The growing support for carbon pricing leads to two systemic approaches: a revenue neutral carbon fee (“carbon tax”) and cap and trade examined in this working paper. U.S. analyses generally do not address their viability in low- and middle-income countries where the greatest emissions occur. Two characteristics of many of these countries must be carefully considered in the choice between the two policy options: institutional capacity and corruption.
The carbon pricing policy selected must work in the major emitting low- and middle-income countries, including China and India, with institutional weakness and serious corruption. Just nineteen countries with these characteristics constitute the second largest emissions group behind China.
A carbon fee and dividend is “administration-lite”, transparent, would reside in the strongest ministry (finance), and provide predictable revenues for household dividends and would receive oversight as part of the countries’ IMF relationship. Regular distribution of the revenues to households would cover household costs of the low-carbon transition, build political will and address a key global policy problem: uneconomic energy prices and affordability.
Cap and trade is a mismatch due to its misaligned incentives, complexity, administrative burden and discretion, “flexibility” and non-transparency. This policy has a high risk of administrative overload, expanding the opportunity for corruption and increasing the concentration of power and wealth.
Implementation of a carbon fee is achievable; cap and trade, unlikely. The U.S. and international community have the opportunity to advance the carbon fee and dividend policy as the most workable alternative in the upcoming Paris negotiations and beyond.