Carbon Pricing

Carbon pricing is a market-based approach designed to reduce carbon dioxide emissions, a key factor in climate change. The concept revolves around assigning a cost to carbon emissions, which aims to discourage excessive pollution while promoting cleaner energy alternatives and technologies. The primary methods of carbon pricing include carbon taxes and cap-and-trade systems. A carbon tax imposes a fee based on the carbon content of various fuels, thereby creating a financial incentive for businesses and consumers to opt for less polluting energy sources. Conversely, cap-and-trade systems allocate a limited number of permits for carbon emissions, allowing companies to trade these permits, thus encouraging reductions in emissions.

Countries like Germany, Australia, and various European nations have implemented carbon taxes, while California and the European Union have adopted cap-and-trade programs. While these strategies aim to effectively mitigate climate change, challenges remain, such as potential competitive disadvantages for industries in jurisdictions with stricter regulations and the need for global cooperation to avoid shifting emissions to regions with less stringent controls. Additionally, carbon pricing addresses only part of the climate issue, as other sectors, like livestock farming, also significantly contribute to greenhouse gas emissions. Overall, carbon pricing represents a critical element in the broader strategy to combat climate change and promote sustainability.

Published in: 2021

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Subject Terms

Carbon Pricing

Abstract

Carbon pricing is a market-based approach to reducing carbon dioxide emissions in the interest of slowing the rate of climate change, by assessing a fee in some form for carbon emissions. The principal forms of carbon pricing are carbon taxes and the permits system called cap and trade. While scientists concur that climate change has likely reached a point of no return, strategies like carbon pricing can be used to reduce carbon emissions while maintaining a healthy economy in order to slow the progression of climate change.

Overview

Carbon pricing is a market-based strategy (or set of strategies) for reducing carbon dioxide emissions in order to slow the rate of climate change. The carbon price is a price that must be paid for the right to produce carbon emissions within a jurisdiction, which acts to discourage unnecessary emissions and incentivize the development and use of alternative energy sources and green technology. Carbon dioxide emissions are produced by all combustion-based energy sources—coal, natural gas, oil, and gasoline—while non-combustion energy sources like wind, solar, geothermal energy, hydropower, and nuclear produce no carbon emissions (and in most cases are renewable).

The most basic form of carbon pricing is the carbon tax, an example of a Pigovian tax, that is, a tax applied in order to create a disincentive for an activity that causes negative externalities. Pigovian taxes were first proposed by economist Arthur Pigou in 1920, and at the time, though climate change was not understood, one of the examples he used was the negative externalities caused by the building of a factory: light pollution, air pollution, and negative health consequences for residents of the neighborhood. In Pigou's language, this is an example where the marginal private interest—the interests pursued by business in the market—diverges from the marginal social interest, the welfare of the community. When there is such a divergence, there is no financial incentive to internalize the marginal social cost, by mitigating it in some way or taking more expensive actions to avoid it. With current technology, for example, operating less polluting equipment is generally more expensive than operating carbon-emitting equipment—this is especially true for businesses that already own and operate the carbon-emitting equipment, but in general fossil fuel usage is cheaper than alternative energy sources like solar or wind.

A carbon tax is a form of ecotax, a category of Pigouvian tax meant to reduce environmentally harmful activities. Germany, for instance, reduced its income tax rates at the turn of the twenty-first century while introducing taxes on petroleum and non-renewable electricity sources, in order to disincentivize fossil fuel usage and incentivize more efficient fuel use.

In theory, carbon taxes offer a cost-effective approach to greenhouse gas emissions that appeases conservative concerns by remaining market-based, rather than imposing legal limits on emissions. The countries responsible for the most emissions from electricity generation—the United States, Russia, and China—have resisted carbon tax plans to date. One of the problems with carbon taxes is that when the same conditions do not apply worldwide, companies facing a significant enough carbon tax cost have an incentive to shift the carbon-emitting elements of their business to countries where that tax cost will be lessened or nonexistent.

Carbon tax evasion is one of the factors in the pollution haven hypothesis, which suggests that so long as there is a disparity in environmental regulations among countries, some companies will have an incentive to relocate to the countries with the lowest standards of regulation or the least ability to enforce them. This has been observed in the real world with prior forms of environmental regulation. Mexico has become a pollution haven for American businesses to conduct polluting activities no longer legal in the United States, for instance, and China keeps manufacturing costs low by ignoring most modern environmental regulation. A similar phenomenon has long been observed with manufacturing labor costs, whereby in the late twentieth century many factories were opened in Asia and Latin America to take advantage of low wages, while service sector functions were outsourced to South and Southeast Asia. Further, a disparity in environmental regulations is likely to persist, as developing nations have resisted the suggestion that they should follow stricter environmental regulations than developed nations were required to follow at the same stage of development.

Carbon taxes typically vary according to the fuel source, with most schemes applying separate taxes for gasoline, diesel fuel, jet fuel, natural gas, and various forms of coal. Carbon taxes are used in Zimbabwe, India, Japan, Australia, and a number of European countries, and play a major role in South Korea's efforts to pioneer sustainability. Several carbon tax schemes have been proposed for EU-wide implementation. Efforts to implement a carbon tax in the United States have been unsuccessful, but Boulder, Colorado, implemented the first municipal carbon tax in 2006, reducing carbon output by over 100,000 tons per year while contributing nearly $2 million in revenue to the city coffers.

Cap and Trade. Cap and trade is the most common name for emissions trading, a carbon pricing approach that, rather than taxing carbon, issues permits for carbon emissions. The basic cap and trade system involves a central agency—usually a government agency, though this role could be delegated—that issues carbon-emissions permits, each of which allows the permit holder to discharge a specific quantity of a specific pollutant in a specific time period. As the "cap" indicates, this agency also sets a limit on how many such permits will be issued; organizations that want to exceed the emissions for which they have bought permits must buy them on a secondary market from organizations that bought more permits than they needed. Alternately, the permits may be allocated by the agency rather than sold. A market also exists for the financial derivatives based on the permits.

The secondary market provides an incentive for companies to minimize their emissions, freeing up permits to be sold to other companies. This is a strategy that has been broadly appealing to moderates in the United States because it addresses conservative issues while also providing a financial incentive for businesses to develop innovative new technologies that use energy sustainably or more efficiently, as well as growing the economy via the secondary market. California has adopted a cap and trade scheme called California Carbon Allowances, and a trading program in the European Union is the largest in the world.

There is precedent in the United States for an emissions trading program. Beginning in 1990, the sulfur dioxide trading system was organized as part of the Clean Air Act's Acid Rain Program, which resulted in a 50 percent reduction in sulfur dioxide emissions by 2007. In 2011, as a result of a legal challenge, the sulfur dioxide trading system was replaced with four separate trading programs, one of which trades in nitrogen oxides, the key component in smog (ground-level ozone). Under President Barack Obama, a cap and trade deal was expected to be inevitable sometime during his two terms, but Congressional opposition prevented it, and the subsequent Donald Trump administration showed no interest in reviving it. Cap and trade has been championed by senators of both parties, as well as former California Governor Arnold Schwarzenegger, the Republican who signed California's cap and trade program into law and saw it grow to the second largest in the world.

In 2018, a number of carbon pricing programs were under discussion in the United States. State legislation in Oregon failed to adopt a proposed cap and trade program, but cap and trade or carbon tax programs were proposed in Washington State, Massachusetts, Connecticut, Rhode Island, Vermont, New Jersey, and Virginia, while California renewed its program, which would otherwise have expired in 2020. The impact of these programs is unclear, because by and large the most polluting states—whose economies are tied to the involved industries—have been the least willing to adopt such programs.

Further Insights

Climate change is the long-term change in the distribution of weather patterns across the world, and is generally discussed in terms of climate change caused or exacerbated by human activity, or anthropogenic climate change. While "deniers" persist and play an influential role in public policy, in the climate science community, there is no serious doubt as to the reality of climate change or the role human activity has played in it; attempts to attribute the last century of climate change to nonhuman causes or to model them as part of a regular cycle of change have been unsuccessful. There are a number of factors that have contributed to anthropogenic climate change, but of those, the increased concentration of greenhouse gases (including carbon dioxide) is one of the main three, along with land surface changes (notably deforestation, which reduces carbon sinks) and the increased atmospheric concentration of aerosols. The effects of climate change are complex—disruption to the weather patterns means that even though the overall effect is one of an increasing average annual temperature across the world, unusually cold winters are also experienced.

Greenhouse gases are so called because they are contributors to the "greenhouse effect," that is, the creation of an atmospheric barrier that concentrates heat near the planet's surface. Carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride are the main greenhouse gases, apart from water vapor, and are generated by power stations, industry, the combustion of fossil fuels, and the by-production of methane and nitrous oxide from modern agriculture. During the period of instrumental record—the period of time in which scientific collection of climate data has been possible, dating to about 1850 for the global record—the observed effects of climate change have included an increase in global average temperature, a trend toward heavy precipitation events, an increase in droughts and heat waves, a rise in sea levels due to the melting of polar ice, the acidification of the ocean, and an intensification of hurricanes, as well as impacts on the life cycles of plants and animals that scientists are just beginning to understand.

In 2016, carbon dioxide levels rose more than 2 parts per million from the previous year to 405.1 parts per million, the highest level in ten thousand years. The 400 parts per million level was long called the carbon threshold by scientists, a mark considered, for all intents and purposes, the point of no return. It is unlikely that carbon dioxide levels will fall below this point in the lifetime of anyone currently living. What human efforts can accomplish, though, is to slow the continued accumulation of greenhouse gases, especially through reductions in carbon emmisions.

Issues

The use of carbon pricing focuses on only one piece of the puzzle in anthropogenic climate change. This is not to say it is an unimportant piece, only that other factors remain unaddressed without additional measures. The livestock sector, for instance, is a significant contributor to anthropogenic climate change. While it is responsible for less than 10 percent of anthropogenic carbon dioxide emissions, it is responsible for almost half of methane emissions and two-thirds of nitrous oxide emissions. Livestock is more greenhouse-gas-intensive and involves more deforestation than agriculture as a whole; raising animals for meat, milk, or eggs requires more land and more resources than raising vegetables. In the case of cattle, the difference is especially stark, and the modern diet, especially in the United States, consists of a much greater proportion of protein and fat from beef than has historically been seen. In other words, the modern cattle industry raises many more cows per person than any past generation.

While vegetarianism or veganism are not necessary solutions to climate change, adopting a more balanced diet in developed nations, one which de-emphasizes animal protein in favor of more vegetables, would do significant good. There are numerous cultural, economic, and practical obstacles to this transition, however, including the relative differences in perishability between fresh produce and meat (which is conventionally frozen for transport and is less impacted in quality by short-term deep freezing than produce).

Here, the effects of the food industry and carbon emissions converge: In addition to its impacts related to production, food has an environmental impact measured in "food miles," or the distance food is transported from its place of production to its place of consumption. in the United States, even domestically produced food is responsible for many more food miles than fifty years ago, and global price differences has led to an increased dependence on food produced overseas. That said, between the carbon emissions of the livestock industry, the use of fertilizers, and the industrial activity of canning and packaging food, the majority of food-related carbon emissions come from production rather than transportation.

While changing eating habits would help with carbon emissions, no individual's choices can have a significant impact, because the resulting shrinkage of carbon footprint is trivial compared with the scale of industrial activity. Environmentalism awareness campaigns have classically focused on lifestyle changes of the individual: Using energy-efficient lightbulbs or reducing transportation fuel usage by carpooling, bicycling, or using public transportation. The overall effect of these individual behavioral changes, in truth, have little effect compared with that produced by alteration in the emissions practices of businesses. That is precisely the benefit of carbon pricing and other initiatives.

Terms & Concepts

Carbon Footprint: The carbon footprint of an individual, group, or activity is its total carbon emissions as the result of fossil fuel usage or other causes; recent efforts have focused on reducing carbon footprints.

Carbon Offset: A carbon offset is an activity undertaken to reduce carbon dioxide emissions in one area to make up for—offset—emissions elsewhere.

Carbon Tax: A carbon tax is a tax levied on the carbon content of fuels in order to disincentivize the use of polluting fossil fuels.

Externality: An externality is a side effect of a commercial or economic activity that is not reflected in the cost of the activity; the pollution of operating a taxi is a negative externality.

Market-based Strategy: A market-based strategy (also market-based solution or policy instrument) is one that addresses a problem through economic policies that provide incentives to encourage or discourage specific behaviors; this can include Pigovian taxes, but can also involve subsidies, tax breaks, and emissions trading.

Pigovian Tax: Named for economist Arthur Pigou, a Pigovian tax is one that is applied with the express goal of reducing negative externalities resulting from a market activity; for instance, tax on tobacco products generates revenue but is primarily intended to incentivize smokers to quit and disincentivize nonsmokers from starting. The term Pigovian subsidy is sometimes used for measures taken to incentivize market activities that generate positive externalities not felt by those who pay for those activities, such as vaccination.

Bibliography

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Carbon Pricing

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Subject Terms

Carbon Pricing

Abstract

Overview

Further Insights

Issues

Terms & Concepts

Bibliography

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