Enciclopédia da Energia Natural   CPMA.COMUNIDADES.NET
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Enciclopédia da Energia Natural CPMA.COMUNIDADES.NET


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is typically set to decline over time, ensuring that
overall carbon emissions do, too. Assuming that all innovation
has been fully anticipated, a declining cap would go hand
in hand with increasing allowance prices over time, making
carbon emissions increasingly costly. That need not and
should not be the case.
In a well-designed program, the cap\u2019s declining path is set
well in advance to enable businesses to plan ahead and invest
and innovate accordingly. As a result, carbon prices may
decline hand in hand with carbon emissions. The carbon
allowance price will be as high as necessary and as low as
possible to achieve emissions reductions set by the declining
cap. In the end, the goal is a low cap and a low price. That is
one key difference from a carbon tax, which sets ever higher
prices for carbon emissions.
Cap and Trade Versus Tax
Cap and trade on the one hand and taxes on the other repre-
sent two sides of the same graph (Figure 2). One regulates the
quantity emitted, with the price being set through the market.
The other sets the price, with the quantity emitted being deter-
mined by how businesses react to the new price for pollution.
Figure 2 translates these quantities emitted into resulting
emissions reductions. If the costs of decreasing carbon emis-
sions were known and did not change over time, absent un-
certainties and other market frictions, carbon caps and carbon
taxes would be the same.
In practice (as well as theory), there are some significant
differences. Since regulators will know neither the benefits nor
costs of emissions reductions with certainty, the ratio of their
relative uncertainties matters. A tax will tend to be preferred on
economic efficiency grounds when the benefits curve is rela-
tively flatter and smoother than the cost curve, giving the
regulator more confidence that its estimated price will produce
approximately the right quantity despite inherent uncer-
tainties. A cap will tend to be better when the benefit curve of
abatement is steeper than the cost curve, making getting the
quantity right more important.
Carbon accumulates in the atmosphere and remains there
for a long time. That stock nature of carbon pollution tends to
flatten the benefits curve for emissions reductions, favoring
taxes. The underlying scientific uncertainty around the exact
benefits of carbon abatement and the possible existence of
unknown and often unknowable thresholds points toward
steeper benefit curves for cumulative emissions, favoring
caps. Similarly, proper cap-and-trade design, in particular
banking and borrowing of allowances (see section Cap-and-
Trade Design Principles), will tend to smooth cost curves and
again favor caps (Figure 3).
Political economy is another important factor. Here, too,
the final verdict depends on the particular circumstances. What
is the likelihood that the political process will yield a carbon
tax that is too low compared to what is necessary? What is the
likelihood that the same process will yield a carbon cap that is
set too high?
One political economy argument clearly favors caps: Re-
gardless of how the regulator chooses to allocate individual
allowances among businesses and other stakeholders and how
allowance prices develop over time, a cap ensures the environ-
mental integrity of the system. The upper limit stays in place.
Industry might find cheap ways to comply with overall emis-
sions limits, driving compliance costs and the resulting carbon
price down \u2013 yet overall emissions still fall to the level of the
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 e
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Quantity of emissions reductions
Carbon cap sets quantity...
...resulting in quantity abated.
...resulting in carbon price.
Carbon tax sets price...
Co
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Benefits of one
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Figure 2 In theory, carbon caps and taxes are equivalent absent
uncertainties and market frictions.
Figure 1 Carbon cap and trade explained (illustration by Jonathan
Fetter-Vorm). Reproduced from Wagner G (2011) But Will the Planet
Notice? New York: Hill & Wang, with permission.
2 Climate Change and Policy | Carbon Cap and Trade
cap. With a tax, the lower the price on carbon, the more is
being emitted. Every tax credit, every form of tax relief increases
overall emissions. In the long run, a cap-and-trade system
could have stringent limits and low prices. Under a tax, the
price would remain high unless and until politics decreases
the tax level. And once it does, emissions may increase again.
Cap-and-Trade Design Principles
Successful cap-and-trade systems share several important fea-
tures. The emissions cap needs to be based on science, decline
over time, be predictable and known well in advance, and
be strictly monitored and enforced to ensure compliance. The
range of compliance options and trading components ought to
be as broad and flexible as possible (while remaining as tightly
enforced as necessary), enabling carbon allowances to be
traded across covered businesses, geographies, sectors, and
time. The more flexible the system, the cheaper it will be to
comply, which in turn enables more ambitious emissions
reduction targets.
The fundamental goal of a cap-and-trade system is to limit
emissions. For carbon cap and trade, the goal is limiting emis-
sions enough to avoid dangerous global warming as indicated
by the best available climate science. Given the global nature of
the problem, the ideal carbon cap-and-trade system would
therefore establish global emissions reduction goals. The lim-
ited progress in the United Nations climate negotiations
process has increasingly prompted action at the national
level, as well as by multinational regions (notably the Euro-
pean Union \u2013 EU) and by subnational jurisdictions such as
states, provinces, and cities. In this case, the individual caps
ought to not only follow climate science but also notions of
fairness of how much each jurisdiction needs to reduce its
emissions as part of a wider global effort.
Predictability is key. Knowing the path of the overall cap
well in advance allows businesses to plan investment deci-
sions, which decreases compliance costs. Coupled with trading
allowances across time, it allows smoother allowance price
paths by letting allowance holders bank allowances for the
future or borrow them to use sooner. Banking allowances
implies greater emissions reductions sooner; borrowing allow-
ances implies more emissions today in exchange for steeper
reductions going forward.
Other more intricate design features may also be important
to the success of a cap-and-trade system. One important deci-
sion is around the points of regulation: upstream in the econ-
omy at the level of energy and fuel producers or distributors
with fewer covered entities, or further downstream at the level
of individual emitting facilities with more covered entities and
possibly more flexibility. Another is the allocation of allow-
ances: carbon allowances are valuable commodities. Each al-
lows for 1 ton of carbon dioxide emissions and, thus, equals
the value polluters are willing to pay in order to emit that ton.
How allowances are distributed turns out to have little
bearing on the final environmental outcome. The overall
cap remains in place regardless of who gets the individual
allowances. If allowances are given to polluters, they obtain
the right to pollute at low or even negative cost. If allowances
are auctioned by the government or given to other stake-
holders, polluters pay for each ton emitted, while government
or others such as households