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10-01: Cap versus Tax after Copenhagen

Modern Energy Review, Vol. 2.  February 5, 2010

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As the Copenhagen Accord makes emphatically clear, developing countries are not accepting emission caps. This will make passing a strong national cap more difficult. Economically cap and trade is a carbon tax with the tax rate set by the permit market to make sure the cap is met. This results in a highly volatile tax rate, which slows investment, makes it more costly, and will likely create political problems as the price of carbon increases over the years.

Any strong international agreement will now need to focus on the price of carbon, rather than on emission caps. To be compatible with a global pricing commitment, any U.S. cap-and-trade policy should stabilize its price with a collar. This will also minimize the risks of a cap’s volatile tax rate. Thing brings cap-and-trade ever closer to a standard carbon tax.