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THE DECISION TO CREATE an emissions trading scheme in Europe, the U.S. and Australia is more about ideology than reducing carbon dioxide. A carbon tax would be simpler, fairer and cheaper.

The basic formula for a trading scheme is simple. Create a market to trade 'pollution' permits, each permit being a right to emit one tonne of carbon dioxide (CO2). Establish a cap for the number of permits issued annually, then auction them.

Brokers manage purchases and traders buy and sell them. Set a target for emissions in 2050, trim the caps each year between now and then, and presto! Emissions fall to match the targets.

This relies on the free market: as CO2 emissions become more costly, companies develop technologies and strategies to lower emissions. But in reality, markets are not always so efficient. As we have seen in the global financial crisis, markets left to operate without oversight can spin out of control and fail catastrophically.

And the challenges are too big for private enterprise alone. To use largescale solar power, for example, we need to build a robust national infrastructure of transmission lines, as the existing system would be unable to handle the vast numbers of distributed generators required.

Then there's the problem of fairness. In principle, a trading scheme can be uniformly applied to all emission sources. In practice, because buying and selling permits is expensive and complex, the schemes only target some industries: so there's inequality in how they're applied and large sectors are exempt.

Another difficulty is the pricing uncertainty created by supply and demand. If demand is 90%, the permit price will be very low and there'll be no incentive to cut emissions. If demand is 110%, producers will become desperate and prices will skyrocket. Who benefits? Mostly the traders and brokers. Faced with a stampede, governments will 'temporarily' increase the number of permits.

Then there are political realities. Governments will return much of the money raised as subsidies to the heavily targeted industries. Voters will be hit by higher electricity and petrol prices, so money will also flow back in the form of tax incentives or handouts.

Of the $23 billion expected to be raised in the first two years in Australia, every dollar will be returned in handouts, with not a cent allocated to technology research or investment in building infrastructure capacity.

Yes, safeguards are proposed to minimise these problems – but they add enormously to the scheme's complexity. Cunning traders will no doubt exploit this. Just look at how traders dealt with the complexity of mortgages and derivatives created over the past 10 years, wreaking havoc on the global financial system.

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