Abstract: With the passage of the 2005 Sense of the Senate climate change resolution calling on the Congress to enact a mandatory, market-based program to slow, stop, and reverse the growth of greenhouse gases, the issue of related costs has taken on increased importance. Indeed, the resolution itself states that the program should be enacted at a rate and in a manner that “will not significantly harm the United States economy” and “will encourage comparable action” by other nations. Facets of the cost issue that have raised concern include absolute costs to the economy, distribution of costs across industries, competitive impact domestically and internationally, incentives for new technology, and uncertainty about possible costs. In general, market-based mechanisms to reduce greenhouse gas emissions, the most important being carbon dioxide (CO2), focus on specifying either the acceptable emissions level (quantity) or the compliance costs (price), and allowing the marketplace to determine the economically efficient solution for the other variable. For example, a tradeable permit program sets the amount of emissions allowable under the program (i.e., the number of permits available limits or caps allowable emissions), while allowing the marketplace to determine what each permit will be worth. Likewise, a carbon tax sets the maximum unit cost (per ton of CO2 equivalent) that one should pay for reducing emissions, while the marketplace determines how much actually gets reduced. In one sense, preference for a carbon tax or a tradeable permit system depends on how one views the uncertainty of costs involved and benefits to be received.

Market-based mechanisms attempt to address the cost issue by introducing flexibility into the implementation process. The cornerstone of that flexibility is permitting sources to decide for themselves their appropriate implementation strategy within the parameters of market signals and other incentives. That signal can be as simple as a carbon tax or comprehensive credit auction that tells the emitter the value of any reduction in greenhouse gases, to a credit marketplace that is constrained by a ceiling price (safety valve) and includes incentives for new technology. As illustrated here, the combinations of market mechanisms are numerous, allowing decision makers to tailor the program to address specific concerns.

In a sense, the options discussed here represent a continuum between alternatives focused on the price side of the equation (e.g., carbon taxes) through hybrid schemes (e.g., safety valves) to alternatives focused on the quantity side (e.g., banking and borrowing). They are tools to assist in the assessment of potential greenhouse gas reduction approaches, leaving any policy decision on balancing the price-quantity issue to the ultimate decision makers.

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Topics: Climate Change, Energy, Economics & Trade