Carbon tax versus cap and trade:
does it really matter?

Carol Montreuil is the Canadian Fuels Association’s Vice-President, Eastern Canada.

Experts often debate the pros and cons of a carbon tax versus a cap and trade system. A carbon tax establishes a price on greenhouse gas (GHG) emissions so carbon emitters (whether companies or consumers) pay an amount per litre for their equivalent GHG emissions. A cap and trade program sets the emissions cap and issues a fixed number of emissions “allowances” each year. These allowances can be auctioned to the highest bidders and traded on secondary markets to establish a carbon price.

Does the type of economic instrument really matter in developing a carbon mitigation policy?

While there are legitimate reasons to favour one form of carbon pricing over the other, if carefully developed, either instrument will ultimately lead to the same result: a new cost of doing business in jurisdictions where implemented, and a new cost for all consumers. Whatever policy is adopted, it should be both transparent and equitable—two critical and political success factors.

Interestingly, carbon taxes and cap and trade programs share several attributes. Both instruments introduce the all-important and so-called price signal on carbon and carbon-based products that influence both industry and consumers’ investments and purchase decisions. Both instruments also generate government revenue that can (hopefully) be used in productive ways to stimulate development of new low-carbon technologies.

Certainty of costs or certainty of emissions reduction?

Still, important differences exist between these two policy options, and each has distinct advantages and disadvantages. By setting an emissions cap that declines over time, a cap and trade policy can increase certainty that emissions will fall below predetermined emissions targets.

A carbon tax offers stable carbon prices so that companies and consumers can make investment decisions with a level of certainty of costs over a given time. While a carbon tax does not offer the same degree of emissions certainty as cap and trade, use of a stringent adjustment mechanism can modulate the tax upward if the initial emission reductions are too low.

One could argue that implementation issues related to either instrument in Europe and North America are mainly the result of design (e.g. weak emission caps, volatility, communication issues), for which solutions are relatively simple. Hence, as important as carbon-tax and cap and trade instruments might be, policy-makers are well advised to focus on severe competitiveness issues that might arise when these economic tools are not applied consistently across competing jurisdictions.