Let's not forget that Carbon Taxes and Cap-and-Trade are Basically Complementary

{Note: the following posting was originally written on January 16, 2010. I re-print it now in light of the current reconsideration of climate change policies by the Christy Clark government}

Alan Durning and Clark Williams-Derry have both written excellent pieces for the Sightline Daily on the issue of carbon taxes versus cap-and-trade that help to clarify the issues.

Basically, the difference between carbon taxes and cap and trade is in where they concentrate uncertainty. "With carbon taxes, the government locks in the price of carbon, and the market decides how much carbon to emit. If fossil fuel prices fall, or the economy surges, or inflation runs hot, emissions can rise despite the tax. With cap and trade, on the other hand, the government locks in the carbon emissions, and the market decides what price carbon needs to be; ideally, emissions fall, slowly and steadily, no matter what happens to the rest of the economy. I tend to think of cap and trade as a variable tax: one that fine-tunes the price to guarantee a certain level of emissions." (Williams-Derry, Sightline Daily January 4.)

I think that there is a complementarity between the "fixed" element of the carbon tax and the "variable" element of the cap-and-trade mechanism. The former has the virtue of clarity: it is a little harder to 'game' or manipulate because loopholes are generally easy to see. (It also easier for businesses and consumers to plan around.) The latter has the virtue of flexibility, providing a constant incentive for emissions reduction. The former might be better at catching small emitters--who account for half of all emissions-- and who might otherwise be oblivious to what is happening in emissions auctions. The latter catches large emitters who might otherwise just write off any carbon taxes on their inputs as a cost of doing business, without greatly changing their behaviour.

Recent news out of Europe has been encouraging to the NDP and the Sightline writers who generally favour cap-and -trade over carbon taxes. First of all, the emissions trading scheme (ETS) is finally working fairly smoothly after a 3-year period when rights allocated to polluters were evidently issued too generously. Secondly, on December 30, the French Constitutional Court struck down France's carbon tax because it was so full of loopholes that it violated the principle of tax equality!

So we now have two perfect examples of how the carbon tax can be "gamed" and the gaming in cap-and trade can be fixed, right? Yes, but note that it took five years to get cap and trade working properly, while the flaws in the French carbon tax were exposed right at the starting gate.

In other words, le Conseil constitutionnel exposed the weakness in a particular carbon tax, but still validated the concept of the carbon tax in general: that it operates in a clear, direct, transparent and (when done properly) equitable and efficient manner.

So, carbon tax or cap-and-trade?  In both cases, the devil is in the details.