Summary: A carbon tax or cap and trade system is a tax on emissions that contribute to global warming. This tax would in theory encourage lower carbon usage and the proceeds would go to encouraging these technologies and minimizing its impact on low income users. As would be expected, there is a huge amount of criticism regarding any attempt to tax carbon through a straight tax or a cap and trade system. What's surprising is that criticism has come from both sides, some environmentalists believe that these systems do not do enough and that introducing the free market into environmental policy will not produce the necessary results, while there are more fiscally conservative people who see any tax increase as a bad thing and would prefer to have the free market decide which technology to support without taking social costs into account.
Basic Idea
The theory behind these systems is that pollution is considered what is called a negative externality because it has a negative effect on a party not directly involved in a transaction. A tax on negative externalities is referred to as a Pigovian tax. The estimated net cost of climate change across the globe has been estimated at an average of $43 per tonne of carbon. There have been a huge number of economic reports that attempt to place values on the risks of climate change versus the cost to mitigate climate change effects, the most high profile of which was the Stern Review by HM Treasury official Nicholas Stern, who said that unless we invest 1% of the global GDP into mitigating the effects of climate change, we could risk a recession worth up to 20% of the global GDP. While this report has taken some criticism, it is safe to say that the effects of global climate change could be huge economically. A carbon tax or cap and trade would attempt to account for this social cost of global climate change that currently no one is paying for, but will cost everyone in the future. This tax would make those producing greenhouse gases pay for them and would help level the playing field for less carbon-intensive technologies that are still more expensive.
Criticism
There are a number of ways these systems could fail, by issuing too many permits, by setting a tax rate far too low, by allowing too many offset credits, by poor accounting procedures, by giving out free permits or exempting some industries. Some point to the ineffectiveness of the EU's first attempt at a cap and trade system, which has been an \"administrative nightmare\", cost a large amount of money and time to implement, and has not reduced emissions because it handed out too many permits and had too many loopholes built in for special interests. Another concern revolves around the fact that global climate change is a global problem, but not all of the world's countries will be taking part in any cap and trade or tax system. This issue is highlighted by the concept of carbon leakage, which is the tendency for energy-intensive industries to migrate from nations with a carbon tax to those without a carbon tax. One way of dealing with this is to impose a carbon-equivalent fee on imports from non-taxing nations. This would not, however, help with the PR nightmare that would result from losing industries due to a carbon tax.