Good question. The main difference between cap-and-trade and carbon tax is that cap-and-trade has the potential to reward companies whose carbon emissions are lower. Here’s how they work:
A carbon tax is a tax set on all GHG emissions. The more emissions for a company, the higher the tax. The incentive here is for companies to explore and develop methods of lowering emissions, thus having to pay a lower tax.
Cap-and-trade is similar, but works differently. A “cap”, or amount, is set on GHG emissions, which is the same for all companies. Each company is given emissions allowances that add up to the “cap” amount, but not more. It then becomes illegal for a company’s emissions to surpass the cap without extra allowances. If the company needs to emit more GHGs, it must buy allowances from companies who have lower emissions. Thus the companies with higher emissions are penalized buy having to spend extra money to buy emissions allowances, and companies with lower emissions are rewarded by making money selling allowances to those with higher emissions.
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