Carbon taxes vs. Carbon credits

I don’t know for sure, but I think that I disagree with an explicit carbon tax. Why should the government be any good at deciding which industries have the best chance of improving their energy efficiency (which they are doing when they set the tax rate on a product-by-product basis)?

I suspect it would be better to go for carbon-credit trading system. Have a (declining) aggregate quota of completely tradable carbon credits, issuing them by open-market auctions on a rolling basis throughout the year. To be economically neutral (that is, non-distortionary), the issuer of carbon credits would need to government-independent (although operating within boundaries set by the government) and either work closely with the central bank or be a new branch of the central bank itself.

This last point would be necessary because if the proceeds from auctioning the credits were not going to be treated as government revenue (and in order to avoid being distortionary, that would need to be the case), any money paid for the credits would need to be recycled back into the economy by the central bank. This would ultimately have the equivalent effect of raising interest rates on carbon-intensive parts of the economy and lowering interest rates for the carbon-free sections while keeping the aggregate rate (and thus, in theory, the overall effect on GDP) unchanged.

In practice, I suspect that we would see some increased volatility in market interest rates and inflation pressures, with both settling down over a few years.

I could be entirely wrong on all this, though. It’s just the result of 20 minutes of thought. I’d welcome any corrections.

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