Carbon pricing is a market-based tool for reducing carbon (or greenhouse gas, GHG) emissions by shifting the external, social costs of climate change to the source of GHG emissions, thus encouraging polluters to reduce emissions and invest in low-carbon growth strategies (Carbon Pricing Leadership Coalition, 2018; World Bank, 2020). The aim of carbon pricing is to put a monetary value on carbon emissions so that the costs of climate impacts (e.g., damage to crops, health care costs associated with heat waves and droughts, and loss of property from flooding and sea level rise) and the opportunities for low-carbon energy options are better reflected in production and consumption choices (Union of Concerned Scientists, 2017).
Carbon pricing is not only widely recognized as a powerful and efficient instrument for reducing carbon emissions. It is also gaining support globally, with over 45 national jurisdictions and 32 subnational jurisdictions (e.g., cities and states) having implemented and/or planned to implement carbon pricing initiatives (See Figure 1).
In 2020, these carbon pricing initiatives cover 12,000 million tonnes of carbon emissions, representing 22.3% of total global GHG emissions. (See Box 1 below for a brief summary of common types of carbon pricing initiatives.)
Box 1: Common approaches to carbon pricing
A carbon tax is a tax levied on the carbon content of fuels meant to encourage the reduction of fossil fuel use and inspire the development of alternatives (“Cap and Trade Basics,” n.d.).
Cap and Trade
A carbon cap and trade (CAT) – sometimes referred to as an emissions trading trading system (ETS) – sets a limit on pollution and creates a market through which a set amount of permits-to-pollute are allotted that can be bought and sold among emitters (“What’s a carbon tax?,” n.d.).
Proxy Carbon Price
A proxy carbon price is a method of internal carbon pricing for which the emissions expected from a project are given a virtual cost associated per tonne of carbon, and evaluated in the Life-Cycle-Cost (LCC) analysis of projects when decision making (Barron et al., 2020).
Lastly, a carbon fund is a reserved budgetary allocation typically used to fund sustainability projects that reduce emissions. This may also be used in tandem with the aforementioned options as a way to save the revenue generated (Barron et al., 2020).
For more detailed descriptions of various carbon pricing instruments, please see the Carbon Pricing Leadership Coalition’s webpage on carbon pricing at: https://www.carbonpricingleadership.org/what.
Not only that, but as reported in the Wall Street Journal and supported by over 25 Nobel Laureate economists, there exists growing and bi-partisan agreement that carbon pricing policies are one of the most cost-effective levers for reducing carbon emissions at the scale and pace required to meet the goals of the Paris Agreement. In fact, recent reports, like that published by Resources for the Future, have suggested that economy-wide carbon pricing programs can cost significantly less than sector-specific strategies when striving to achieve emissions targets (Hafstead, 2020).
Business leaders have also shown increased support for carbon pricing policies, as they can provide the regulatory certainty that companies may require for long-term investments in clean-energy technology. In 2017, the CDP reported that roughly 1,400 companies – including more than 100 Fortune Global 500 companies with collective annual revenues of US$7 trillion – disclosed that they are currently using, or planning to implement, an internal carbon price within two years. And in 2019, the CEOs of 13 U.S. and Global Fortune 500 companies – including BP, Citi, DuPont, Ford Motor Company, Shell, and Unilever – put out a call for action on an economy-wide carbon pricing policy and launched the CEO Climate Dialogues to advance a market-based approaches to achieve carbon reduction goals.
In addition to being backed by business and proven as efficient means for reducing carbon emissions, carbon pricing policies can also generate a number of economic benefits, with implications for low-carbon growth and improved social equity.
Examples of potential uses for carbon pricing revenues include (Hafstead, 2019):
- Providing per capita dividends or using carbon revenues to cut other taxes including income, sales, especially for low-income individuals;
- Investing in low-carbon innovations (e.g., renewable energy technology, electric vehicles, and energy efficiency solutions) to accelerate the transition to cleaner energy sources and reduce consumer costs;
- Supplying rebates on electricity bills to offset the disproportionate impacts of higher energy prices for low- and moderate-income households;
- Providing transition assistance to worker in communities that depend on the fossil fuels industry for their livelihoods; and
- Investing in communities disproportionately impacted by pollution from fossil fuel industries and providing support for more climate-resilient infrastructure (e.g., improved roads, leviews, and seawalls) or relocation costs for communities at high risk (Union of Concerned Scientists, 2017).
In this way, carbon pricing policies can often be complementary to other energy policies and policies aimed at promoting social equity, leading to the creation of more resilient and comprehensive solutions capable of withstanding market fluctuations (Hood, 2013; Baranzini et al., 2017).
If priced appropriately, carbon pricing can place a strong incentive on deep decarbonization by encouraging technological improvements. Carbon pricing can force financial institutions to consider the potential risks of carbon-intensive projects and preferentially invest in low carbon emissions projects, which can in turn catalyze clean energy technology development and overall carbon emissions reductions.
For example, the European Union Emissions Trading System (EU ETS) – the world’s largest GHG cap-and-trade scheme – has increased patents for low carbon technology among regulated firms by as much as 10% and spurred innovations in energy storage and alternative energy sources, including biofuel, wind, solar, thermal, and solar photovoltaic energy (Calel and Dechezleprêtre, 2016). These firms have also been able to employ other mitigation strategies that were not viable prior to the advent of the EU ETS, such as switching from coal to gas-fired power plants, which has resulted in total annual carbon emissions reductions of 50 to 100 million tonnes (3-6%) (Calel and Dechezleprêtre, 2016). Ultimately, it is believed that leveraging the power of carbon pricing policies to spur technological innovation, switching to low-carbon energy sources, expanding the electrification of economic activities, and improving energy efficiency can deliver the carbon emissions reductions required from the energy sector by 2040 to meet the goals of the Paris Agreement (New Climate Economy, 2018).
- Baranzini, A., van den Bergh, J. C. J. M., Carattini, S., Howarth, R. B., Padilla, E., & Roca, J. (2017). Carbon pricing in climate policy: seven reasons, complementary instruments, and political economy considerations. Wiley Interdisciplinary Reviews: Climate Change, 8(4), e462. https://doi.org/10.1002/wcc.462
- Barron, A. R., Parker, B. J., Sayre, S. S., Weber, S. S., & Weisbord, D. J. (2020). Carbon pricing approaches for climate decisions in U.S. higher education: Proxy carbon prices for deep decarbonization. Elem Sci Anth, 8(1), 42. https://doi.org/10.1525/elementa.443
- Calel, R., & Dechezlepretre, A. (2016). Environmental policy and directed technological change: evidence from the European carbon market. Review of Economics and Statistics, 98(1). https://doi.org/10.1162/REST_a_00470
- Cap and Trade Basics. (n.d.). Center for Climate and Energy Solutions. Retrieved October 19, 2020, from http://www.c2es.org/content/cap-and-trade-basics/
- Carbon Pricing Leadership Coalition. (n.d.). Understanding carbon pricing. Retrieved October 16, 2020, from https://www.carbonpricingleadership.org/what
- CDP. (2017). Putting a price on carbon: Integrating climate risk into business planning. https://b8f65cb373b1b7b15feb-c70d8ead6ced550b4d987d7c03fcdd1d.ssl.cf3.rackcdn.com/cms/reports/documents/000/002/738/original/Putting-a-price-on-carbon-CDP-Report-2017.pdf?1507739326
- Climate Leadership Council. (n.d.). Economists’ Statement on Carbon Dividends Organized by the Climate Leadership Council. Retrieved October 16, 2020, from https://www.econstatement.org/
- Economists’ Statement on Carbon Dividends. (2019, January 16). Wall Street Journal. https://www.wsj.com/articles/economists-statement-on-carbon-dividends-11547682910
- Hafstead, M. (2019). Carbon Pricing 102: Revenue Use Options Carbon Pricing Revenue. https://media.rff.org/documents/Carbon_Pricing_Explainer_102.pdf
- Hafstead, M. (2020). Decarbonizing Colorado Evaluating Cap and Trade Programs to Meet Colorado’s Emissions Targets. Resources for the Future. https://media.rff.org/documents/Decarbonizing_Colorado_-_RFF_Report.pdf
- Hood, C. (2013). Managing interactions between carbon pricing and existing energy policies: Guidance for policymakers. Paris: International Energy Agency. https://ieta.wildapricot.org/resources/EU/Overlapping_Policies_Drafting_Group/managinginteractionscarbonpricing_final.pdf
- Meridian Institute. (2019, May 15). Leading U.S. Businesses Call on Congress to Enact a Market-Based Approach to Climate Change. https://docs.wixstatic.com/ugd/ab534e_4b3f934392ec447a9d24e0c9360025c0.pdf
- New Climate Economy. (2018). Unlocking the Inclusive Growth Story of the 21st Century: Accelerating Climate Action in Urgent Times. https://newclimateeconomy.report/2018/wp-content/uploads/sites/6/2018/09/NCE_2018_FULL-REPORT.pdf
- The World Bank. (n.d.). What is Carbon Pricing? Retrieved October 16, 2020, from https://carbonpricingdashboard.worldbank.org/what-carbon-pricing
- Union of Concerned Scientists. (2009, July 17). Carbon Pricing 101: When carbon emissions cost money, we produce less of them. Retrieved October 16, 2020, from https://www.ucsusa.org/resources/carbon-pricing-101
- What’s a carbon tax? (n.d.). Carbon Tax Center. Retrieved October 19, 2020, from https://www.carbontax.org/whats-a-carbon-tax/