Carbon Tax and Regulation

What are the different types of interventions that the government can introduce?

Governments have the ability to intervene with a wide range of measures that can be broadly classified into two categories:

• Direct regulation - It is where the government regulates an activity by imposing restrictions or by providing some form of support to encourage certain behaviour. Regulations are common when dealing with externalities. Examples of regulations that aid in addressing emissions or the broader climate change challenge include, the ban on the use of lead in petrol, new fuel-efficiency standards for cars or the outright ban of the manufacture and use of chlorofluorocarbons which we know cause damage to the ozone layer.
• Corrective tax - Most commonly known as carbon tax  is an example of a Pigouvian tax which, in this case, is a tax that creates a disincentive by penalising activities that generate greenhouse gases. In economics parlance, a carbon tax internalises the negative externality of greenhouse gas emissions and climate change. The carbon tax is imposed on fossil fuels and the size of the tax is determined by the carbon content of that fuel. So, for example, fuels such as coal, which release the most carbon, will be taxed the most.

What are the disadvantages of a corrective tax?

• Unawareness of the impact it will have on the behaviours of businesses and households in advance.
• The reduction in emissions could be very different from the target

What is a cap and trade system?

In a cap and trade system, the authorities set an emission cap or a limit of the amount of greenhouse gas emissions by all the participants in the system over a period of time. The cap applies to all participating countries and businesses. The cap is then transformed into tradable emission allowances.

The EU emissions trading system is the largest gas emissions trading system in the world and is an example of a cap and trade system. The EU system covers sectors of the economy that are responsible for the bulk of greenhouse gas emissions and this includes power stations, industrial plants and airlines.

What are the disadvantages of cap and trade system?

• Complexities of dealing with the practicalities at the country, sector and company level
• The price of the emission allowance is uncertain