ADDING QUANTITY CERTAINTY TO A CARBON TAX THROUGH A TAX ADJUSTMENT MECHANISM FOR POLICY PRE-COMMITMENT

arbon taxes and cap-and-trade programs are emissions-pricing policies that create incentives to reduce harmful greenhouse gas (“GHG”) emissions.1 These policies raise the price of fossil fuels (the burning of which emits GHGs into the atmosphere), inducing businesses and consumers to substitute away from those fuels and thereby reduce emissions. Economists agree that emissions pricing is the most costeffective method to reduce GHG emissions.2 The choice between a carbon tax and a cap-and-trade program is less clear-cut. Both policies price emissions, but how that price is set is very different. Carbon taxes directly set the emissions price, while the level of emissions is determined by market forces. In contrast, cap-and-trade programs set the overall level of emissions (via the number of permits issued) and allow the market to set the price. In the absence of uncertainty, this distinction doesn’t matter: policymakers could either pick the price to achieve the (known) quantity of emissions desired, or set the quantity of allowable emissions and let the market determine the (identical) price. If macroeconomic levels or abatement costs are uncertain, however, the two policies could have very different ex post outcomes.3 An extensive literature within economics addresses the relative efficiency of these two policy instruments in the presence of uncertainty.4 Here, we focus on a different question: