My greatest concern is that policy makers, in fashioning an energy policy, will attempt to mandate or ordain solutions that are doomed to fail. One policy option that is intended to reduce emissions and that has received much attention is the cap-and-trade system. But before we rush to enact something like it, we must ask whether it can best achieve our shared goal of actually reducing greenhouse-gas emissions.

Such a system was implemented in the European Union in 2005. Unfortunately, the EU Emission Trading Scheme is struggling to achieve the overall reductions that its supporters had hoped for. One reason for this is that cap-and-trade systems inevitably introduce unnecessary cost and complexity, which undercut their effectiveness.

It is also important to remember that a cap-and-trade system requires a new market infrastructure to trade emission allowances. Creating this new “Wall Street” of emissions brokers will take the emphasis away from reducing carbon emissions and redirect it to trading on price volatility. For businesses and consumers, these market gatekeepers and resultant price swings add cost and create uncertainty.

What’s more, cap-and-trade systems, because of their complexity, have inherent problems with verification and accountability. They require a vast expansion of administrative and regulatory officialdom to ensure that emissions allowances are not exceeded—yet another cost for businesses and consumers to bear. There is, however, another policy option that governments should consider: a carbon tax.

As a businessman, it is hard for me to speak favorably about any new tax. But a carbon tax strikes me as a more direct, transparent, and effective approach. It avoids the cost and complexity of having to build a new market for securities traders or the necessity of adding a new layer of regulators and administrators to police companies and consumers. A carbon tax can also be more easily implemented. It could be levied under the current tax code without requiring significant new infrastructure or enforcement bureaucracies.

A carbon tax is also the most efficient means of reflecting the cost of carbon in all economic decisions—from investments companies make to fuel their requirements to the product choices consumers make. In addition, such a tax should be made revenue neutral. In other words, the size of government need not increase as a result of the imposition of a carbon tax. There should be reductions or changes to other taxes—such as income or excise taxes—to offset the impact of the carbon tax on the economy.

Finally, there is another potential advantage to the direct-tax, market-cost approach: a carbon tax may be more suitable for setting a uniform standard to hold all nations accountable. This last point is important! Given the global nature of the challenge—and the fact that the economic growth of developing economies will account for a significant portion of future increases in greenhouse-gas emissions—policy options must encourage and support global engagement.

The decades ahead will hold many challenges for the American people. One of the most important ones will be how we obtain the energy to power our economy and sustain prosperity. We have many policy decisions to make in the weeks and months ahead—decisions that will shape the years and decades to come.

This piece is adapted from a speech given at the Woodrow Wilson International Center for Scholars, Washington, DC, on January 8, 2009.

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