How does a carbon tax differ from carbon emissions trading?

This study note explains the distinction between a carbon tax and carbon emissions trading

Carbon tax and carbon emissions trading are two policy tools aimed at reducing greenhouse gas emissions and mitigating the effects of climate change. While both policies put a price on carbon emissions, they differ in the way they do so.

Carbon tax

• A carbon tax is a direct tax on the emission of greenhouse gases, such as carbon dioxide.
• The tax is based on the amount of CO2 emitted and is designed to create an economic incentive for individuals, companies, and governments to reduce their carbon footprint.
• Revenue generated by the tax can be used to fund clean energy initiatives or support affected communities.

Carbon emissions trading

• Carbon emissions trading, also known as cap-and-trade, is a market-based system for reducing greenhouse gas emissions.
• Under a cap-and-trade system, the government sets a limit, or cap, on the total amount of emissions that can be produced in a given period.
• Companies are then issued permits, or allowances, to emit a certain amount of CO2.
• If a company emits less than its allotted amount, it can sell its surplus allowances to another company that has exceeded its limit.

The main difference between a carbon tax and carbon emissions trading is the way they create an economic incentive to reduce emissions. A carbon tax creates a direct financial disincentive for emitting CO2, while carbon emissions trading creates a market for emissions allowances, which creates an indirect financial disincentive for emitting CO2.

In conclusion, both a carbon tax and carbon emissions trading are effective tools for reducing emissions and mitigating the effects of climate change, and the choice between the two will depend on the specific political and economic context in which they are introduced.