Cap and Trade Versus Carbon Tax: An Analysis Based on a CGE Model

Abstract

Cost-effectiveness comparisons between two typical pricing policies, i.e., cap and trade and carbon tax, are rare in the literature and are tackled in this study. We define various carbon shadow prices at different administrative levels. By using a computable general equilibrium model, the cost-effectiveness of various policies is compared in terms of the estimation of carbon shadow prices. The results show that an energy cap-and-trade policy yields a close GDP-based carbon shadow price but a lower GSPV-based (gross-social-production-value-based) carbon shadow price than a proportional energy reduction policy does. Compared to a cap-and-trade policy, a carbon tax policy yields a much lower GDP-based carbon shadow price but a higher GSPV-based price. Improving the stringency of either a cap-and-trade policy or a carbon tax policy has limit impact on the industrial structure of the whole economy despite the impact on both the GDP and the GSPV are different between these two policies. The comparison of the two carbon pricing policies mainly implies that a carbon tax is more cost-effective than cap-and-trade for a carbon- and trade-intensive economy, but cap-and-trade has lower sector-level impacts than carbon tax especially when the cap restriction is loose.