Practice question · Multiple choice
A Pigouvian tax and a cap-and-trade permit system can reach the same emissions outcome. What is the practical difference between choosing them?
Hints
- Under a tax, does the regulator know how much abatement it will get?
- Under a cap, does anyone know what the permit will cost?
Show the answer
B. A tax fixes the price; permits fix the quantity
Why
Each instrument fixes one blade of the scissors and lets the other move, so the choice is about which risk matters more, a hard climate threshold argues for the cap, cost certainty for the tax. Weitzman's 1974 result formalises exactly this, and it is why the EU chose an ETS while others chose carbon taxes.
Practise Externalities and Public Goods
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