Is it better for governments to set the price of carbon through taxes, or should they set emission quotas and allow trading? While both strategies aim to put a price on carbon emissions and thus shift the economy away from emission-emitting activities, they go about it in a fundamentally different way. A key difference between the two is that a carbon tax means government control, while carbon trading appeals to champions of the free market.

Fundamentally, both approaches view the environment as a right. People have the right to clean air, a stable climate, water, etc. Historically this hasn't been the case. Businesses have had carte blanche to pollute as much as they want so long as profits go up. Today, a paradigm shift has happened and the general consensus is that any activity that negatively affects the environment should demand compensation — either by the offending party paying a carbon tax or by the purchase of carbon credits. Between these two options, creating a market and commodifying Greenhouse Gas (GHG) emissions is by far the superior option.

Some idealists argue that placing a monetary value on the environment is unethical — that it transforms nature from a sacred preserve into a mechanism of capitalism, manipulating our collective attitude toward Earth and legitimizing polluting actions. But don't carbon taxes do the exact same thing regarding putting a monetary value on the environment? Shouldn't we the people demand restitution from companies that pollute as we transition away from our global addiction to fossil fuels?

Why Carbon Credits Win

Carbon credits are significantly more effective than a carbon tax when it comes to combating the climate crisis because they encourage innovation of new technologies, engage the banking and financial sector, and allow companies to directly see the positive impact they have. Of course, third-party verification registries like Verra and Gold Standard are required in carbon markets, as well as a mindset of constant innovation. When used appropriately with transparency and integrity, carbon credits are an indispensable weapon in the war on climate change.

If a carbon tax becomes the global status quo, companies will know exactly what their carbon footprint is, how much it will cost, and who they will pay. At the beginning of the year, corporations will know almost exactly what they owe. They can run a simple cost-benefit analysis to determine whether to pay upfront costs for innovative technology or simply pay the tax. Carbon markets, by contrast, introduce volatility. It is hard to predict the price of CO₂ in one year, let alone five or ten. This uncertainty will push companies to implement new technologies that reduce their carbon footprint immediately, rather than risk the potentially exorbitant cost of credits in the future.

A Historical Precedent

The price of CO₂ credits has been rising, and so has demand. The United States Clean Air Act of 1990 offers instructive historical analysis. The world's first mandatory emissions trading scheme was passed with bipartisan support and signed into law by President George H.W. Bush — not to combat climate change directly, but to address acid rain by lowering sulfur dioxide and nitrogen oxide emissions. The price of an offset was $140 per ton in 1995 and peaked at $1,550 in 2005. By 2007, prices had dropped to $460 per ton — because companies had made drastic changes and adopted innovative technologies that significantly reduced their emissions. Based on supply and demand, prices fell as the market adapted. The success of this emissions trading scheme was the inspiration for the Kyoto Protocol in 1997.

Incubating Innovation

Carbon markets not only incubate innovation among businesses that emit GHG gases, but also those that sequester them. Biochar is a 2,000-year-old technique for disposing of organic waste where material is buried and burned through a process called pyrolysis — it sequesters carbon and improves soil fertility. Carbon credits can work as an instrument to fund this kind of innovative technology, which sequesters a tremendous amount of carbon and protects the environment. The question of whether a project could have happened without funds generated from a CO₂ market is called additionality — a fundamental element of a quality credit.

In Sir Ronald Cohen's book Impact: Reshaping Capitalism to Drive Real Change, he illuminates a new investment trend called impact investment, showing how banks, VCs, and pension funds are prioritizing impact alongside profit. Social Impact Bonds (SIBs) allow investors to profit while simultaneously empowering noble causes. Many investors see this as a win-win. We need the private sector's brainpower and billions of dollars in capital to address climate change — and emission markets are the mechanism to engage them.

Accountability and Transparency

With CO₂ credits, there is a balance sheet. Companies calculate their emissions and purchase an equivalent number of carbon credits — each representing one ton of sequestered CO₂ — to offset their carbon output. This begs the question: with a carbon tax, what is the guarantee that the funds generated actually help the environment? Traditionally, economists assume the public sector's goal is maximizing its budget rather than the social good. Creating a market is necessary because markets help us innovate, become more efficient, and interact with things we value.

There is a fundamental disconnect when it comes to paying taxes. Every April we gather our documents and deal with the IRS — we don't see where that money goes or the direct benefit to our community. The same is true for corporations. Emission markets, by contrast, allow companies to support projects aligned with their sustainability goals: renewable energy programs, reforestation efforts, or support for disenfranchised communities. Companies must actively choose the best projects that match their values. That is why corporations are creating new roles with titles like "Sustainability Manager." The benefit is that they get to see the good they are doing and share it with the public — and it is inspiring to be part of a company that is proactively trying to mitigate climate change.

Conclusion

Danone CEO E. Faber said, "The economy without the social side is barbarism; the social side without the economy is utopia." Hopefully there comes a day when neither carbon credits nor a carbon tax is needed because the world no longer uses fossil fuels — but until that day we need a realistic plan for the transition. When comparing a carbon tax and a carbon credit, it is clear that the latter is the superior option. CO₂ credits foster innovation, engage the financial sector, and allow institutions to make their own decisions about how best to combat climate change. When used appropriately, with integrity and transparency, GHG emission markets are an essential tool to combat the climate crisis.

Works Cited

Brohé, Arnaud, et al. Carbon Markets: An International Business Guide. Routledge, 2016.

Cohen, Ronald. Impact: Reshaping Capitalism to Drive Real Change. Morgan James Publishing, 2021.