Carbon tax and cap & trade are both methods that policy makers can use to reduce carbon emissions. Pollution is a negative externality; left to themselves firms with produce more pollution than the socially efficient amount because the private marginal cost of the firm is less than the social marginal cost. This occurs because the marginal cost of the pollution is not borne by the firm. This is an example of a market failure that causes an efficiency loss. Policy makers can correct the problem by internalizing the cost of pollution for the firm. Pollution abatement, on the other hand, is a positive externality. Free markets will not do enough to abate pollution because the social marginal benefit is higher than the private marginal benefit of the firm. The government can correct this by giving the firm incentive to do more pollution abatement.
It should be noted that the socially efficient level of pollution is still above zero. Even though some radical environmentalists would like to see Canada and its industries produce zero levels of carbon emissions it is in the public interest to pollute. The rule of thumb used in pollution abatement is that pollution should only be reduced as far as the costs are lower than the benefits. Pollution abatement is, in itself, considered to be a reasonable social objective as proven by the amount of media and international attention it receives. Numerous international organizations have pollution agreement sides, such as NAFTA. Canada has agreed, in these treaties, to reduce green house gases by specific amounts. It is, however, hard to put an economic price tag on the social benefit of pollution abatement.
There are four basic solutions to all externality problems.
- Internalizing the externality
- Quantity controls and standards
- Taxes and subsidies
- Market creation
Taxes and subsidies - Carbon Tax
Carbon tax achieves the socially efficient level of pollution by raising the firm’s marginal cost to the social cost. Taxes raise the private marginal cost by the amount of the tax. This is shown diagrammatically in figure 1 in the table of figures. By raising the private cost to the social cost the firm will produce the socially efficient quantity, shown in the figure as Q-optimum. Taxes work well because they offer incentive effects for pollution abatement and they take advantage of some market forces. Taxes are easily incorporated by the firm into its normal cost of doing business.
The firm will abate carbon emissions as long as the marginal abatement cost is lower than the cost of the tax. When the marginal abatement cost becomes higher than the tax the polluting firm will choose to pay the tax and pollute. This situation is shown in figure 2. The cost of pollution abatement to the left of the cap line is shown by the area B, the tax cost is shown by the area A and B. Thus it is cheaper for the firm to abate pollution up to the point of the tax line when the abatement cost become the area C and D, more than the tax cost.
Taxes are an enticing form of pollution abatement for the government because it provides a clear source of revenue. However, when compared to standards and cap & trade, the government has less control over the quantity of emissions. Taxes affect the cost of doing business and the market determines the quantity of emissions and the amount of pollution abatement activity. With sophisticated forecasts the government can have a fairly good idea of how much a tax will affect the quantity of emissions. Taxes require accurate monitoring technologies to ensure appropriate tax amounts are levied. Having known schedules of future tax hikes will positively affect the behaviour of the firm towards future abatement practices, such as investing in more efficient equipment.
One of the main problems associated with taxes is public relations. Many citizens and firms are strongly against raising taxes. Taxes may also be more susceptible to lobbying parties than the cap & trade method which may deter sufficient tax levels being set. British Columbia adopted the Carbon tax in 2008 . It did this to address the problem of carbon emissions and to bring in additional revenue.
Market creation - Cap & Trade
Cap & trade is a policy example of quantity control and market creation. It also works to limit pollution to a level equal to the socially efficient quantity. It does this by internalizing the cost of the externality through permits. A set amount of issued permits allows the government to limit to the amount of carbon emissions.
In the Cap & trade method the government issues out carbon permits to polluting firms. Each permit gives the firm permission to emit a unit of carbon. There are various ways of handing out these permits. One way is to give more permits to high pollution abatement cost firms. A second is the give each firm the same number of permits. The third, and probably best way, is to auction off the permits. In the first two methods the permits can be re-sold in a secondary market. All methods allow the forces of the market to decide the price of pollution. If the firm’s marginal abatement cost is lower than another firm’s abatement cost it would propose a trade. The abatement cost to the firm is reduced by the amount is saves by selling the permits. This is shown in figure 3. The low marginal abatement cost firm saves the costs shown by the areas C, G, and K by selling the permit to the high marginal abatement cost firm. The government has less control over the price of emissions in this method compared to the tax method but cap & trade utilizes market forces to set a price that more accurately reflects the actual value of pollution relative to the limit the government wishes to set.
The fact that the government is able to set a cap on the quantity of emissions through the amount of permits it releases may be one of the reasons the Government of Canada wants to adopt a cap & trade method; it will enable them to reach its international pollution abatement goals with more certainty than a tax would. It’s a better approach then simple quantity controls and standards because it allows the market forces to determine the price of pollution, giving low marginal pollution abatement cost firms incentive to reduce pollution and high marginal pollution abatement cost firms the ability to ‘buy’ more pollution.
Policy makers can use either the tax method or the cap & trade method to reduce pollution to the socially efficient quantity. Both methods increase efficiency and prevent the market failure associated with externalities. Economists prefer tax and cap & trade over standards and quantity control because they both utilize market forces. The main difference between the two methods is how they are administered and how the costs are distributed. The cost to the firm can be lower for the cap & trade method, depending on how the permits are distributed. If the permits are auctioned off cost to the firm may be very similar to that of the tax method . Both methods give the firm incentive to reduce carbon emissions and to abate them through new technology investments. The government receives revenue through taxes but using the auction distribution method of cap & trade the government can also receive revenue. Neither method is universally or significantly better than the other. The best selection depends on the specific situation and needs of the policy maker.
I feel the best method for Canada and the Government of British Columbia is the cap & trade method. The main goal of pollution abatement is reducing the quantity of pollution to the socially efficient amount. The cap & trade method allows more certainty at meeting the reduction goals than the tax method. The cap & trade method also helps at reducing the power of lobbying parties as the cost of pollution is set by market forces and not by a policy maker. By using the auction method of permit distribution British Columbia could achieve much needed revenue.
I wrote this article a few years ago and unfortunately Harper's Government in Canada doesn't seem to want to address the issue. They posted a video on their YouTube account claiming that we should "REJECT this expensive new tax hike". Comments are closed so we can't hold an open discussion on that channel. Harper recently claimed that "nobody in the world is regulating their oil and gas sector" which is misleading at best and probably just false. Countries like Norway and Mexico use techniques that I mentioned earlier and the European Union has a cap and trade program that covers a range of industrial facilities.
Nothing I mention here is new or revolutionary. I would like to get more info on why Harper is so against enforcing policies that I feel would help control waste emissions.
I hate politics. I feel so alienated by it all. And when the ruling government posts shit like this image, I just want to die. Even someone non-partisan, a non-Canadian, should be offended by this. This isn't sharing knowledge. It isn't helping me make a critical decision come election time. It's crap that makes people not want to vote - and that's what allowed Harper to gain power.