Most of the world's governments agree by now that global warming poses a serious threat to the future well-being of all people and they agree that it is desirable to reduce the concentration of CO2 in the atmosphere by lowering our emissions of CO2. This consensus was expressed in part through the Kyoto Protocol (signed in 1997, put into place in 2005), which set targets for emissions reductions by the countries of the world (the US, Canada, Andorra, Afghanistan, and South Sudan are the only holdouts). This protocol calls for reductions in emissions that would effectively produce the SRES A1B scenario that we talked about earlier in the course. The individual countries then are left to figure out how to meet the emissions reduction goals. So, how could countries make this work — that is the question.
There are two strategies that a country might adopt — a carbon tax or a cap-and-trade system. The carbon tax approach would reduce emissions by providing a strong incentive to be more efficient and use cleaner energy sources. The cap-and-trade system instead sets an overall limit or cap on emissions and then allocates or auctions off the right to emit carbon and then allows these emission rights to be bought and sold in a kind of carbon market.
Before we could consider a tax on carbon, we need to know what is the cost of emitting a certain quantity of carbon.
By emitting carbon into the atmosphere, we are effectively imposing an economic burden due to carbon dioxide's contribution to climate change, which will inevitably cost us money. The thing is, we don’t pay these costs as we emit carbon, but they are nevertheless costs that will add up. Economists call these kinds of things “externalities”. They estimate that one ton of carbon emitted to the atmosphere imposes a cost of about $40, and the per capita costs for an American are about $200. As you might expect, this is a very tricky thing to estimate and estimates vary quite a bit.
Let's try to put these numbers into perspective, beginning with the emissions related to a normal American's activities. If you drive 10,000 miles in a year and your car gets 28 miles per gallon of gasoline, you are emitting about one ton of carbon (this is equivalent to 3.67 tons of CO2). A normal household in America might use 10,000 kWh (kiloWatt hours) of electricity, and if this is coming from a coal-burning power plant, the household is emitting about 3 tons per year. If your electricity comes from burning natural gas, the same amount of electrical power use emits just 1.5 tons of carbon.
What if we said that we were going to pay for these externalities related to emitting carbon into the atmosphere via some kind of tax or fee to cover the $40/ton cost? This would mean something like a 10¢ per gallon increase in gasoline and about a 10% increase in the average household electric bill for electricity generated by coal. By doing this, we would be covering the anticipated future costs of our carbon emissions.
But covering the anticipated future costs of carbon emissions is only part of the goal. We also need policies that will help reduce emissions. One might think that the taxes or fees mentioned above could contribute to a reduction in emissions in the sense that by making things more expensive, people will use less, and this is probably true to a certain extent, but we can definitely do more. For instance, imposing a larger tax or fee on gasoline and electricity generated by fossil fuels would provide a stronger incentive to consume less and thus emit less carbon.
Another approach is one known as “cap-and-trade”. In this policy, a state or country establishes an overall limit or cap on the carbon emissions for each year and then allocates or auctions shares of this total to utilities, companies, etc. These entities receive shares (which are like permits for emitting a certain amount of carbon) and can then sell them to others (thus the “trading” aspect to this policy). The appeal of this kind of approach is that there is a fixed limit to the emissions — it is controllable and predictable, whereas a simple “carbon tax” approach does not guarantee any particular total emissions amount and if a country wanted to use such a tax to meet specific goals, the tax would have to be adjusted frequently, which businesses would have a hard time dealing with (they like predictability in things like taxes).
This is the approach that has already been adopted by the European Union, who, in 2005 launched the European Union Emission Trading Scheme. This is the largest greenhouse gas emissions trading scheme in the world and is one of the EU's central policies for meeting their cap set in the Kyoto Protocol. How is it working? The EU's total emissions have steadily declined over this time period, so it seems to be working.