Cap and Trade vs Carbon Tax
Cap and Trade and Carbon Tax are two Environmental Economics concepts in AP Economics that students often mix up. In short: cap and trade is cap and trade is a system that limits total pollution and lets firms buy and sell permits to emit within that cap. Meanwhile, carbon tax is a carbon tax is a fee on the carbon content of fuels, designed to make polluters pay for the external cost of emissions. Here is how they compare side by side.
Cap and trade is a system that limits total pollution and lets firms buy and sell permits to emit within that cap.
The government sets a cap and issues tradable permits; firms that cut emissions cheaply can sell permits to those that can't. It puts a market price on pollution and achieves a target at the lowest total cost, addressing a negative externality.
A carbon tax is a fee on the carbon content of fuels, designed to make polluters pay for the external cost of emissions.
It is a Pigouvian tax that internalizes the negative externality of carbon emissions, raising the private cost up to the social cost and reducing pollution to a more efficient level. Revenue can fund rebates or green investment.