The Economics of Carbon Taxes

Mark Thoma has a good overview of the economics of the carbon tax vs cap-and-trade debate. John Whitehead, it seems, is more or less agnostic, after having run through the economic theory; Lynne Kiesling, on the other hand, says that a cap-and-trade system is superior:

Most importantly, how do we know the right level at which to set the tax? This is where we get to the Coasian/Hayekian crux of the problems with Pigouvian taxes that the other commenters did not account for in their analyses. The most problematic aspect of Pigouvian taxes is that they rely on the assumption that the policymaker has sufficient knowledge to be able to set the optimal tax. The knowledge of the optimal level of emissions and the optimal tax rate is not, in Hayek's phrase, given to any one mind. That is the knowledge problem. That means that the policymaker has to have information about production processes, production costs, the epidemiological and other health and consumption effects of the product, and the economic value of those epidemiological and other consumption effects. That is a heroic assumption.

The key point here is that we know exactly where to set the cap, in a cap-and-trade system, in order to reduce carbon emissions to a desired level. But we have no idea how big a carbon tax would have to be in order to come up with the same result.

Jeffrey Miller, in Thoma's comments, says that a small tax now could be ramped up every year "somewhat aggressively until actual emissions match the goal" – a scheme which takes away the price certainty that proponents of a carbon tax love so much.

Ultimately, it's just not true "that to pick a quantity is really also to pick a price, and vice versa", as Thoma's first commenter claims. That's the whole point of a cap-and-trade system: you pick a quantity, and then the associated price fluctuates, on the market, according to all manner of unforeseeable variables including consumer behavior and technological advances. Given that the goal here is to get a certain quantity of carbon emissions, it's much better to fix that quantity and to let the price fluctuate than it is to fix a price and have no certainty at all that carbon emissions will fall as much as required.