The 21st Century climate challenge

advantages. Even so, tax systems can also behighly complex, especially when, as would bethe case with carbon taxation, they incorporateexemptions and special provisions.Moreover, the design and implementation oftaxation systems is no less open to lobbying byvested interests than permit allocations undercap-and-trade programmes.Price volatility is a challenge incap-and-trade systems. Here too, however, it isimportant not to over emphasize the differences.If the policy aim is to achieve quantitativegoals in the form of reduced emissions, carbontaxation will have to be constantly amended inthe light of quantitative outcomes. Marginal taxrates would have to be adjusted to reflect undershootingor overshooting, and uncertaintiesover marginal tax rates could become a sourceof instability in energy prices.What about the argument that carbontaxation offers a predictable revenue streamto finance wider tax reform? This is animportant potential benefit. However,cap-and-trade programmes can also generaterevenues, provided that they auction permits.Transparent auctioning offers severaladvantages apart from revenue mobilization.It enhances efficiency and reduces thepotential for lobbying by vested interestgroups, addressing two of the major drawbackswith quota systems. Signalling the gradualintroduction and scaling up of auctioning tocover 100 percent of permit allocation shouldbe an integral part of cap-and-trade design.Unfortunately, this is not happening underthe EU ETS, though several states of theUnited States have proposed the developmentof auction-based cap-and-trade systems.From a climate change mitigation perspective,cap-and-trade offers several advantages. Ineffect, taxes offer greater price certainty, whilecap-and-trade offers greater environmentalcertainty. Strict enforcement of the quotaguarantees a quantitative limit on emissions,leaving markets to adjust to the consequences.The United States acid-rain programmeprovides an example of a cap-and-trade schemethat has delivered tangible environmentalbenefits. Introduced in 1995, the programmetargeted a 50 percent reduction in emissions ofsulphur dioxide (SO 2). Tradable permits weredistributed in two phases to power plants andother SO 2-intensive units, creating incentivesfor rapid technological change. Today, thetargets are close to attainment—and sensitiveecosystems are already recovering. 36In the context of climate change, quotasmay be the most effective option for achievingthe stringent near-term goals for emissionreductions. Put simply, cap-and-trade offersa quantitative mechanism for achievingquantitative targets. Getting the price righton marginal tax would produce an equivalenteffect over time. But getting the price wrong inthe early stages would compromise mitigationefforts because it would lead to higher emissionsrequiring more stringent future adjustments.What is important in the context of anydebate over the relative merits of carbon taxationand cap-and-trade is clarity of purpose.The ambition has to be aligned with the carbonemissions trajectory for avoiding dangerousclimate change. For developed countries, thattrajectory requires 30 percent cuts by 2020 andat least 80 percent cuts by 2050 against 1990levels. The credibility of any cap-and-tradescheme as a mechanism for avoiding dangerousclimate change rests on its alignment withthese targets—a test that the EU ETS currentlyfails (see below).Estimating carbon taxation levels consistentwith our sustainable emissions pathwayis difficult. There is no blueprint for estimatingthe marginal taxation rate consistentwith that pathway. One reason for this isuncertainty about the relationship betweenchanged market incentives and technologicalinnovation. Economic modelling exercisessuggest that a carbon price in the range ofUS$60–100/t CO 2would be broadly consistentwith the mitigation efforts required. Theintroduction of the tax would have to be carefullysequenced to achieve the twin goal of signallingthe long-term direction of policy, withoutdisrupting markets. One possible option is agraduated approach along the following lines:• A tax of US$10–20/t CO 2introducedin 2010;Economic modellingexercises suggest that acarbon price in the range ofUS$60–100/t CO 2would bebroadly consistent with themitigation efforts required3Avoiding dangerous climate change: strategies for mitigationHUMAN DEVELOPMENT REPORT 2007/2008 127