of the solar spectrum trapped; consequently, an increase in the amount of these gasses means an increase in the energy trapped thus a net increase in the temperature of the globe.

The increase in industrial activities has resulted in the release of massive amounts of carbon dioxide and other greenhouse gasses in the atmosphere. These include the burning of fossil fuels to power industrial and domestic activities; and the destruction of forests that acts as zones of carbon dioxide consumption on the globe. The increase in solar energy entrapment has caused an increase in the global temperature; since 1861, the global climate has been shown to have increased by 0.6 degrees centigrade; and if the current emission trend continues, it is expected to rise by 1.4 degrees by the year 2100 (Nabi & Qader, 2008).

Effects of accumulation of greenhouse gases on the global temperature.
Figure B; Effects of accumulation of greenhouse gases on the global temperature. Source: Nabi & Qader, 2008.

The effects of increased global temperatures include a change in the global climate with increased incidences of extreme weather such as hurricanes, heatwaves, floods, and drought. Others include melting of polar and glacial ice, rise in sea level, bleaching of corals, and negative effects on species whose habitats are affected (Choi & Fisher, 2003).

Such events would also cause political problems with people being forced to migrate from the affected areas (such as the Netherlands and other low lying islands and coastal zones), the collapse of agriculture and increased food shortages, reduced supply of fresh water, changes in dynamics of (for example vector-borne diseases see Nabi & Qader, 2008); with massive social and economic losses to the affected countries (Choi and Fisher, 2003). Eventually, the globe may degenerate into an international conflict.

Carbon Tax vs. Cap-And-Trade System

Carbon taxation has obvious superiority to cap-and-trade systems; although the latter has been successful in the reduction of SO2 and acid rain reduction in the united states (USEPA, 2009), it cannot be safely assumed that similar measures will be successful in curbing the emission of carbon; this is due to the fact that such emission has a global effect and the sources of such emissions are comparatively numerous and from both economic and domestic activities.

For starters, carbon taxes will allow for a more accurate prediction of the market prices of energy for the future compared to cap-and-trade (Grossman, 2009). This is beneficial because it will allow for the making of decisions that are pegged on the cost and availability of fuel to power industrial and domestic ventures. By placing a tax on the carbon from the very production, the cost of the fuel in regards to carbon emissions will be predetermined and will allow both producers and consumers to make appropriate choices regarding their form and source of fuel. On the contrary, by allowing market forces to control how much penalty is paid for carbon emission as provided by cap-and-trade, the energy prices will fluctuate according to events pegged on the global climate change, such as extreme weather.

Secondly, carbon taxes have more potential for the quick reduction of emissions than caps; the simplicity of planning and execution of the former ensures that such efforts are put in place in as shortest period as possible in order to avert a climatic disaster. While a single tax can easily be instituted on all ventures emitting carbon at the same time, the same cannot be said for the caps. Issues will always arise with the major players opposing such restrictions; with a good number asking for an exemption. In view of this, years may pass before a universally acceptable system is formulated; during this time, carbon will continue accumulating in the environment.

For the purposes of balancing a carbon credit market to ensure that there is minimum abuse and maximum emission reduction, the government is faced with a huge portfolio of administration that may cost too much in funds and public support to be sustainable. Additionally, the market complexity may make it inefficient and difficult to predict even for the major players in the market (Grossman, 2009). On the contrary, a carbon tax involves a simple calculation of the amount of tax on the carbon emitted during the production of a unit of energy.

Additionally, the market players in such a market will only be interested in economic benefit rather than global social wellbeing. Since they have to be involved in the setting of such emission caps, it is inevitable that they will try (and succeed) in manipulating such regulations in a manner that puts much more money in their pocket. Additionally, these negotiations most likely peg the caps on levels of past emissions; the industries may very well be tempted to increase their emissions before a cap-and-trade goes into effect so that they can peg their past emission high and benefit maximally from selling artificial carbon credits; all this having a devastating effect on the global climate.

As mentioned before, the carbon tax is enforced right from the source, as such, all the people using fossil fuel have to pay for the carbon emitted. On the contrary, cap systems are only aimed at industrial activities. This is not practiced since in the US 60% of the emissions are attributed to domestic activities (Houser & Heilmayr, 2009); what use is a cap system then if it cannot control this source of pollution?


Compared to the carbon tax, the cap-and-trade system suffers from obvious disadvantages; these range from complexity to lack of transparency. These would make the former much more efficient than the latter. Additionally, the money collected from penalties on carbon emissions can easily be directed to the development of environmentally friendly and economically sound energy sources.

In regards to climate change, our planet is at crossroads, a wrong path will lead us to a climatic cataclysm. Additionally, the clock is ticking and tough decisions regarding the inhabitants of this planet have to be made now. It is time to give up individual (and corporate) ambitions for the welfare of our planet.


Choi, O. and Fisher, A. (2003): The Impacts of Socioeconomic Development and Climate Change on Severe Weather Catastrophe Losses: Mid-Atlantic Region (MAR) and the U.S. Climatic Change 58(1–2): 149–170.

Grossman Nick (2009): Pricing Carbon Efficiently and Equitably: Carbon Tax Center 2007-2009: Web.

Houser T, Shashank M, and Heilmayr R. (2009): A Green Global Recovery? Assessing US Economic Stimulus and the Prospects for International Coordination: Peter G. Peterson Institute for International Economics and World Resources Institute Policy Brief Number PB09. Web.

Ladislaw S, Kathryn Zyla, Jonathan Pershing, Frank Verrastro, Jenna Goodward, David Pumphrey, and Britt Staley (2009): A Roadmap for a Secure, Low-Carbon Energy Economy: Balancing Energy Security and Climate Change: World Resources Institute and the Center for Strategic and International Studies. Web.

Nabi SA, Qader SS (2008): Is Global Warming Likely to Cause an Increased Incidence of Malaria? Libyan Journal of Medicine, AOP: 090105.

US Environmental Protection Agency (2009): Web.

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