International and Country Perspectives
Edited by Iris Claus, Norman Gemmell, Michelle Harding and David White
Chapter 10: Carbon Taxes vs Tradable Permits: Efficiency and Equity Effects for a Small Open Economy
John Freebairn INTRODUCTION 10.1 Economists and some governments, including New Zealand, have debated the relative merits of a tax or a system of tradable permits as a marketbased and cost-effective policy intervention to reduce pollution.1 Actual examples include the pollution of the atmosphere, waterways and the landscape, with greenhouse gases being a key contemporary policy topic. Greenhouse gas emissions associated with the combustion of fossil fuels, deforestation, agriculture and other industrial processes (but with scant attention to human breathing and population growth) are a form of global atmospheric pollution with a high probability of external costs of climate change in the future. In principle, a tax set at the marginal external cost, or a tradable permit with the quota set at the quantity equating marginal social benefits and costs, would result in a net gain in economic efficiency. In response to meeting its target under the 1998 Kyoto Protocol agreement to reduce greenhouse gas emissions, the New Zealand Government initially focused on a carbon tax, then in 2005 switched to a tradable permit scheme, and in 2009 proposes to review the options. Meanwhile, 27 European Union countries have introduced a tradable permit scheme, and Australia proposes to introduce a carbon tax in mid-2011 and then a tradable permit scheme from mid-2012. A global agreement with all the large polluters participating seems some time away. This chapter compares and contrasts the operation and economic effects of a carbon or emissions tax versus a tradable permit scheme to reduce greenhouse gas emissions....
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