Tradeable Allowances and Carbon Taxes: Cost Effective Policy Responses to Global Warming

Abstract

This paper considers cost-effective policies to reduce greenhouse gas emissions. At the international level, tradeable carbon emission allowances are proposed. Domestically, tradeable allowances for carbon dioxide are proposed for large sources, while a carbon tax, linked to the market price of allowances, is suggested for small sources. Trading of emission reduction responsibilities among nations is encouraged to lower compliance costs, facilitate cost sharing, and provide an economic incentive for countries to become signatories to international emissions control agreements and to adhere to their commitments. National policies could target emissions fees and emissions permits at those sectors where they are most appropriate. Emissions fees are better suited to sources with relatively small emissions; tradeable emissions permits are better suited to large sources. A C02 emissions trading system could be extended to include methane and CFCs as well as reforestation. While economic incentive approaches to environmental control offer no panacea, they frequently do offer a practical way to achieve environmental goals more flexibly and at lower cost than more traditional regulatory approaches. They merit serious consideration as policies to address emissions of greenhouse gases are developed.