Carbon Caps Are the Best Policy

Why taxing emissions is an inferior approach.

By FRED KRUPP
Curbing carbon emissions will spur a new generation of competition for the old ways of generating energy, especially from Big Oil. So when Exxon Mobil CEO Rex Tillerson says he favors a carbon tax over a cap-and-trade system, it's worth asking why the energy giant would want to put a government levy on its own product.
Perhaps Exxon has concluded what many analysts already know: That the best chance to overhaul our oil-addicted economy is through a cap on fossil-fuel pollution. And that has Big Oil running for cover. A cap is not only a very different policy compared to a carbon tax, but a far superior approach, environmentally and economically.
From an environmental point of view, the difference is stark. A cap is a legal limit on pollution. There is no guessing what will happen -- the level of emissions is set in law, and enforcement of that limit proceeds accordingly. No air pollution problem has ever been solved except by imposing a legal limit on emissions.
Environmental taxes have worked well to raise revenue, but without a cap they inevitably become a license to pollute in unlimited amounts. Moreover, to require that other countries make the reciprocal commitments necessary to lower global pollution, we have to enact our cap -- and have other nations do the same in a transparent, verifiable and enforceable way. A carbon tax doesn't make such a system of commitments possible.
From an economic point of view, the case for a cap is also strong. A well-designed cap will push our economy towards clean, domestic energy in the most flexible way possible, leaving business free to grow and thrive. Investors will be driven by the market's demand for clean energy. Companies that make clean energy products -- from steel for wind turbines to energy-efficient windows, and all the companies that supply them -- will become engines of job creation.
The essential nature of a cap-and-trade system is positive and therefore much more powerful than a tax. Behavior shifts not only to avoid the cost of emissions, but to achieve additional reductions below the required levels, which can be sold to others as carbon credits. The system directly engages the profit motive in pursuit of the environmental goal. In addition, establishing the cap level in law will give companies the certainty necessary to make major, job-creating capital investments now.
On this critical issue of enforcement, some have tried to use the current economic crisis to claim that a tax is superior because they believe the trading system will be overly complex. They suggest that somehow a tax system will emerge from the legislative branch without similar problems. Anyone who has watched a tax bill move through Congress, or leafed through the 17,000 pages of the IRS code, knows that is not true. We can create an effective cap if we establish clear rules to avoid the market manipulation.
As we work our way out of the current recession, it's also important to remember one of the most economically elegant aspects of a cap: It is self-adjusting based on economic conditions. While a carbon tax could only be modified through the cumbersome legislative process, the market price of emissions permits under a cap will fluctuate with the economy. Costs would go down during slow economic periods (because industrial activity, and therefore demand for permits to emit pollution, would be lower) and then, when robust growth returns, incentives would automatically ramp up. Try doing that with a tax.
Finally, rather than debate economic theory, we can look at history. In 1990, President George H.W. Bush and a Democratic Congress joined together to pass the world's first cap-and-trade law to limit the pollution that causes acid rain. It was a simple, straightforward plan to have government set the rules and let the people involved solve the problem. It worked faster and cheaper than anyone predicted.
The almost daily drumbeat of scientific reports underscores the urgency of fast action, and clear limits. A cap is the smart, centrist, environmentally rigorous approach to our energy and climate challenges. It's the best way to truly change our future for the better.
Mr. Krupp is president of Environmental Defense Fund and co-author of "Earth: The Sequel" (W.W. Norton, 2008).