Compare carbon taxes with emission trading schemes as government policy tools.

Introduction

Why do we need environmental control

Over the last century and a bit the world have added 40% more CO2 to the Earth’s atmosphere. Every year the World collectively add more again than we did the year before. The Earth is on an accelerating drive to change our planet’s atmosphere. The main source of this additional CO2 is the burning of fossil fuels.
There is a common consensus that global warming is an effect of increased carbon emission and only a few groups still hold on to the belief that there is no connection between emissions of greenhouse gases (Carbon) with the effect of global warming.
The leading scientist have predicted Australia has 5 years to reduce its carbon emission to prevent dangerous climate change which may cause average temperate to increase on average by 2 degrees.
For the benefit of Australian farmers, grazers and fisherman to enable them to have the best chance to feed the world, and Australian’s primary industry to have the best opportunities for sustainable growth, measures must be undertaken to reduce carbon emission.
Government initiatives is required to correct because environmental control, air quality and climate change are all public goods. Public goods are those that everyone can enjoy and no one can be excluded from enjoying the goods. Since it is a public good, everyone can enjoy but no one actually pay for anything to enjoy the good. Public good can lead to negative externalities where the consumption of a shared resource by companies and entities acting in their own and immediate self-interest diminishes or even destroys the public good for everyone. Since air pollution through emission of CO2 is free, companies and entities are unwilling to reduce CO2 levels especially air pollution and climate change are the responsibility of the world at large and the job of each countries respective government.
The only way to reduce carbon footprint and reduce the emission of CO2 is to put a price on emission of carbon and therefore ‘make the polluters pay’. This way the price to pollute will be included as a cost variable and considered the same way that expenses such as wages, rent, electricity, royalty etc are considered. When a price is put on carbon emission, it provides a clear disincentive to continue the current level of carbon emission but reduce carbon emission in a way that has the least impact on the current company production.

In addition, a price on carbon emission means extra costs to the company and this has the effect of the company to not just reduce emissions but to explore other alternative energy type such as renewable energy. The benefit is long term carbon emission reduction and potential development of low-emission technology for future use.

Carbon Tax

A carbon tax as the name suggests itself is a tax on pollution or carbon emission. The government set a price on the price of carbon with the resulting market force determining how much quantity of emission is reduced. Since there is a price on carbon emission, it becomes one of the factors of doing business and therefore a price that need to be paid by the business. Just like costs such as labour costs, rent and electricity- the price of carbon emission is another cost that the business needs to bear. There are no limits on how much emission a company can do, but any emission the business undertakes will need to be paid for in term of carbon tax.
Carbon taxes offer a potentially cost-effective means of reducing greenhouse gas emissions. Carbon tax address the issue that the polluters are not taxed sufficiently for the extra pollution that these companies are emitting to the local atmosphere. The pricing of carbon will need to be specific and take into consideration factors such as
• The desirable emission level on a global scale
• The amount of revenue the government would like to generate from the scheme
• Likelihood of reduction in carbon emission on productivity
• Likelihood to alter carbon price in the future

Currently, Australia has a carbon pricing mechanisms where companies that emit over 25,000 tons per year of Carbon dioxide equivalent greenhouse gases and which are not in the agricultural or transport industry are required to surrender their permit and pay tax on the excess emissions. Government agencies report that in Australia, over 260 companies were liable to pay carbon tax in 2013(Department of Climate Change).

Advantages

Disadvantage
Emission Trading Scheme

The emission trading scheme on the other hand is a government initiative that set a limit on the total emission that is applicable and issue permits to emit a specific volume of pollutant. The permit can be traded and as a result, the market determines the price of carbon by the trading of permits – another word for emission trading. Therefore the government set a limit on the final level of emissions and the price of emission is set by the market in term of trading of emission permits. If a company want to increase their emission of certain pollutant, they will need to purchase extra permits in order to increase their emission level. On the other hand, the seller of the permit receives a monetary amount for the sale of the permit. In essence, the seller receives a monetary amount for reduction in emission of the pollutant as the sale of the permit means decrease in emission levels.
Many countries have policies where a set number of permits need to be retired each year in order to reduce the pollution level through the years. The reduction in permit allows gradual reduction of emission levels in a way that is market controlled rather than by government controlled pricing.
Advantage

1. Economic Driver
The advantage of an emission trading scheme is that the price of carbon trade is determine by the market and does no require further adjustment from the government. The government set out the reduction in targets so that they know the total amount of reduction in carbon emission that is required and the market will determine the price by the trading of emission permits. For big emitting companies, they have the options to buy permits to increase their pollution level. As a result, their willingness to purchase permit will determine the price of emitting or price of carbon trade. The main advantage that this is a free market mechanism and the government do not need to intervene. With carbon pricing, the government need to set the market price for carbon for this year and subsequent years and monitor closely the impact of carbon tax on both carbon emission and also the price of commodity as companies and business pass down the cost of carbon pricing to its customers. This problem to an extent is alleviated with the Emission trading scheme as if the company maintains its current emission level, the company do not bear any extra costs from year to year.

2. Certainty of result
Since the fundamental idea is that the government set targets to restrict emission targets by limiting the number and the emission level of each permit, there is more certainty that the ETS will have the effect of reducing carbon emission. Carbon pricing simply put a price on carbon and many theorist argue that if the price of carbon is not priced correctly, it may have the effect of increasing emission trade. Since there is no consensus on the price of carbon, a market based mechanism such as the ETS is more effective way to reduce carbon emission
3. Efficiency
By combining trading with a price for emitting CO2, cap-and-trade seeks out the most efficient reduction projects within the market, delivering a lowest cost outcome. A carbon tax is simply another tax on the company and this will ultimately be passed onto consumers in term of increase in prices and services.
As a result, government will need to provide subsidies to compensate consumer for the increase in price due to the introduction of carbon tax and this becomes cumbersome from an administrative point of view and also is extremely inefficient.
Economic theories argues that using tax to alter behavior should be the last option unless there is market failure or market inefficacy. Taxation to alter behavior is highly

4. Policy and procedure flexibility
Compliance flexibility is delivered through the ability to “make or buy”, i.e. to implement a project and make reductions (including selling allowances), or to buy allowances from the market. A tax is unable to replicate the incentive for companies to reduce emissions that a trading system brings. Cap-and-trade delivers a profit-incentive to companies which discover stronger and more effective ways of reducing emissions. Perhaps because of the lack of positive incentive, energy tax elasticities are not high, and their impact on behaviors and consumption is low.
Policy flexibility comes through the mechanism for distribution of allowances. For example, in Phase III of the EU ETS some allowances will be distributed for free to deal with competitiveness concerns. Despite this, the incentive to reduce emissions remains in that the allowances have a value. Replicating this approach in a tax-based system—through tax credits or exemptions—would add the complexity that tax-proponents claim to avoid.

Reference

Department of Climate Change. "Starting Emissions Trading on 1 July 2014 Policy Summary". Australian Government. Retrieved 25 July 2013.