Key Takeaways
- Carbon pricing, either in the form of a carbon tax or a cap-and-trade system, has the potential to limit pollution to an economically optimal level.
- Carbon pricing allows various pollution sources with differing marginal abatement costs to achieve emissions reduction efficiently whereas regulations tend to treat all pollution sources alike.
- Carbon pricing has greater efficiency advantages over regulations when technology changes over time than when it is fixed.
- A carbon tax combined with revenue recycling would be a less costly policy to reduce emissions than regulations of comparable effectiveness.
- It is difficult to compare the distributional impact of carbon taxes to that of regulations, as there is substantial analysis of the distributional effects of a carbon tax but very limited information on how environmental regulations would impact various demographic groups.
Introduction
There is a broad consensus that the world faces a serious threat from climate change, and that reduction of greenhouse gas emissions, eventually to net zero, is essential to mitigating that threat. There is less consensus, however, on how to go about it.
The two leading options for reducing greenhouse gas emissions (or carbon emissions, for short) are carbon pricing and command-and-control regulations. The former relies on markets to achieve emission reductions while the latter relies on regulations, such as performance standards and technology mandates. Carbon pricing and command-and-control regulations both remain in contention, either as alternatives or as complementary policies.
This paper is intended to serve as an economic explainer comparing carbon pricing policies to regulatory policies. It introduces the economic basics of carbon pricing, provides a detailed comparison of carbon pricing and regulations, and discusses the potential impact of the interaction of the two types of policies.