A comparison of taxes and tradable permits in national climate policy

This article discusses domestic climate policy design in a country that has made a binding commitment to the Kyoto Protocol but at the same time want to limit the number of industry shutdowns that follows from the policy. It is furthermore considered how public budget constraints might affect climate policies. The similarities between an optimally-designed taxation regime and a domestic tradable permit regime that is integrated into the international permit market are brought into focus. The similarities presuppose a greenhouse gas tax that fluctuates in accordance with the international permit price. It is argued that climate policy can generate double dividends, but that the allocation of free permits reduces these dividends. It is concluded that some organisations promotion of systems tradable permits, with distribution of permits free of charge, as an alternative to carbon taxes must be understood from their effect on income distribution. The paper is to a large extent based on an article, Holtsmark (1999), written in Norwegian and prepared for presentation at a seminar held by the Norwegian Ministry of Finance in November 1998. I gratefully acknowledge Lynn P. Nygaard's translation to English. Valuable comments on the Norwegian article from Cathrine Hagem, Michael Hoel and Jon Vislie were also appreciated