Reducing greenhouse-gas emissions would be beneficial in limiting the degree of damage associated with climate change. However, decreasing those emissions would also impose costs on the economy-in the case of CO2, because much economic activity is based on fossil fuels, which release carbon in the form of carbon dioxide when they are burned. Most analyses suggest that a carefully designed program to begin lowering CO2 emissions would produce greater benefits than costs.
Employing incentive-based policies to reduce CO2 emissions would be much more cost-effective than using more-restrictive command-and-control approaches (such as imposing technology standards on electricity generators). Incentive-based policies use the power of markets to identify the least costly sources of emission reductions. Thus, they can better reflect technological advances, differences between industries or companies in their ability to make low-cost emission reductions, and changes in market conditions.
Policymakers can choose between two general forms of incentive-based policies - those that limit the overall level of emissions (so-called quantity instruments) or those that reduce emissions by raising their price (so-called price instruments). The simplest price-based mechanism would be a tax on emissions.