Cap and Trade or Carbon Tax?

In his address before Congress last night President Obama called on ''Congress to send me legislation that places a market-based cap on carbon pollution and drives the production of more renewable energy in America.'' The question is, will a cap and trade system deliver the desired result better than a straight carbon tax?

A debate held last October at Columbia University between Yvo de Boer, the executive secretary of the United Nations Framework Convention on Climate Change and Jeffrey Sachs, director of Columbia''s Earth Institute, sheds some light on the subject.

De Boer argues the merits of the Kyoto Protocol, which set limits on greenhouse gas emissions for signatory developing countries and led to the European Union''s carbon emission trading system. Central to this cap and trade scheme is the Clean Development Mechanism. The CDM allows companies in developing countries that exceed their carbon caps to purchase offsetting CDM certificates. These certificates finance clean technology projects in developing countries.

De Boer reports that there are now 1170 registered clean development mechanism projects in 49 developing countries. He notes, however, that he is not ''blind'' to the challenges that the CDM faces, including the sometimes-questionable ''additionality'' of CDM projects. Many argue that these projects would have gone ahead without outside investment and that the CDM is no more than a cheap way for developing countries to buy their way out of carbon compliance.

De Boer believes that carbon cap and trade and the CDM, though imperfect, are worthy works in progress. And he does not oppose a complementary set of carbon taxes. "We need a set of tools to spur both private and public money flows," he says. "Climate change is a global problem and we will need all the tools at our disposal."

Sachs argues that market-based mechanisms like cap and trade have not demonstrated that they can turn the trajectory of carbon emissions as ''sharply and dramatically as we need to do it.'' The CDM, says Sachs, ''is unfortunately a very small marginal tool that isn''t going to really change the broad framework of how energy is produced and technology distributed.'' He also fundamentally dislikes cap and trade because he believes it encourages the continued deployment of questionable, risky financial instruments. ''I am not so keen on sending our best and brightest off to do more financial market engineering'' for the carbon markets, he says. ''I think the meltdown shows how we took a generation of brilliant young people and put them to tasks that don''t solve problems.''

Sachs believes that a carbon tax is much easier to administer than a cap and trade scheme. ''There are just a few places we get carbon from and by taxing upstream''at the refinery or the wellhead''you reach a carbon price for the whole economy,'' he says. Cap and trade systems on the other hand, require monitoring the compliance of hundreds of thousands of enterprises, which, Sachs suggests, keeps a lot of regulators, attorneys, and auditors busy but has questionable impact on carbon emissions.

Unlike a cap and trade system that thrives on price volatility, a carbon tax will put a floor on the price of carbon. A more certain price for carbon encourages long-term investment in clean technologies, says Sachs. While Wall Street''s financial engineers make money from cap and trade, a carbon tax allows real engineers to figure out ways to get CO2 under control. But Sachs isn''t holding his breath waiting for Congress to act on his suggestion. ''The US is neurotic when it comes to taxes,'' he says.


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