Editing Emissions trading (section)

=== Prices versus quantities, and the safety valve ===
[[File:Regional Greenhouse Gase Initiative (REGI) allowance clearing price in September 2008 through December 2021 (51840469964).png|thumb|upright=1.5|Quarterly clearing price of an allowance to emit a ton of carbon dioxide in the US [[Regional Greenhouse Gas Initiative]], 2008–2021. The price of carbon emission has increased as the number of allowances issued has decreased.]]
There has been longstanding debate on the relative merits of ''price'' versus ''quantity'' instruments to achieve emission reductions.<ref>{{cite journal |doi=10.2307/2296698 |last=Weitzman |first=M. L. |title=Prices vs. Quantities |journal=Review of Economic Studies | volume =41 |issue= 4 |date=October 1974 |pages=477–491 |jstor=2296698 |citeseerx=10.1.1.1031.4819 }}</ref>

An emission cap and permit trading system is a ''quantity'' instrument because it fixes the overall emission level (quantity) and allows the price to vary. Uncertainty in future supply and demand conditions (market [[volatility (finance)|volatility]]) coupled with a fixed number of pollution permits creates an uncertainty in the future price of pollution permits, and the industry must accordingly bear the cost of adapting to these volatile market conditions. The burden of a volatile market thus lies with the industry rather than the controlling agency, which is generally more efficient. However, under volatile market conditions, the ability of the controlling agency to alter the caps will translate into an ability to pick "winners and losers" and thus presents an opportunity for corruption.

In contrast, an [[Carbon tax|emission tax]] is a ''price'' instrument because it fixes the price while the emission level is allowed to vary according to economic activity. A major drawback of an emission tax is that the environmental outcome (e.g. a limit on the amount of emissions) is not guaranteed. On one hand, a tax will remove capital from the industry, suppressing possibly useful economic activity, but conversely, the polluter will not need to hedge as much against future uncertainty since the amount of tax will track with profits. The burden of a volatile market will be borne by the controlling (taxing) agency rather than the industry itself, which is generally less efficient. An advantage is that, given a uniform tax rate and a volatile market, the taxing entity will not be in a position to pick "winners and losers" and the opportunity for corruption will be less.

Assuming no corruption and assuming that the controlling agency and the industry are equally efficient at adapting to volatile market conditions, the best choice depends on the sensitivity of the costs of emission reduction, compared to the sensitivity of the benefits (i.e., climate damage avoided by a reduction) when the level of emission control is varied.

A third option, known as a ''safety valve'', is a hybrid of the price and quantity instruments. The system is essentially an emission cap and permit trading system but the maximum (or minimum) permit price is capped. Emitters have the choice of either obtaining permits in the marketplace or buying them from the government at a specified trigger price (which could be adjusted over time). The system is sometimes recommended as a way of overcoming the fundamental disadvantages of both systems by giving governments the flexibility to adjust the system as new information comes to light. It can be shown that by setting the trigger price high enough, or the number of permits low enough, the safety valve can be used to mimic either a pure quantity or pure price mechanism.<ref>{{cite journal |last1=Jacoby |first1=D.H. |last2=Ellerman |first2=A.D. |title=The safety valve and climate policy |journal=Energy Policy |volume=32 |issue=4 |pages=481–49 |date=March 2004 |doi=10.1016/S0301-4215(03)00150-2 |bibcode=2004EnPol..32..481J |hdl=1721.1/3561 |url=https://dspace.mit.edu/bitstream/1721.1/3561/1/MITJPSPGC_Rpt83.pdf |hdl-access=free |access-date=2019-09-23 |archive-date=2007-06-28 |archive-url=https://web.archive.org/web/20070628142224/http://dspace.mit.edu/bitstream/1721.1/3561/1/MITJPSPGC_Rpt83.pdf |url-status=live }}</ref>