Cap-and-Trade vs. Tax

There’s a debate in the US about cap-and-trade as a means to curb greenhouse gas emissions. In a short article in the Harvard College Economics Review, Charles Kolstad, an economist at UC Santa Barbara, claims that a cap-and-trade system is not a tax in disguise, something which has been claimed.

In your first environmental economics class, you’ll learn how a cap or quota on something, pollution for example, is equivalent to a tax in some aspects. They may spread income around differently, but not necessarily. They may also differ when it comes to efficiency. An important issue is how the price (the price of the quota or the level of the tax) is set. Kolstad writes 


A […] subtle advantage of a cap-and-trade system is that the pollution price is induced by a market, not chosen by a bureaucrat [p. 23]. 

But how does Kolstad argue his claim?

 What is the difference between a tax and a revenue-raising cap-and-trade? The primary purpose of a tax is to raise revenue; a secondary purpose is to modify incentives (perhaps even perversely). The primary and fundamental feature of a cap-and-trade system is that it induces a price on pollution, providing an incentive for polluters to innovate and clean up their act. A secondary feature is that revenue is collected. That secondary feature can be neutralized by reducing taxes elsewhere in order to make the program revenue neutral. This is why a cap-and-trade system is not the same thing as a tax [p. 23].  

 The argument is semantic and I don’t find it convincing; I’m tempted to say not even true. To be sure, the encyclopedia entry for tax on says:

[I]mposition of compulsory levies on individuals or entities by governments. Taxes are levied in almost every country of the world, primarily to raise revenue for government expenditures, although they serve other purposes as well (my emphasis).

Landing fees on harvested fish, for example, is a tax whose primary purpose is to modify incentives and not raise revenue. Further, any tax can in principle be made revenue neutral. However, Kolstad is more concerned with the political process of getting cap-and-trade through legislation, where, presumably, semantics are important.

[A] revenue-neutral cap-and-trade, which cannot be labeled a tax, may have the easiest time making it through the tough political obstacles it faces [p. 23].

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One Response to “Cap-and-Trade vs. Tax”

  1. Krugman Picks Up the Ball « Kvams Says:

    […] Picks Up the Ball By kvams After I started discussing cap-and-trade, Krugman saw the need to explain the economics behind it (not the best ‘popular’ […]

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