Carbon Pricing: The Tool that Makes All Other Tools Work Better

Deep decarbonization of the U.S. economy, let alone of the entire world, is a daunting task. No single approach to climate policy is going to accomplish the mission by itself.

That said, among the policy alternatives, carbon pricing is perhaps the most widely discussed, but also most widely misunderstood. Whether envisioned in the form of carbon taxes or emissions trading (cap-and-trade), carbon pricing is often portrayed as a one-trick pony that nudges consumers toward burning less gasoline and utilities to switch from coal to gas, but does little else. In reality, though, carbon pricing is capable of doing far more than that. It is highly versatile, touching every corner of the economy, and capable of working hand-in-hand with other tools of climate policy to increase their effectiveness. Figure 1, which is adapted from a paper by Fergus Green and Richard Denniss, provides an overview of the climate policy toolkit. It is based on three distinctions that will be useful in framing the issues discussed in this commentary.

The first distinction is between market-based and regulatory policies. Market-based policies are those that aim to affect…