Why a carbon tax is better than carbon trading

Two ways of reducing carbon emissions are carbon taxes (where companies are charged a certain amount per unit of carbon emitted) and capping-and-trading carbon (where the government decides how much carbon emission would be acceptable, and then gives out permits for emitting carbon, and allows companies to trade these credits). The Economist has a good article arguing that taxes are the better way to go. That says a lot, coming from an economist. I'd thought that carbon trading sounded neat, but this article convinced me otherwise. Link.

Three key points that made me change my mind:

1. Carbon trading makes the cost of carbon emissions volatile, which makes the entire market more volatile. If companies are trading a limited number of carbon credits, the price of carbon emissions will fluctuate, like anything traded on a market. And when the price of carbon emissions goes up and down, so will the price of almost everything - from food to manufactured goods to construction. As well as being a pain, that volatility could be very bad for the economy.

2. Carbon taxes encourage innovation more than carbon trading. If the cost of emitting carbon can fluctuate, it is very hard for companies to know whether reducing their emissions will be worth the cost of making the change. What's worse, a major innovation that reduces carbon emissions could drive the price of a carbon credit down. By contrast, if every company has to pay a dollar per unit of carbon emitted, it means that companies will know exactly how much money they will save by reducing their carbon emissions. "It'll cost a million bucks to reduce our emissions by two million bucks worth - so we know it's worth it".

3. Carbon taxes cost companies more; carbon trading costs everyone more. With a carbon tax, the government gets more revenue. That means they can either reduce other taxes, or pass more money on to the people most hurt by global warming and the higher cost of carbon pollution - for example, low people who are hit by higher prices, or farmers ruined by climate change. In a carbon trading system, the higher cost of pollution is still passed on to the consumer - but all the money is going from company to company.