Difference between Carbon Tax and Cap and Trade

Carbon Tax and Cap and Trade are policies to reduce carbon emissions through alternative ways by using market incentives to reduce emissions. Carbon Tax and Cap and Trade are opposite sides of the same coin.

What is Carbon Tax?

Carbon Tax is the tax that is levied on the carbon emissions required to produce goods and services. Under this, the government sets a price the emitters must pay for each ton of the greenhouse gas they emit.

A Carbon Tax sets the price of carbon dioxide and enables the market to determine the quantity of emission reductions.

What is Cap and Trade?

Cap and Trade is a system used for controlling carbon emissions and other forms of atmospheric pollution that limits the aggregate emissions from a group of emitters by setting a “cap” on maximum emissions.

Cap and Trade set the quantity of emission reductions and it lets the market determine the price.

Differences between Carbon Tax & Cap and Trade

The following table highlights the major differences between Carbon Tax and Cap and Trade −

Carbon Tax
Cap and Trade
There are very few concerns.
Many companies reap vast profits for themselves on the basis of how the permits are designed and distributed.
Emission certainty
Taxes could be set at levels where it is expected to deliver a given reduction in CO2 over time.
For example, in good economic times, the industry as a whole or a few specific companies may decide to pay the tax and meet the market demand for products.
The firms can set limits on emissions through the politicians may continually back off from it.
Price predictability
The level of tax is fixed and the businesses will know exactly how much energy purchase/consumption will cost.
The prices for emissions permits may fluctuate in an open market, which might cause some real planning challenges in the business and lead to emergency “changes” in the rules.
Incentives and investment
As the cost is fixed it enables the business to make more informed and confident business investments to reduce the CO2 emissions, but the ROI will depend on the level of tax.
As the overall cost of emissions is more volatile, the investments in new technologies to reduce emissions are likely to be constrained by the last of clarity about ROI.
Overall effectiveness
It is less subject to political manipulation, but the level of tax that is needed to make an impact is not well understood in this case, and it is also not clear if the politicians are willing to go that far anyway.
It is highly dependent on the details of how aggressively the caps are phased in, how the permits are created and distributed, and various other factors.
Time to results
In theory it could be implemented way faster but it would impact the behavior only at levels the government would fear to go.
It might take fairly long to set up all the mechanisms and achieve the end rustles.


While Carbon taxes are way easier to implement and are less open to political challenges, the Cap and Trade systems are more likely to provide appropriate pricing to incentivize the changes which are needed to combat climate change.

Cap and Trade have one environmental advantage over Carbon tax as it provides more certainty about the number of emission reductions that will lead to a little less certainty about the price of emissions (which are set by the emissions trading market).