The Economics of Carbon Taxes


Thoma has a good overview of the economics of the carbon tax vs cap-and-trade

debate. John

Whitehead, it seems, is more or less agnostic, after having run through

the economic

theory; Lynne

Kiesling, on the other hand, says that a cap-and-trade system is superior:

Most importantly, how do we know the right level at which to set the tax?

This is where we get to the Coasian/Hayekian crux of the problems with Pigouvian

taxes that the other commenters did not account for in their analyses. The

most problematic aspect of Pigouvian taxes is that they rely on the assumption

that the policymaker has sufficient knowledge to be able to set the optimal

tax. The knowledge of the optimal level of emissions and the optimal tax rate

is not, in Hayek’s phrase, given to any one mind. That is the knowledge

problem. That means that the policymaker has to have information about

production processes, production costs, the epidemiological and other health

and consumption effects of the product, and the economic value of those epidemiological

and other consumption effects. That is a heroic assumption.

The key point here is that we know exactly where to set the cap, in a cap-and-trade

system, in order to reduce carbon emissions to a desired level. But we have

no idea how big a carbon tax would have to be in order to come up with the same


Jeffrey Miller, in Thoma’s comments, says that a small tax now could be ramped

up every year "somewhat aggressively until actual emissions match the goal"

– a scheme which takes away the price certainty that proponents of a carbon

tax love so much.

Ultimately, it’s just not true "that to pick a quantity is really also

to pick a price, and vice versa", as Thoma’s first commenter claims. That’s

the whole point of a cap-and-trade system: you pick a quantity, and then the

associated price fluctuates, on the market, according to all manner of unforeseeable

variables including consumer behavior and technological advances. Given that

the goal here is to get a certain quantity of carbon emissions, it’s much better

to fix that quantity and to let the price fluctuate than it is to fix a price

and have no certainty at all that carbon emissions will fall as much as required.

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