So What is Carbon Pricing?

Dec 29, 2019 · 4 min read

by Hadia Faheem

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World Bank

On December 2, heads of state from all around the world will congregate in Madrid for the 25th Conference of the Parties to the UN Convention on Climate Change (COP25). The document that was the inspiration for this annual international gathering is the UN Framework Convention on Climate Change (UNFCCC) signed in 1992 at the Earth Summit in Brazil. The document contains a list of 197 countries that agreed to mitigate greenhouse gas emissions by keeping the global temperature to only 1.5 degrees Celsius above pre-industrial levels.

Of the 197 countries, 187 have ratified the Paris Agreement. Every 5 years, each party to the agreement must report on their progress towards reducing emissions and propose a new plan to continue doing so. The 2019 conference in Madrid is the last conference before COP26 in 2020, where every country is required to submit new action plans.

There are multiple different strategies that countries can pursue to reduce their carbon footprints. One of the most popular and effective examples is carbon pricing. The term has been thrown around in the media and by experts in recent years since climate change has made headlines but what exactly is it?

By definition, carbon pricing is a form of tax imposed on polluters and other entities that release huge carbon emissions. The goal is to encourage them to limit their carbon footprints by essentially forcing them to incur monetary costs for polluting. Most economists agree that it is one of the most effective ways to reduce emissions considering the consensus that climate change is a form of market failure. What this means is that prices for carbon fuel do not account for and are not reflective of the negative externalities they produce in society. Individuals and businesses that are producing greenhouse gas emissions are not paying a high enough price for the damage they cause to the environment. Hence, carbon pricing .

The two most popular types of carbon pricing are cap and trade systems and carbon taxes. Cap and trade is directed more widely at businesses and corporations. Every country is assigned a specific emissions allowance, and emissions permits are subsequently allotted or sold to different corporations within the country. These permits are the amount of emissions that a company is allowed to release every year. In a cap and trade system, governments do not dictate how companies should run their businesses, nor are they imposing specific practices to cut emissions It solely incentivizes companies to either find ways to reduce emissions or invest in cleaner alternatives because they cannot exceed their permitted amounts. If a company uses up less than the amount it was granted, it can sell these extra allowances on the market to other companies. In the long term, a country’s overall cap on carbon emissions is reduced annually. This leads to more expensive, less excess allowance being sold in the open marketp. Companies will have to make the investment in cleaner business operations or be forced to incur fines on their carbon fuel usage.

A carbon tax, on the other hand, is an alternative method of carbon pricing. In this case, the government does not set a limit on the level of emissions and instead tax all emissions that businesses and consumers produce at a pre-set price to discourage excessive emissions . Although carbon taxes have support from economists from all political points of view, politicians have been historically unsuccessful when it comes to passing carbon tax-related legislation. The idea of levying an additional tax of any sort, even one that would have a favorable impact on the environment, is incredibly unpopular with the majority of voters, regardless of what country they are from.

Washington state passed a proposal to impose a carbon fee of $15 per ton of greenhouse gases produced on businesses and consumers. The money would then be funneled into communities most hard-hit by climate change in the state, but it was struck down when it only managed to garner the support of 43% of voters.

Across the Atlantic, President Macron was forced to abandon his version of the carbon tax. The French government introduced a 6.5 cent fuel tax to reduce drivers’ gasoline and diesel consumption, and the price increase was met with riots all across Paris. In Australia, the government also shelved its carbon pricing scheme in 2014, after only 3 years.

Carbon pricing programs are not ineffective, but they have played a limited role in the efforts to mitigate climate change due to their relative unpopularity among the electorate. There have been efforts in recent years to carry out carbon pricing schemes. Canada has levied a tax of $15 per ton of CO2 produced by oil, coal, and gas that will continue to increase in the coming years, upon provinces that refused to set their own carbon pricing initiatives. Nine northeastern states and California have set up their own cap and trade system, and use the returns to invest in cleaner energy sources.

For now, economists and scientists both acknowledge that carbon pricing may be the most efficient way to tackle increased emissions. However, public push back has largely muted any potentially significant effects that the plan could have on combating climate change. Many individuals see the increase in taxes and costs in the short-term, and choose to focus on those when it comes to judging these programs. It can be especially difficult to take what may happen in the future into consideration because it’s difficult to envision or care about upcoming events that a carbon pricing policy is trying to prevent, especially when said policy is negatively impacting one’s livelihood in the moment. The future challenge for governments is determining how to align voters’ and business’ short-term economic interests with the long-term environmental interests of the planet.


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