Addressing the Risks of Climate Change:

The Environmental Effectiveness and Economic Efficiency of Emissions Caps and Tradable Permits, Compared to Carbon Taxes



An ACI study sponsored in February 2007 and authored by esteemed national economist and former Undersecretary of Commerce Dr. Robert Shapiro found that carbon taxes are a better alternative to emissions caps and tradable permits (commonly referred to as cap-and-trade).  After more than two years have passed, the study remains unrefuted and calls into question why are we moving toward a costly cap and trade policy, particularly as the economy is struggling.


In examining the effectiveness and administrative challenges between carbon taxes and cap-and-trade strategies, Dr. Shapiro’s study found that carbon taxes are a more effective way to lower emissions than cap-and-trade schemes, because they force businesses and industries to make the right choice between: 1) reducing carbon consumption and increase energy efficiency; or 2) paying increasingly higher energy costs.  That choice provides the right incentives for countries and companies to reduce CO2 emissions. 



Shortcomings of Cap-and-Trade Schemes

While ACI does not support either approach, the study calls into question the imposition of a cap and trade scheme.  Although both policy proposals would result in significantly higher prices for fossil fuels, unlike cap-and-trade schemes, carbon taxes cannot be manipulated by the markets and would offer the most stable, as well as transparent, system for consumers and industry alike.  A cap-and-trade scheme also would create much more volatility in energy and energy-related prices, as well as increase administrative complexity and the prospects for blatant corruption.  The ineffectiveness of the cap-and-trade system is exemplified by the European Emissions Trading Scheme (ETS), where European CO2 emissions actually increased in 2005, and the European Environmental Agency has projected that the EU is likely to achieve no more than one-quarter of its Kyoto-targeted reductions by 2012.  In addition, much of the European “reductions” simply reflect credits purchased from Russia or non-Annex-I countries, with no net environmental benefits.



Considerations for Carbon Taxes

Carbon taxes would increase energy prices and do so in a manner that is fair, transparent and non-volatile.  Carbon taxes would also provide businesses and industries with incentives to invest in more efficient technologies that actually reduce CO2 output and achieve the policy objective of lowering emissions.  

  • Carbon taxes directly raise the price of carbon-based energy, imposing the greatest costs on those firms and economies that produce the most emissions.  In this way, they have direct incentives to reduce their energy emissions and substitute to cleaner forms of energy, until the cost of doing so is greater than the tax. 
  • Carbon taxes would avoid the price volatility and administrative problems associated with cap and trade, as well as improve economic efficiency.  In raising the price of carbon-intensive products, carbon taxes would make alternative energy sources more price competitive. 
  • Carbon taxes would offer a more effective way to reduce Greenhouse Gas Emissions (GHG) and provide more powerful incentives for the development of new, climate friendly technologies. 
  • While the poorest-nations could still be exempt, carbon taxes would bring many of the developing countries into the project. 



Cap and Trade is Bad Economic Policy

While both carbon taxes and cap-and-trade schemes would raise energy prices for American Consumers, and ACI does not endorse either approach,  carbon taxes can be a more effective means to reduce carbon emissions than cap-and-trade.  Carbon taxes would also produce less price volatility than the alternative, because carbon taxes raise the costs of energy by the same amount regardless of how fast company or country emissions grow.  As another benefit, the resulting predictable cost of a carbon tax also simplifies government and business decisions about the investments and the steps that they can take to reduce emissions.  While discouraging corruption and reducing the administrative challenges associated with cap-and-trade schemes, a carbon tax is fair and may encourage fully international participation.   


For a copy of Dr. Shapiro’s report “Addressing the Risks of Climate Change: The Environmental Effectiveness and Economic Efficiency of Carbon Taxes, Compared to Emissions Caps and Tradable Permits,” visit 









American Consumers Institute

The American Consumer Institute is an independent consumer organization devoted to improving the lives of American consumers by providing information on important issues that affect them.  For more information, visit