Carbon price
Carbon 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 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 gases 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 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 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 less likely to be efficient.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. 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. 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:
| Source | Year | Carbon price per ton of | Remarks |
| Interagency Working Group | 2013 / 2016 | $42 | Central estimate for 3% discount rate in 2020 |
| Interagency Working Group | 2013 / 2016 | $212 | High impact value for 2050 / 3% discount / 95th percentile |
| German Environmental Agency | 2019 | $ | With 1% time preference |
| German Environmental Agency | 2019 | $ | Without time preference |
| Kikstra et al. | 2021 | $3372 | Including economic feedbacks |
Implementation
Cap-and-trade systems can include price stability 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
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 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, 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 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
- subsidies for negative emissions: Depending on the technology, such as PyCCS or BECCS, 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.
Policy mix method
While carbon pricing is regarded as an economically efficient tool for emissions reduction, research suggests it should be part of a broader policy mix including green industrial policies to address market barriers like technology spillovers and coordination failures.
Green industrial policies can lower the political resistance to carbon pricing by fostering the deployment of clean energy technologies, which reduces the economic burden on consumers when carbon prices eventually rise.
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 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 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.| country / region | type | share | coverage / remarks | revenue 2020 |
| EU | ETS | 39% | industry, electricity, intra-EU aviation | $22.5 bn |
| China | ETS | 40% | electricity, district heating | launched 2021 |
| Canada | tax | 22% | National pricing in Canada, additional taxes and ETS in provinces | $3.4 bn |
| France | tax | 35% | non EU-ETS | $9.6 bn |
| Germany | ETS | 40% | non EU-ETS: transport, heating | $ bn expected, launch 2021 |
| Japan | tax | 75% | $2.4 bn | |
| Sweden | tax | 40% | transport, buildings, industry, agriculture | $2.3 bn |