Economists are split on whether a tax on carbon dioxide emissions or a cap-and-trade system, such as the European Union’s emissions trading scheme (EU ETS), is the most effective in mitigating greenhouse gas emissions, and which system is best suited to aviation remains the subject of considerable debate.

The debate has begun to rage once again as the Jan. 1 deadline for complying with the EU-ETS looms. A majority of the members of the International Civil Aviation Organization (ICAO) Council on Nov. 2 accepted a declaration condemning the unilateral application of the EU ETS to international aviation. This declaration is not legally binding, but sends a strong political statement that most of the ICAO Council does not believe a regional cap-and-trade system should apply to a global business like aviation.

A cap-and-trade system offers direct and measurable effects on emissions reductions by setting a limit for overall emissions, says Steve Cochran, VP-climate at the Environmental Defense Fund. “A cap ensures that the problem we focus on is emissions by limiting emissions over time,” he says. This forces companies to change behavior and to emit less, whether by cutting back on carbon-intensive operations or investing in new technologies that emit less carbon dioxide.

An added benefit of a cap-and-trade system is that it offers the cheapest method for companies to reduce carbon emissions, Cochran says. The EU ETS will allocate 85% of emissions credits to airlines for free in the first year. This will enable airlines either to tailor operations so that they remain under the limit or to buy additional credits from companies in other industries on the carbon market. “Getting emissions reductions both cheaper and faster is a good thing,” Cochran says.

But other economists disagree on the financial equation. The price of a carbon allowance in the ETS fluctuates depending on supply and demand. In 2009, a carbon allowance was €30 per metric ton of emissions. Today, an allowance is roughly €10. For an industry such as aviation, this fluctuation actually can hamper emissions reduction by not giving airlines enough clarity to plan and invest in new technologies, argues economist Kevin Neels, a principal at the Brattle Group, a Cambridge, Mass.-based economic consultancy. “A tax allows businesses to forecast more accurately without having to forecast the price of emissions,” he says.

Aviation is a cyclical industry, with demand higher at peaks in the business cycle and low during the troughs. A cap would penalize airlines during the troughs by making the cost of compliance higher, whereas a tax is simpler, allowing airlines to pay for carbon actually emitted, says Neels.

However, a tax, being constant, could dampen demand over time as consumers alter travel behavior to avoid higher fares. A cap-and-trade system, on the other hand, would even out airline demand over time, says Neel. “In a cap-and-trade system, airline travel will become more expensive during peaks of the business cycle and less expensive during troughs,” he says. In other words, consumers could opt to travel less when tickets are more expensive and travel more during down periods.

But a tax allows flexibility, Neels notes. Governments can adjust the tax rate to lower emissions or to stimulate demand.

Both systems, if designed correctly, can have the equivalent results in reducing emissions, Jan Brueckner, professor of economics at the University of California, Irvine, tells Aviation Week. “Both approaches eventually raise the cost of fuel, either directly, through a tax, or indirectly with an emissions rights system,” he says. “Every unit of fuel will have a cost, either taxed or for the cost of a permit,” he explains. A cap sets limits, while a tax eventually causes changes in behavior with higher costs.

Brueckner notes that the fluctuation of prices in a cap-and-trade system could be a problem for airlines. At current EU emissions allowance prices, the cost of emissions would be about 8% of an airline’s per-passenger fuel costs for a short-haul flight. In 2009, it would have been 24% of the per-passenger fuel cost. “This creates further volatility in the airline’s cost structure,” he says.

In Brueckner’s analysis, both systems could effect change in a number of ways. Higher costs could lead airlines to force manufacturers to develop more fuel-efficient aircraft in the long term. In the near term, airlines could raise fares and cut traffic in order to cut fuel costs or to operate under the emissions cap. “Flight frequencies could go down but this will not be a huge effect,” he says.

Meanwhile, at ICAO, the fight over the ETS continues. The non-binding declaration accepted on Nov. 2 opens the way for a country that objects to the ETS to bring a formal complaint under Article 84 of the Chicago Convention. Barring a formal complaint, the dispute could put pressure on ICAO to devise its own aviation-specific carbon mitigation program, whether a tax or a market-based measure like the ETS, Pamela Campos, an attorney for EDF, tells Aviation Week.