The scientific evidence is now overwhelming: climate change presents very serious global risks, and it demands an urgent global response (Stern, 2006). Although some are still arguing over the cause the effect is no longer in doubt.
As a result, over a decade ago, most countries joined an international treaty — the United Nations Framework Convention on Climate Change (UNFCCC) — to begin to consider what could be done to reduce global warming and to cope with whatever temperature increases are inevitable. More recently, an addition to the treaty was approved: the Kyoto Protocol. Countries with commitments under Kyoto are required to meet emission targets and timeframe goals.
To say that climate change is a complex issue is a vast understatement. Uncertainty is generated by the scale and complexity of potential effects and associated costs, which can only be estimates at best. Add the complexity of the uncertainty and imperfection of the real world which includes politics and economics and practical policy approach is limited.
Stern (2006) states that when dealing with such uncertainty, policy approaches can include
- taxing of emissions,
- applying quantity restrictions,
- establishing property rights which underpin bargaining or trading, or
- a single control body.
A single control body is out of the question, particularly considering that participants could not even reach agreement on emission levels at Copenhagen. A tax requires consensus and needs to be agreed on a very broad if not global level to be effective. A full set of property rights are difficult to establish considering that many of those affected are yet to be born and therefore cannot bargain. At the very least, any climate change policy approach should ensure that GHG emitters are required to wear the cost of the damage their emissions cause, with a cost high enough to incentivise a preference for low carbon alternatives.
It would seem reasonable then to allow the mechanisms of the market to establish a cost for carbon in an emission trading scheme, or at least be the easier of the options to implement. A cap and trade system reflects the options of quantity restriction and property rights. The mechanisms of Kyoto favor a cap and trade system establishing a carbon market. With Cap and Trade systems, the overall quantity of emission is established and then the entities within the system i.e. firms, countries etc are free to decide on how to best deliver the reductions.
Established in 2005, the European ETS is the largest and first of the Kyoto trading mechanisms. As the first it has undergone a steep learning curve. The release of the Stern Review which discusses examples from the EU ETS suggests that Trading Schemes may not be the best approach considering the failure of the EU ETS to deliver anywhere near its targets and the enormous costs involved (Stern, 2006). The European ETS did not fail because of the system applied, but rather a failure to effectively control the mechanisms of the system. Failures included over allocation, or caps that were greater than actual emissions and limited scope resulting in the system only capturing a low % of emitters, making price setting difficult. There were administrative issues like excessive free allocation with a knock on effect of windfall profits for emitters. There was general underestimation of the administrative requirements. The EU ETS lacked the complexity and sophistication required to deal with the reality of the free market. There were many criticism of the fledgling system. Stern (2006) noted that the EU went down the trading path having failed to agree on a common carbon tax. This highlights the issue of trying to establish such a tax globally, but suggests that ultimately, if consensus could be reached a tax might be more effective for the short time frame allowed for controlling emissions
The reality is that there is and will be uncertainty about the cost and benefit of action, leaving any solution open to criticism. The uncertainty will decrease over time and as that happens then costs and targets can be adjusted accordingly. In the mean time however the suggestion is that whatever method is used, it should distinguish between the long and short term, the goals should be clear and precise and short term policy should be flexible enough to mitigate the risk of costs getting out of control.
In practical terms, a long term stabilization goal needs to be agreed, again highlighting the failure of Copenhagen. The price mechanism could be a tax or a tradable quota but for the short term, a tax would undoubtedly be most effective. The disadvantage of a Tax is the challenge associated with global establishment and adjustment. Individual countries can establish a tax without consultation however the result would most likely be increased revenues for that government with little effect on emission levels elsewhere.
Assuming a Tax could be agreed, the ease with which it could be adjusted to meet the long term stabilization goal would be its greatest advantage. As understanding evolves, policy will need to evolve and the mechanisms will need to adjust accordingly and with ease.
The unpredictability of market drivers like oil price for example is easier to react to with tax. In certain circumstances however if input cost is low, the polluter may just choose to wear the tax and pass the cost on to the consumer, with little resultant change in emission. It is unlikely though that oil prices will fall a great deal any time soon with the peak in global production occurring in 2005. (EIA, 2010)
Tax revenues raise public revenues. Those revenues can be used to pass on tax incentive to the polluting industry easing the transition. Alternatively tax revenue can be funneled to innovation.
In a quota based system the revenue can only collected if the quotas are initially sold by governments. If the quotas are free then the benefit goes to the polluter in the form of profit. This is one of the criticisms of The EU ETS where quotas were freely given without any impact on emissions. It’s a big if though.
Equity relies heavily on the ease with which finance can flow between developed and undeveloped countries. A tax system would require the implementation of additional vehicles to allow for this transfer.
The sophistication required for complimentary policies and measures most likely lends itself to government policy making mechanisms, but government policy making can be costly and inflexible. Both tax and tradable quota systems are capable of financing carbon reduction. Only the quota system will do it automatically and via the most cost effective path, and only then if managed properly. The failings of the EU ETS have highlighted the difficulties of getting this right however and as a result the pain and compromise of arriving at a equitable and effective tax rate is now being examined as a preferred path.
Energy information administration – EIA – official energy statistics from the U.S. government. (2010). Retrieved 4/15/2010, 2010, from http://www.eia.doe.gov/
Stern, N. H. (2006). The economics of climate change: The stern review Cambridge, UK ; Cambridge University Press, 2007.
United Nations FCCC. (2010). United nations framework convention on climate change. Retrieved 4/14/2010, 2010, from http://unfccc.int/2860.php
United Nations, Food and Agriculture Organisation. (2010). Climate change. Retrieved 4/5/2010, 2010, from http://www.fao.org/climatechange/en/
World resources institute | global warming, climate change, ecosystems, sustainable markets, good governance & the environment. (2010). Retrieved 4/18/2010, 2010, from http://www.wri.org/