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Pricing carbon: Part two

Hydrocarbon Engineering,

In a recent report, Charles Frank of the Brookings Institute discussed the pro and cons of a US carbon tax versus cap-and-trade.

Easier administration

Frank claimed in the report that a carbon tax is clearly easier to administer because with cap-and-trade there is an additional administrative requirement – the allocation of allowances.

Early attempts at allocation allowances – for example, the sulfur dioxide trading system used in the US in the 1990s – allocated allowances on the basis of historical emissions by source. Frank explained that the more modern approach is to auction allowances as fine by the nine eastern US states comprising the Regional Greenhouse Gas Initiative (RGGI). Auctions are easier to administer and more politically palatable, he claimed.

Cap-and-trade would be prohibitively expensive to administer if applied to automobile transportation or residential heating and cooling, according to Brookings. Thus a tax on fuels used for transportation, heating, and cooling is the preferred way to promote CO2 abatement in these sectors.

Tracking political palatability

Frank highlighted that there have been some instances where carbon taxes for transportation and heating and cooling of buildings have been popular, especially when designed to be tax neutral in that carbon tax revenues are used to reduce other taxes.

However, carbon taxes on large electricity, steel, chemical and cement plants tend to meet considerable resistance from vested interests. In contrast, cap-and-trade markets for utility-scale power plants are politically viable; they are operating in 10 states in the US and EU. More US states may adopt cap-and-trade policies to achieve Environmental Protection Agency (EPA) proposed reductions in state-wide carbon dioxide emissions. Meanwhile, China is establishing seven regional pilot programs for emissions trading, all but one of which is already up and running.

Best of both

Frank explained in his report that one of the potential disadvantages of cap-and-trade is that, without a limit on the price of allowances, the cost of abatement can far exceed the estimated benefits of abatement. However, Frank holds that this problem can be easily solved; by putting an upper limit on the price of allowances.

This is what the RGGI has attempted to do by instituting a Cost Containment Reserve of emission allowances, which can be sold by the participating states to market participants at a fixed price in lieu of requiring them to buy allowances through auctions. Provided the reserve is large enough, this puts a cap on the price of the allowances. In effect a source of emissions can either buy an allowance through the market or pay a tax.

Adapted from a report by Emma McAleavey.

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