In contrast to levying a direct carbon tax on the industry, using tradeable permits as part of a cap-and-trade system is a superior, market-oriented approach to reducing greenhouse gas emissions. Under such a system, the Canadian government would set a hard limit on the amount of CO2 that can be emitted by the economy. This limit is then parceled out into a series of certificates, which are then sold on the open market to anyone willing to buy. Purchasing such a permit would then allow the holder to emit the amount of carbon stated on the certificate. If a company needs to emit more CO2, it then needs to purchase more CO2. If there are CO2 certificates available on the market, they can be bought and sold like any other financial instrument, such as stocks.
The advantages of such a scheme over a carbon tax is that this scheme is market-based, meaning that the price of pollution is set by the supply and demand of the market. In theory, this means that the government setting the pollution cap doesn’t have to worry about what the value of the tax should be, only what volume of CO2 certificates should be issued. Setting this limit to a feasibly sustainable amount of CO2 pollution would allow sustainable development in the same way that, for example, chemical exposure limits in the workplace set a concentration to which workers can be exposed on a long-term basis. Since the price is set by the market, the market can adjust the price to take care of changes.
Tradeable permits also open up the possibility of creating a green economy in ways that a carbon tax never could. Rather than using the revenues from a carbon tax to fund environmental restoration efforts, the government could simply authorize private companies working on environmental restoration to issue permits based on the amount of carbon they sequestered. With an appropriate amount of oversight, someone could find a company that plants trees, and the company would be allowed to issue permits for, say, one tonne per year of CO2 for every 100 trees planted. The company could then use the funding generated from the sale of these permits to finance their activities.
Lastly, tradeable permits would be a lot easier to internationalize than a carbon tax. Since the CO2 problem is clearly not well-recognized internationally, a globally scalable solution to said problem needs to be found. Since the permits under a cap-and-trade scheme are no different from other financial instruments, there would already be an extensive infrastructure in place to allow international trading of emissions permits.
Economists have found that markets are great at allocating resources, provided that the resources in question are depletable and excludable; that is, they are removed from the economy on consumption, and that a consumer can exclude other consumers from using the resource that he just paid for. While the air is not an excludable resource (unless you’re a villain in Spaceballs), pollution can certainly be thought of as depleting the air. A tax on CO2 would certainly disincentivize its emission, but using a tradeable permit scheme, the emission of CO2 could become a commodity. Tradeable permits would serve as a tool to explain the environmental damage of CO2 to Adam Smith’s invisible hand, and let it account for the cost of releasing CO2. If there is significant oversight to monitor emissions levels, and there are mechanisms in place for businesses to trade permits on carbon dioxide production, then bargaining will allow the cost of pollution to be quantified, thereby providing incentive to reduce it.
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