Which works better: carbon trading or a carbon tax?

Most economists that I speak to seem to agree that a carbon tax is better because it's more efficient, transparent and simple. Cap-and-trade schemes, on the other hand, can allow governments to pay off politically powerful polluters, such as the coal industry, by giving them permits.

I believe that cap-and-trade creates opportunities for cheating. They can lead to unpredictable fluctuations in energy prices and they do nothing to offset high power costs for consumers. Carbon taxes, on the other hand, can be structured to deliver clean-energy incentives.

Ultimately, however, the choice boils down to practical and political considerations. The bottom line is that politicians who want to keep their jobs would not want to introduce a tax. That's political suicide. But cutting greenhouse gas emissions can only work when all the big polluting countries work together.

And therein lies the problem.

That's what caught my attention when I read a European Economics open report for Europe advocating a carbon tax.

"The tax-based measures tend to perform best," the report says. "This is because, as well as achieving reductions in carbon emissions, they raise tax revenue which we have assumed is used to reduce taxes - and the associated deadweight cost of taxation - elsewhere in the economy."

The report canvasses the prospect of introducing taxes on car fuel, aviation, gas and electricity. Increasing the fuel tax on cars would probably hurt the most because it's already taxed, the report says. On the other hand, it will raise a lot of money and could result in tax cuts in other areas.

Obviously, carbon taxes can't be introduced unless there are tax cuts in other areas. But it's hard to see politicians going down this direction. For a start, drivers vote.

What means is that carbon trading is second-best. Still, it is likely to be the only scheme that will produce results. A well-designed and carefully monitored scheme can reduce emissions. But all the wrinkles have to be sorted out.