[[File:Carbon taxes and emission trading worldwide.svg|alt=Carbon taxes and emission trading worldwide|thumb|Emission trading and carbon taxes around the world (2021)
]] Carbon pricing (or pricing) is a method for governments to mitigate climate change, in which a monetary cost is applied to greenhouse gas emissions. This is done to encourage polluters to reduce fossil fuel combustion, the main driver of climate change. A carbon price usually takes the form of a carbon tax, or an emissions trading scheme (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 are a negative externality – 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. Regions with carbon pricing include most European countries and Canada. On the other hand, top emitters like India, Russia, the Gulf states and many US states have not introduced carbon pricing. Australia 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, 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 calculate a damage of more than $300 per ton of as a result of economy feedbacks and falling global GDP growth rates, while policy recommendations range from about $50 to $200. Many carbon pricing schemes including the ETS in China remain below $10 per ton of . One exception is the European Union Emissions Trading System (EU-ETS) which exceeded €100 ($) 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.
In a carbon tax model, a tax is imposed on carbon emissions produced by a firm. In a cap-and-trade 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. Ceteris paribus, 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. 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:
Interagency Working Group (US government) | 2013 / 2016 | $42 | Central estimate for 3% discount rate in 2020 |
$212 | High impact value for 2050 / 3% discount / 95th percentile | ||
German Environmental Agency | 2019 | $ (180 €) | With 1% time preference |
$ (640 €) | Without time preference | ||
Kikstra et al. | 2021 | $3372 | Including economic feedbacks |
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.
+ Carbon pricing schemes with more than $2 bn revenue |
revenue 2020 |
$22.5 bn |
launched 2021 |
$3.4 bn |
$9.6 bn |
$ bn (€7.4 bn) expected, launch 2021 |
$2.4 bn |
$2.3 bn |
$0.24 |
$0.27 |
$0.11 |
$0.10 |
$0.06 |
$0.04 |
$0.02 |
$0.03 |
$0.29 |
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 rules 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 by high-income countries Eco-tariff 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.
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.
Similar views have previously been discussed by Joseph Stiglitz 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 and the International Monetary Fund (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:
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 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, from reducing carbon emissions, 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 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.
Interactions with renewable energy policies
A carbon tax can have an additive environmental effect to policies such as subsidies for the supply of Renewable energy. 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 emphasis.
Carbon pricing and economic growth
Advantages and disadvantages
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."
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