Internationally recognised climate science confirms that early and drastic cuts in greenhouse gas emissions are required over coming decades in order to avoid the risk of a runaway effect of unmitigated climate change. Australia's economy and environment are significantly exposed to the effects of climate change. There exists a clear rationale for policy makers to act early and with conviction. So what is the most effective 'instrument' for reducing greenhouse gas emissions - a carbon tax or a cap and trade system?
A 'cap-and-trade', or emissions trading scheme is one of Australia's key climate change mitigation policies. It works by setting a limit, or 'cap', on the aggregate annual emissions from all the covered types and sources of emissions. By lowering the cap over time, the Australian Government is aiming towards achieving the national emissions reduction target. Liable companies are issued emission allowances which represent the right to emit a specific amount of emissions. They are then required to surrender one allowance for each tonne of carbon dioxide equivalent emitted during the compliance period. The total amount of allowances cannot exceed the cap, limiting total emissions to that level. Emissions allowances will be tradable and the price determined by demand and availability in the market. In this article, we outline six of the key benefits of a cap-and-trade system.
First. Where a tax would have to be applied to each individual greenhouse gas, emissions trading can deal with all six Kyoto Protocol gases in one comprehensive strategy because each gas has a specific "global warming potential" in relation to carbon dioxide, giving liable companies more flexibility in reducing emissions.
Second. A carbon tax might provide certainty in the cost of compliance and lower administrative costs, making it easier to plan long-term investments. However, under a carbon tax, there is no limit on the amount of emissions or an assurance over the quantity of reductions. In line with scientific evidence suggesting that significant reductions are necessary, emissions trading has the advantage of setting a cap on overall emissions and therefore controlling the quantity of emissions directly. In contrast, under a carbon tax, the Government would have to adjust the tax in relation to emission levels to try to meet the emissions reduction target. These tax adjustments would be contingent on the outcomes of and uncertainties associated with political processes.
Third. The intent of a cap-and-trade system is that companies that need to increase the number of emission allowances pay a charge for polluting, while companies that have reduced emissions have the opportunity of generating a new source of income by selling their excess allowances and use that income to finance low-carbon technologies, processes and products. By reducing emissions, companies can reduce their liability and improve their environmental performance at a lower cost. However, in order to provide companies with economic incentives to do so, there must be sufficiently ambitious targets to create scarcity and demand of allowances, as well as an effective and equitable distribution of allowances through auctioning.
Fourth. Great potential for international collaboration and agreement exists by linking the Australian Carbon Pollution Reduction Scheme to other schemes such as the European Emissions Trading System. A linkage to the international market can help share the burden of reducing emissions by providing access to more low(est)-cost reduction opportunities. A carbon tax would exclude Australia from this emerging international market, valued at US$126 billion in 2008. The implementation of the European Emissions Trading System has already granted European companies a perceptible advantage for a possible worldwide greenhouse gas market, and significant experience with regard to the operation of trading, brokerage and verification.
Five. A cap and trade scheme makes a direct link between energy consumption, production and greenhouse gas emissions. It encourages companies to look for efficiency and innovative solutions at the firm level to reduce their energy intensity.
Finally, it is questionable whether a carbon tax would eliminate debates on industry support or exemption, or how to facilitate the necessary shift towards a low-carbon economy.
Unfortunately, most of the debate - if not all - around the Carbon Pollution Reduction Scheme has focused on who should bear its economic burden, rather than on how to effectively tackle climate change. In Europe, emissions have fallen for the fourth consecutive year in 2008 to 11% below 1990 levels, more than halfway to the EU's legally-binding target of a 20% cut by 2020. The challenge remains: Can Australian firms and industries transition to a low-carbon economy?