The Lazy Economist: Carbon tax versus cap & trade

A breakdown of the two most popular emission-reducing strategies

A factory emitting money into the air.
Photo: 

It’s hard to look at the news and miss the discussion on carbon pricing.

Whether it’s complaints about Justin Trudeau killing jobs with his carbon taxes, or warnings about how the Canadian government is nowhere near to its Paris Climate Accord commitments, people have a lot of opinions on how governments should approach limiting greenhouse gas emissions.

Regardless of your stance, it’s important to understand the tools governments have at their disposal to limit emissions and incentivize the use of greener alternatives. 

Carbon taxes and cap and trade programs are the two most common types of carbon-pricing schemes used by the government. While they both work towards similar goals, they’re very different systems and render very different results.

A carbon tax targets the emission of greenhouse gases, like the extra taxes drivers pay at the gas station. The rationale behind carbon taxation is that as carbon gets more expensive, greener alternatives will be cheaper by comparison and will become more widely-used.

Under a cap and trade system, on the other hand, governments place a firm limit on how much greenhouse gas companies and corporations can emit.

The cap can apply to large electrical power plants, industrial plants, and fuel distributors. Companies who emit greenhouse gases can receive quotas, which are licences to release certain amounts of emissions. The Canadian government then either sells or distributes as many pieces of quota as are allowed under its carbon cap.

A carbon cap makes up the first half of the policy. The trading part is done by companies who buy and sell bits of quota to each other. Companies that have excess quota can sell it, while those who have less and need more can buy additional licenses.

With this strategy, the amount of emissions into the atmosphere stays capped, and—if the price of purchasing a new quota is more than the price of switching to a greener alternative—companies are encouraged to adopt cleaner machinery. 

As an undergraduate student, I have no clue which one of these strategies is better for the economy or environment. In fact, many people who study this system for a living disagree over it, as a lot of the potential benefits are hard to pin down.

Since we can’t exactly know how much it will actually cost for people to switch to some greener alternative—and thus which strategy works best—most of us will have to settle for at least knowing what carbon taxes and cap and trade actually mean.

When commenting, be considerate and respectful of writers and fellow commenters. Try to stay on topic. Spam and comments that are hateful or discriminatory will be deleted. Our full commenting policy can be read here.