Difference Between Carbon Tax and Cap and Trade

Cap and trade and a carbon tax are two independent solutions for lowering greenhouse gas emissions (GHG). Each method has ardent adherents. Those who support cap and trade claim that it is the only way to successfully safeguard the environment. Those in favor of a carbon price believe that it is a better method since it reduces government involvement. The significant discrepancies between them must be investigated further.

Carbon Tax vs Cap and Trade

The main difference between a carbon tax and a cap and trade is that a carbon tax is an economic levy that costs companies based on the number of gaseous pollutants they create, whereas a cap and trade is an economic strategy that limits how much damaging gases may be generated.

Carbon Tax vs Cap and Trade

A carbon tax is a levy paid on the carbon emissions produced by the production of goods and services. It is intended to minimize CO2 emissions by raising fines. This decreases consumption for such merchandise while also encouraging efforts to diminish their environmental impact. A carbon tax also ensures that the expenses of adherence are predictable.

Cap and trade are a government regulation policy that aims to limit, or cap, the overall number of emissions of specific chemicals, most notably carbon dioxide, as a result of industrial activity. Corporations are charged if their emission exceeds the limits set by their licenses. Corporations that cut their emissions can resell any surplus licenses to other businesses.

Comparison Table Between Carbon Tax and Cap and Trade

Parameters of ComparisonCarbon TaxCap and Trade
Type of SystemIt is an economic taxIt is an economic policy
ProcessA carbon tax directly assigns a monetary value to the proportion of greenhouse gas emissions emitted.Each year, a cap-and-trade program gives a specified number of emissions “entitlements.”
Cost CertaintyA tax ensures that the costs of compliance are predictable.A cap-and-trade system fulfills a predetermined environmental target, but the cost of doing so is decided by market forces.
Compliance FlexibilityA tax asks a company to select how much to cut its emissions as well as how much tax to pay every year.It gives businesses the freedom to make multi-year compliance planning decisions.
Success of SystemThis system has proven to be less effective in countriesThis system has proven to be more effective in countries (like US and EU)

What is Carbon Tax?

A carbon tax is a fee levied on carbon emissions emitted during the production of commodities. Carbon taxes are intended to draw the light on the “concealed” socioeconomic consequences of carbon pollution, that otherwise would only ever be felt indirectly, such as more extreme precipitation.

They are meant to reduce greenhouse gas emissions by increasing premiums in this way. This reduces demand for such commodities while also stimulating actions to reduce carbon dioxide emissions.

In its most generic definition, a carbon tax solely applies to CO2 emissions. When the combustion of a hydrocarbon, such as coal, gasoline, is being used, a large portion of the carbon is transformed into CO2.

Climate change is caused by greenhouse gas emissions, which harms human and environmental health. Carbon content can be taxed at any step in the product cycle to lessen this negative consequence.

Carbon taxes, according to research, successfully cut emissions. Many economists say that carbon pricing is the most cost-effective strategy to combat climate change. Several governments and more than 100 localities have pledged to achieve carbon neutrality soon.

A multitude of investigations has concluded that, in the absence of increased social welfare benefits, a carbon price would disproportionately affect poor households over wealthier households.

What is Cap and Trade?

Cap and trade are a popular phrase for a government regulation scheme that aims to limit, or cap, the overall number of emissions of specific chemicals, most notably carbon dioxide, as a consequence of workplace activity. Cap and trade supporters say that it is a more appealing alternative to a carbon tax.

A cap-and-trade scheme can perform in a variety of different ways. A government grants a restricted number of yearly licenses to corporations that enable them to release a specified quantity of carbon dioxide. As a result, the total amount authorized becomes the “limit” on emissions.

Companies are charged if their emissions exceed the limits set by their licenses. Corporations that lower their emission can offer or “transfer” their unsold permissions to other businesses.

However, the government reduces the number of permits issued each year, decreasing the global emissions ceiling. As a result, the permits become more expensive. Companies will have the funds to engage in renewable technology once it becomes less expensive than purchasing permissions.

The cap-and-trade system is occasionally referred to as a capitalistic system. That is, it establishes a monetary value on emissions. Its supporters claim that a cap-and-trade regime provides an incentive for businesses to invest in cleaner technology in order to avoid purchasing permissions that will cost more each year.

Opponents believe that it might result in excessive production of toxins up to the government’s revenue limit levels. They believe that the allowed limits will be set too liberally, impeding the transition to greener energy.

Main Differences Between Carbon Tax and Cap and Trade

  1. A carbon tax is an economic tax charged by the government whereas cap and trade is an economic policy.
  2. A carbon tax penalizes companies for the amount of harmful emissions they emit, however a cap-and-trade scheme limits the quantity of emissions that may be generated.
  3. A carbon tax ensures certainty about costs of compliance whereas in a cap-and-trade system, the certainty of reaching goal depends on the market.
  4. A carbon tax provides less flexibility of compliance to the amount of emissions whereas a cap-and-trade system provides more flexibility.
  5. Carbon tax has proven to be less effective in reducing emissions whereas cap and trade has been more effective.


Foreign nations are using various measures to reduce greenhouse gas emissions. The cap-and-trade system and the carbon tax are two examples of such schemes.

A cap-and-trade system accomplishes a predetermined environmental objective by setting a cap and issuing a matching number of permits, but the cost of achieving that goal is decided by market forces.

A carbon tax, on the other hand, gives certainty regarding compliance costs, but the resultant reductions in GHG emissions are not preset and would be established by market mechanisms. It asks a company to select how much to cut its emissions as well as how much tax revenue to pay each year.

To minimize the carbon price observed by enterprises under a tax, government intervention to cut the amount of the tax, rather than market forces, would be necessary. In this respect, cap and trade may be viewed as giving a self-adjusting price, which is high when the industry is doing well and low when the economy is doing poorly. A tax, on the other hand, does not self-adjust.


  1. https://www.sciencedirect.com/science/article/pii/S2211467X20300365
  2. https://www.sciencedirect.com/science/article/pii/S0959652619334766
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