Carbon Pricing
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Carbon pricing (or pricing) is a method for governments to
mitigate climate change Climate change mitigation (or decarbonisation) is action to limit the greenhouse gases in the atmosphere that cause climate change. Climate change mitigation actions include energy conservation, conserving energy and Fossil fuel phase-out, repl ...
, in which a monetary cost is applied to
greenhouse gas emissions Greenhouse gas (GHG) emissions from human activities intensify the greenhouse effect. This contributes to climate change. Carbon dioxide (), from burning fossil fuels such as coal, petroleum, oil, and natural gas, is the main cause of climate chan ...
. This is done to encourage polluters to reduce
fossil fuel A fossil fuel is a flammable carbon compound- or hydrocarbon-containing material formed naturally in the Earth's crust from the buried remains of prehistoric organisms (animals, plants or microplanktons), a process that occurs within geolog ...
combustion, the main driver of
climate change Present-day climate change includes both global warming—the ongoing increase in Global surface temperature, global average temperature—and its wider effects on Earth's climate system. Climate variability and change, Climate change in ...
. A carbon price usually takes the form of a
carbon tax A carbon tax is a tax levied on the carbon emissions from producing goods and services. Carbon taxes are intended to make visible the hidden Social cost of carbon, social costs of carbon emissions. They are designed to reduce greenhouse gas emis ...
, or an
emissions trading scheme Carbon emission trading (also called carbon market, emission trading scheme (ETS) or cap and trade) is a type of emissions trading scheme designed for carbon dioxide (CO2) and other greenhouse gases (GHGs). A form of carbon pricing, its purpose ...
(ETS) that requires firms to purchase allowances to emit. The method is widely agreed to be an efficient policy for reducing greenhouse gas emissions. Carbon pricing seeks to address the economic problem that emissions of and other
greenhouse gas Greenhouse gases (GHGs) are the gases in the atmosphere that raise the surface temperature of planets such as the Earth. Unlike other gases, greenhouse gases absorb the radiations that a planet emits, resulting in the greenhouse effect. T ...
es are a
negative externality In economics, an externality is an indirect cost (external cost) or indirect benefit (external benefit) to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced ...
– a detrimental product that is not charged for by any market. 21.7% of global GHG emissions are covered by carbon pricing in 2021, a major increase due to the introduction of the
Chinese national carbon trading scheme The Chinese national carbon trading scheme is an intensity-based trading system for carbon dioxide emissions by China, which started operating in 2021. This emission trading scheme (ETS) creates a carbon market where emitters can buy and sell emi ...
. Regions with carbon pricing include most European countries and
Canada Canada is a country in North America. Its Provinces and territories of Canada, ten provinces and three territories extend from the Atlantic Ocean to the Pacific Ocean and northward into the Arctic Ocean, making it the world's List of coun ...
. On the other hand, top emitters like
India India, officially the Republic of India, is a country in South Asia. It is the List of countries and dependencies by area, seventh-largest country by area; the List of countries by population (United Nations), most populous country since ...
,
Russia Russia, or the Russian Federation, is a country spanning Eastern Europe and North Asia. It is the list of countries and dependencies by area, largest country in the world, and extends across Time in Russia, eleven time zones, sharing Borders ...
, the Gulf states and many US states have not introduced carbon pricing.
Australia Australia, officially the Commonwealth of Australia, is a country comprising mainland Australia, the mainland of the Australia (continent), Australian continent, the island of Tasmania and list of islands of Australia, numerous smaller isl ...
had a carbon pricing scheme from 2012 to 2014. In 2020, carbon pricing generated $53B in revenue. According to the
Intergovernmental Panel on Climate Change The Intergovernmental Panel on Climate Change (IPCC) is an intergovernmental body of the United Nations. Its job is to "provide governments at all levels with scientific information that they can use to develop climate policies". The World Met ...
, a price level of $135–$5500 in 2030 and $245–$13,000 per metric ton in 2050 would be needed to drive carbon emissions to stay below the 1.5°C limit. Latest models of the
social cost of carbon The social cost of carbon (SCC) is an estimate, typically expressed in dollars, of the economic damages associated with emitting one additional ton of carbon dioxide into the atmosphere. By translating the effects of climate change into monetary t ...
calculate a damage of more than $300 per ton of as a result of economy feedbacks and falling global
GDP Gross domestic product (GDP) is a monetary measure of the total market value of all the final goods and services produced and rendered in a specific time period by a country or countries. GDP is often used to measure the economic performance o ...
growth rates, while policy recommendations range from about $50 to $200. Many carbon pricing schemes including the ETS in China remain below $10 per ton of . One exception is the
European Union Emissions Trading System The European Union Emissions Trading System (EU ETS) is a carbon emission trading scheme (or ''cap and trade'' scheme) that began in 2005 and is intended to lower greenhouse gas emissions in the EU. Cap and trade schemes limit emissions of spec ...
(EU-ETS) which exceeded €100 ($) per ton of in February 2023. A carbon tax is generally favoured on economic grounds for its simplicity and stability, while cap-and-trade theoretically offers the possibility to limit allowances to the remaining carbon budget. Current implementations are only designed to meet certain reduction targets.


Overview

Carbon pricing is considered by many economists to be the most economically efficient way to reduce emissions, taking into account the costs of both efficiency measures and the inconvenience of lesser fossil fuels. By pricing the externalities of carbon emissions, efficiency comes about by eliminating the
market failure In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value.Paul Krugman and Robin Wells Krugman, Robin Wells (2006 ...
of the unpriced external costs of carbon emissions at its source. It is regarded as more efficient than renewable energy subsidies given to individual firms, because the difficulties of determining the value of emissions to each firm makes
command and control regulation Command and Control (CAC) regulation finds common usage in academic literature and beyond. The relationship between CAC and environmental policy is considered in this article, an area that demonstrates the application of this type of regulation. Ho ...
less likely to be efficient. In a
carbon tax A carbon tax is a tax levied on the carbon emissions from producing goods and services. Carbon taxes are intended to make visible the hidden Social cost of carbon, social costs of carbon emissions. They are designed to reduce greenhouse gas emis ...
model, a tax is imposed on carbon emissions produced by a firm. In a
cap-and-trade Carbon emission trading (also called carbon market, emission trading scheme (ETS) or cap and trade) is a type of emissions trading scheme designed for carbon dioxide (CO2) and other greenhouse gases (GHGs). A form of carbon pricing, its purpose ...
design, the government establishes an emissions cap and allocates to firms emission allowances, which can thereafter be privately traded. Emitters without the required allowances face a penalty more than the price of permits. Assuming all else is equal, the market for permits will automatically adjust the carbon price to a level that ensures that the cap is met. The EU ETS uses this method. In practice, it has resulted in a fairly strong carbon price from 2005 to 2009, but that was later undermined by an oversupply and the
Great Recession The Great Recession was a period of market decline in economies around the world that occurred from late 2007 to mid-2009.
. Recent policy changes have led to a steep increase of the carbon price since 2018, exceeding 100€ ($) per ton of in February 2023. Evaluations of 21 carbon pricing schemes, show that at least 17 of these have caused reductions in greenhouse gas emissions. The achieved emissions reductions range between 5% and 21% for the studied schemes. The exact monetary damage of the social cost caused by a tonne of depends on climate and economic feedback effects and remains to some degree uncertain. Latest calculations show an increasing trend:


Implementation

Cap-and-trade systems can include
price stability Price stability is a goal of monetary and fiscal policy aiming to support sustainable rates of economic activity. Policy is set to maintain a very low rate of inflation or deflation. For example, the European Central Bank (ECB) describes price s ...
provisions with floor and ceiling limits. Such designs are often referred to as hybrid designs. To the extent the price is controlled by these limits, it can be considered a tax.


Carbon tax versus emissions trade

Carbon emissions trading Carbon emission trading (also called carbon market, emission trading scheme (ETS) or cap and trade) is a type of emissions trading scheme designed for carbon dioxide (CO2) and other greenhouse gases (GHGs). A form of carbon pricing, its purpose ...
works by setting a quantitative limit on the emissions produced by emitters. As a result, the price automatically adjusts to this target. This is the main advantage compared to a fixed
carbon tax A carbon tax is a tax levied on the carbon emissions from producing goods and services. Carbon taxes are intended to make visible the hidden Social cost of carbon, social costs of carbon emissions. They are designed to reduce greenhouse gas emis ...
. A carbon tax is considered easier to enforce on a broad-base scale than cap-and-trade programs. The simplicity and immediacy of a carbon tax has been proven effective in British Columbia, Canada – enacted and implemented in five months. A hybrid cap-and-trade program puts a limit on price increases and, in some cases, sets a floor price as well. The upper limit is set by adding more allowances to the market at a set price while the floor price is maintained by not allowing sales into the market at a price below the floor. The
Regional Greenhouse Gas Initiative The Regional Greenhouse Gas Initiative (RGGI, pronounced "Reggie") is the first mandatory market-based program to reduce greenhouse gas emissions by the United States. RGGI is a cooperative effort among the states of Connecticut, Delaware, Maine, ...
, for example, sets an upper limit on allowance prices through its cost containment provision. However, industries may successfully lobby to exempt themselves from a carbon tax. It is therefore argued that with emissions trading, polluters have an incentive to cut emissions, but if they are exempted from a carbon tax, they have no incentive to cut emissions. On the other hand, freely distributing emission permits could potentially lead to corrupt behaviour. Most cap and trade programs have a descending cap, usually a fixed percentage every year, which gives certainty to the market and guarantees that emissions will decline over time. With a tax, there can be estimates of reduction in carbon emissions, which may not be sufficient to change the course of climate change. A declining cap gives allowance for firm reduction targets and a system for measuring when targets are met. It also allows for flexibility, unlike rigid taxes. Providing emission permits (also called allowances) under emissions trading is preferred in situations where a more accurate target level of emissions certainty is needed.


Revenue policies

Standard proposals for using carbon revenues include * a return to the public on a per-capita basis This can compensate the risk of rising energy prices reaching high levels as long as cheap wind and solar power is not available yet. Rich people who tend to have a larger carbon footprint would pay more while poorer people can even benefit from such a regulation. * subsidies accelerating the transition to renewable energy * research, public transport, car sharing and other policies that promote
carbon neutrality Global net-zero emissions is reached when greenhouse gas emissions and removals due to human activities are in balance. It is often called simply net zero. ''Emissions'' can refer to all greenhouse gases or only carbon dioxide (). Reaching net ze ...
* subsidies for negative emissions: Depending on the technology, such as PyCCS or
BECCS Bioenergy with carbon capture and storage (BECCS) is the process of extracting bioenergy from Biomass (energy), biomass and capturing and storing the carbon dioxide (CO2) that is produced. Greenhouse gas emissions from bioenergy can be low becaus ...
, the cost for generating negative emissions is about $150–165 per ton of CO2. The removal past emissions – 1,700 Gt in total – can theoretically be addressed by auctioning allowances starting with a price that exceeds the removal costs of the proposed emissions.


Price levels

About one third of the systems stays below $10/t, the majority is below $40. One exception is the steep incline in the EU-ETS reaching $60 in September 2021. Sweden and Switzerland are the only countries with more than $100/t.


Market price surge in fossil fuels

Unexpected spikes in natural gas prices and commodities such as oil and coal in 2021 caused a debate whether a carbon price increase should be postponed to avoid additional social burden. On the other hand, a redistribution on a per-capita-basis would even release poorer households which tend to consume less energy compared to wealthier parts of the population. The higher the high carbon price the greater the relief. Looking at individual situations though, the compensation would not apply to commuters in rural areas or people living in houses with poor insulation. They neither have liquidity to invest into solutions using less
fossil fuels A fossil fuel is a flammable carbon compound- or hydrocarbon-containing material formed naturally in the Earth's crust from the buried remains of prehistoric organisms (animals, plants or microplanktons), a process that occurs within geologica ...
and would be dependent on credits or subsidies. On the other hand, a carbon price still helps to provide an incentive to use more effective fossil fuel technologies such as CCGT gas turbines in contrast to high-emission coal.


Scope and coverage

In the relevant countries with ETS and taxes, about 40% to 80% of emissions are covered. The schemes differ much in detail. They include or exclude fuels, transport, heating, agriculture or other greenhouse gases apart from like
methane Methane ( , ) is a chemical compound with the chemical formula (one carbon atom bonded to four hydrogen atoms). It is a group-14 hydride, the simplest alkane, and the main constituent of natural gas. The abundance of methane on Earth makes ...
or fluorinated gases. In many EU member states like France or Germany, there is a coexistence of two systems: The EU-ETS covers power generation and large industry emissions while national ETS or taxes put a different price on petrol, natural gas and oil for private consumption.


Other taxes and price components

The final consumer price for fuels and electric energy depends on individual tax regulations and conditions in each country. Though carbon pricing is playing an increasing role,
energy tax An energy tax is a tax that increases the price of energy. Arguments in favour of energy taxes have included the pursuit of macroeconomic objectives, e.g., fiscal deficit reduction in the 1990s, as well as environmental benefits, i.e., reduced pollu ...
es,
VAT A value-added tax (VAT or goods and services tax (GST), general consumption tax (GCT)) is a consumption tax that is levied on the value added at each stage of a product's production and distribution. VAT is similar to, and is often compared wi ...
, utility expenses and other components are still the main cause for completely different price levels between countries.


Impact on retail prices

The table gives examples for a carbon price of $100 or 100 units of any other currency accordingly. Food calculation is all based on equivalents including the high impact of
methane emissions Increasing methane emissions are a major contributor to the rising concentration of greenhouse gases in Earth's atmosphere, and are responsible for up to one-third of near-term global heating. During 2019, about 60% (360 million tons) of methane r ...
.


Economics

Many economic properties of carbon pricing hold regardless of whether carbon is priced with a cap or a tax. However, there are a few important differences. Cap-based prices are more volatile and so they are riskier for investors, consumers and for governments that auction permits. Also, caps tend to short-out the effect of non-price policies such as renewables subsidies, while carbon taxes do not.


Carbon leakage

Carbon leakage Carbon leakage is a concept to quantify an increase in greenhouse gas emissions in one country as a result of an emissions reduction by a second country with stricter climate change mitigation policies. Carbon leakage is one type of spill-over ef ...
is the effect that regulation of emissions in one country/sector has on the emissions in other countries/sectors that are not subject to the same regulation. There is no consensus over the magnitude of long-term carbon leakage. The leakage rate is defined as the increase in CO2 emissions outside the countries taking domestic mitigation action, divided by the reduction in emissions of countries taking domestic mitigation action. Accordingly, a leakage rate greater than 100% means that actions to reduce emissions within countries had the effect of increasing emissions in other countries to a greater extent, i.e., domestic mitigation action had actually led to an increase in global emissions. Estimates of leakage rates for action under the Kyoto Protocol ranged from 5% to 20% as a result of a loss in price competitiveness, but these leakage rates were considered very uncertain. For energy-intensive industries, the beneficial effects of Annex I actions through technological development were considered possibly substantial. However, this beneficial effect had not been reliably quantified. On the empirical evidence they assessed, Barker ''et al.'' (2007) concluded that the competitive losses of then-current mitigation actions, e.g., the EU-ETS, were not significant. Under the EU ETS rule
Carbon Leakage Exposure Factor
is used to determine the volumes of free allocation of emission permits to industrial installations. A general perception among developing countries is that discussion of climate change in trade negotiations could lead to green
protectionism Protectionism, sometimes referred to as trade protectionism, is the economic policy of restricting imports from other countries through methods such as tariffs on imported goods, import quotas, and a variety of other government regulations ...
by high-income countries
Eco-tariffs An eco-tariff, also known as an environmental tariff, is a trade barrier for the purpose of reducing pollution and improving the environment. These trade barriers may take the form of import tax, import or export taxes on products that have a l ...
on imports ("virtual carbon") consistent with a carbon price of $50 per ton of CO2 could be significant for developing countries. In 2010, World Bank commented that introducing border tariffs could lead to a proliferation of trade measures where the competitive playing field is viewed as being uneven. Tariffs could also be a burden on low-income countries that have contributed very little to the problem of climate change.


Interactions with renewable energy policies

Cap-and-trade and carbon taxes interact differently with non-price policies such as renewable energy subsidies. The
IPCC The Intergovernmental Panel on Climate Change (IPCC) is an intergovernmental body of the United Nations. Its job is to "provide governments at all levels with scientific information that they can use to develop climate policies". The World M ...
explains this as follows:
A carbon tax can have an additive environmental effect to policies such as subsidies for the supply of RE. By contrast, if a cap-and-trade system has a binding cap (sufficiently stringent to affect emission-related decisions), then other policies such as ''RE subsidies have no further impact on reducing emissions'' within the time period that the cap applies mphasis added


Carbon pricing and economic growth

According to a 2020 study carbon prices have not harmed economic growth in wealthy industrialized democracies. In order for such a business model to become attractive, the subsidies would therefore have to exceed this value. Here, a technology openness could be the best choice, as a reduction in costs due to technical progress can be expected. Already today, these costs of generating negative emissions are below the costs of CO2 of $220 per ton, which means that a state-subsidized business model for creating negative emissions already makes economic sense today. In sum, while a carbon price has the potential to reduce future emissions, a carbon subsidy has the potential to reduce past emissions.


Advantages and disadvantages

In late 2013,
William Nordhaus William Dawbney Nordhaus (born May 31, 1941) is an American economist. He was a Sterling Professor of Economics at Yale University, best known for his work in economic modeling and climate change, and a co-recipient of the 2018 Nobel Memorial ...
, president of the
American Economic Association The American Economic Association (AEA) is a learned society in the field of economics, with approximately 23,000 members. It publishes several peer-reviewed journals, including the Journal of Economic Literature, American Economic Review, an ...
, published ''The Climate Casino'', which culminates in a description of an international "carbon price regime". Such a regime would require national commitments to a carbon price, but ''not'' to a specific policy. Carbon taxes, caps, and hybrid schemes could all be used to satisfy such a commitment. At the same time
Martin Weitzman Martin Lawrence Weitzman (April 1, 1942 – August 27, 2019) was an American economist and a professor of economics at Harvard University. He was among the most influential economists in the world according to Research Papers in Economics (RePEc). ...
, a leading climate economist at Harvard, published a theoretical study arguing that such a regime would make it far easier to reach an international agreement, while a focus on national targets would continue to make it nearly impossible. Nordhaus also makes this argument, but less formally. Similar views have previously been discussed by
Joseph Stiglitz Joseph Eugene Stiglitz (; born February 9, 1943) is an American New Keynesian economist, a public policy analyst, political activist, and a professor at Columbia University. He is a recipient of the Nobel Memorial Prize in Economic Sciences (2 ...
and have previously appeared in a number of papers. The price-commitment view appears to have gained major support from independent positions taken by the
World Bank The World Bank is an international financial institution that provides loans and Grant (money), grants to the governments of Least developed countries, low- and Developing country, middle-income countries for the purposes of economic development ...
and the
International Monetary Fund The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution funded by 191 member countries, with headquarters in Washington, D.C. It is regarded as the global lender of las ...
(IMF). The "Economists' Statement on Climate Change" was signed by over 2500 economists including nine Nobel Laureates in 1997. This statement summarizes the economic case for carbon pricing as follows:
The most efficient approach to slowing climate change is through market-based policies. In order for the world to achieve its climatic objectives at minimum cost, a cooperative approach among nations is required – such as an international emissions trading agreement. The United States and other nations can most efficiently implement their climate policies through market mechanisms, such as carbon taxes or the auction of emissions permits.
This statement argues that carbon pricing is a "market mechanism" in contrast to renewable subsidies or direct regulation of individual sources of carbon emissions and hence is the way that the "United States and other nations can most efficiently implement their climate policies."
Carbon offset Carbon offsetting is a carbon trading mechanism that enables entities to compensate for offset greenhouse gas emissions by investing in projects that reduce, avoid, or remove emissions elsewhere. When an entity invests in a carbon offsetting ...
s for individuals and businesses may also be purchased through carbon offset retailers like Carbonfund.org Foundation. A new quantity commitment approach, suggested by Mutsuyoshi Nishimura, is for all countries to commit to the same ''global'' emission target. The "assembly of governments" would issue permits in the amount of the global target and all upstream fossil-fuel providers would be forced to buy these permits. In 2019 the
UN Secretary General The secretary-general of the United Nations (UNSG or UNSECGEN) is the chief administrative officer of the United Nations and head of the United Nations Secretariat, one of the United Nations System#Six principal organs, six principal organs of ...
asked governments to tax carbon. The economics of carbon pricing is much the same for taxes and cap-and-trade. Both prices are efficient; they have the same social cost and the same effect on profits if permits are auctioned. However, some economists argue that caps prevent non-price policies, such as renewable
energy subsidies Energy subsidies are measures that keep prices for customers below market levels, or for suppliers above market levels, or reduce costs for customers and suppliers. Energy subsidies may be direct cash transfers to suppliers, customers, or relat ...
, from reducing
carbon emissions Greenhouse gas (GHG) emissions from human activities intensify the greenhouse effect. This contributes to climate change. Carbon dioxide (), from burning fossil fuels such as coal, petroleum, oil, and natural gas, is the main cause of climate chan ...
, while carbon taxes do not. Others argue that an enforced cap is the only way to guarantee that carbon emissions will actually be reduced; a carbon tax will not prevent those who can afford to do so from continuing to generate emissions. Besides cap and trade, emission trading can refer to project-based programs, also referred to as a credit or offset programs. Such programs can sell credits for emission reductions provided by approved projects. Generally there is an additionality requirement that states that they must reduce emissions more than is required by pre-existing regulation. An example of such a program is the
Clean Development Mechanism The Clean Development Mechanism (CDM) is a United Nations-run carbon offset scheme allowing countries to fund greenhouse gas emissions-reducing projects in other countries and claim the saved emissions as part of their own efforts to meet internat ...
under the Kyoto Protocol. These credits can be traded to other facilities where they can be used for compliance with a cap-and-trade program.Types of Trading
. Clean Air Market Programs. Retrieved July 8, 2012.
Unfortunately the concept of additionality is difficult to define and monitor, with the result that some companies purposefully increased emissions in order to get paid to eliminate them. Cap-and-trade programs often allow "banking" of permits. This means that permits can be saved and can be used in the future. This allows an entity to over-comply in early periods in anticipation of higher carbon prices in subsequent years.Cap and trade programs for greenhouse gas
iasplus.com
This helps to stabilize the price of permits.


Notes


References


Sources


Global Warming of 1.5 °C —
** * * * * * * *


External links


Our Climate Put A Price On It campaign

CDM Rulebook
— Defines Kyoto commitments
UN Climate Change Framework
— Lists national commitments for 2020
Pricing Carbon Initiative
— US focused effort for carbon-pricing commitments {{DEFAULTSORT:Carbon Pricing Carbon finance Fossil fuels Subsidies Environmental tax