The 21st Century climate challenge

3Avoiding dangerous climate change: strategies for mitigationThere are strong groundsfor introducingcap-and-trade, especiallyto meet the short term andmedium-term goals uponwhich success in avoidingdangerous climate changeultimately depends• Administration. Advocates of tax-basedapproaches maintain that they offer wideradministrative advantages. In principle,duties on CO 2emissions can be introducedthrough the standard tax system,with opportunities for evasion limited byenforcement at key points in the economy.One estimate for the United States suggeststhat a carbon tax applied to 2000 entitiescould cover virtually all fossil fuel consumption,limiting opportunities for evasion. 31• Limiting distortions caused by vested interests.As in any system of quota allocation,cap-and-trade schemes are open to manipulationby vested interests. As one commentatorhas written, issuing allowances is “in essenceprinting money for those in control of thepermits”. 32 Who gets how many permits and atwhat price are issues that have to be determinedthrough political processes. Inevitably thoseprocesses are open to influence by powerfulactors—power companies, oil companies,industry and retailing, to name a few. Pandemiccheating has been highlighted as the Achilles’heel of cap-and-trade approaches.• Price predictability. While both taxation andcap-and-trade raise the cost of CO 2emissions,they do so in very different ways. Carbontaxes directly influence price in a predictablefashion. By contrast, cap-and-trade schemescontrol quantity. By fixing the quantity ofemissions, such schemes will drive pricesthrough whatever adjustment correspondsto the quota ceiling. Critics of cap-and-tradeargue that quotas will accentuate energy pricefluctuations, affecting business investmentand household consumption decisions.• Revenue mobilization. Carbon taxationhas the potential to generate large streamsof revenue. Because the tax base for carbonlevies is so large, even a modest tax coulddeliver considerable amounts. For theOECD, a tax on energy-related CO 2emissions set at US$20/t CO 2would releaseup to US$265 billion annually. 33 Revenuesderived from carbon taxation can provide asource of finance for the reform of taxationsystems, while maintaining fiscal neutrality(leaving the tax-to-GDP ratio unchanged).Carbon tax revenue can be used to reducetaxation on employment and investment, orto create new incentives for the developmentof low-carbon technologies. For example, inthe early 1990s Norway introduced a carbontax on energy which now generates almost2 percent of GDP in revenue. The revenueflows from carbon taxation have supportedtechnological innovation and financedreductions in labour taxes. 34 In Denmark,carbon taxation has played an important rolein reducing carbon intensity and promotingthe development of renewable energy. Since1990, the share of coal in primary energy usehas fallen from 34 to 19 percent, while theshare of renewables has more than doubledto 16 percent.Taxes and quotas: the differencecan be exaggeratedCarbon taxation does offer an effective routefor cutting emissions. Many of the claimedadvantages are real—as are many of theproblems highlighted with cap-and-tradesystems. Yet there are strong grounds forintroducing cap-and-trade, especially to meetthe short term and medium-term goals uponwhich success in avoiding dangerous climatechange ultimately depends. Moreover, differencesbetween cap-and-trade and taxation canbe overstated. In practice, neither approach isinherently more complex than the other. Bothrequire monitoring, enforcement and effectivegovernance systems—and both have to addressthe question of how to distribute costs andbenefits across society.Administrative complexity is one area inwhich the differences have been overstated.Quota-based systems in any economic sectorcan create formidably difficult administrativeproblems. 35 However, the concentration ofCO 2emissions in large-scale power plants andcarbon-intensive industries makes it possibleto operate cap-and-trade schemes through arelatively small number of enterprises. The EUETS, considered in more detail below, operatesthrough less than 11,000 enterprises.Administration of carbon levies throughthe tax system may have some operational126 HUMAN DEVELOPMENT REPORT 2007/2008