Which statement correctly differentiates carbon tax and cap-and-trade?

• A. A carbon tax creates a trading market for permits; cap-and-trade sets a direct price on emissions.
• B. A carbon tax sets a direct price on emissions; cap-and-trade uses a cap and allows trading of permits to reduce emissions.
• C. Cap-and-trade sets a direct price on emissions; carbon tax establishes a cap.
• D. Both policies require emission reporting but neither uses a price mechanism.

Answer: (C)

The key distinction is price versus quantity control. A carbon tax imposes a direct price on each ton of CO2 emitted, so emitters face a known cost per unit and total reductions depend on how behavior changes in response to that price. It provides price certainty but does not guarantee a specific total level of emissions.

Cap-and-trade fixes the total amount of emissions by issuing a limited number of permits. Firms must hold permits for their emissions, and permits can be bought or sold, so the market determines the price. This guarantees an environmental outcome (the cap) but means the price path can be uncertain.

So the correct idea is: carbon tax sets a direct price on emissions; cap-and-trade uses a cap and allows trading of permits to reduce emissions. The other statements mix up which policy sets the price or the cap, or claim there’s no price mechanism.