Five Things to Know about Carbon Pricing
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- Authors: IAN PARRY
- Published: September 2, 2021
Overview
- Carbon pricing provides across-the-board incentives to reduce energy use and shift to cleaner fuels and is an essential price signal for redirecting new investment to clean technologies.
- Carbon pricing can be implemented through a tax on the carbon content of fossil fuels or their CO2 emissions, or through emissions trading systems where firms acquire allowances for each ton of greenhouse gases emitted.
- Revenue from carbon taxes can be used to lower burdensome taxes on workers and businesses or to fund investment in climate technology.
1. Implementation and design
- Carbon taxes:
- Implemented through a tax on the carbon content of fossil fuels or on their CO2 emissions.
- Straightforward to administer as an extension of existing fuel taxes.
- Can provide certainty about future emissions prices to mobilize clean technology investment.
- Revenues can be used to lower taxes on workers and businesses or to fund climate technology investment.
- Emissions trading systems:
- Firms must acquire allowances for each ton emitted; supply of permits is limited by government.
- Businesses can buy and sell allowances, establishing a market price for emissions.
- Can mimic tax advantages via price-stabilizing mechanisms (price floors) and revenue-raising measures (permit auctions).
2. Current coverage, momentum, and gaps
- More than 60 carbon tax and emissions trading programs have been introduced at regional, national, and subnational levels.
- Recent developments:
- Major pricing initiatives launched in China and Germany.
- Emissions price in the European Union has risen above €50 a ton.
- Canada announced its emissions price would rise to CAN$170 a ton by 2030.
- Coverage and price gaps:
- Only about one-fifth of global emissions are covered by pricing programs.
- Global average price is only $3 a ton.
- Global carbon price of about $75 a ton is needed to reduce emissions enough to keep global warming below 2°C.
3. Carbon pricing within a comprehensive mitigation strategy
- Supporting measures to enhance effectiveness and acceptability:
- Regulations on emission rates or feebates (fees and rebates for products or firms based on emissions intensity).
- Use of carbon pricing revenues to boost the economy and counteract economic harm from higher fuel prices.
- Just transition measures for low-income households and vulnerable workers and regions (stronger social safety nets and retraining); these would require only a minor portion of carbon pricing revenues.
- Public investment in clean technology infrastructure (electric vehicle charging stations, power grid extensions to accommodate wind and solar).
- Gradual extension of carbon pricing to other sectors like forestry and agriculture.
4. International coordination: carbon price floor proposal
- Rationale:
- Unilateral actions create competitiveness concerns and uncertainty about other countries’ policies, hindering aggressive scaling up.
- Proposed two key components:
- Focus on the small number of countries responsible for the majority of global emissions to facilitate negotiation:
- An arrangement among China, the European Union, India, and the United States would cover 64 percent of future global CO₂ emissions.
- An agreement among the Group of Twenty (G20) large economies would cover 85 percent of emissions.
- Focus on a minimum carbon price each country must implement (a price floor), providing an efficient and easily understood parameter while allowing countries to set higher prices if needed to meet Paris pledges.
- Design considerations:
- Developing economies could have lower price floors and simple mechanisms for financial and technological support.
- Flexibility to accommodate countries where carbon pricing is politically difficult, provided other policies achieve equivalent emissions reductions.
- Effectiveness scenario:
- A 2030 price floor of $75 a ton for advanced economies, $50 for high-income emerging market economies such as China, and $25 for lower-income emerging markets such as India would keep warming below 2°C with just six participants (Canada, China, European Union, India, United Kingdom, United States) and other G20 countries meeting their Paris pledges.
5. Comparative regimes and risks without coordination
- Alternative regimes considered:
- A uniform price regime requiring all participants to impose the same carbon price:
- Does not allow equity through differentiated floors.
- Does not accommodate countries where carbon pricing is politically difficult.
- An emissions-targets regime with annually tightening targets:
- Requires agreement on many parameters.
- Creates zero-sum bargaining (lax targets for some require stricter targets for others).
- Leaves uncertainty about specific policy actions countries would take.
- Risk of unilateral responses:
- Without an international price floor or similar arrangement, countries likely to impose tariffs on carbon-intensive imports (border carbon adjustments).
- Example: European Union announced such a proposal in July 2021; others are considering it.
- Limitation: border carbon adjustments would price only emissions embodied in traded products and not the large share of nontraded emissions (for example, from power generators, manufacturers selling domestically, buildings, and transportation), making them far less effective for scaling up global mitigation than an international carbon price floor.
Ian Parry, "Five Things to Know about Carbon Pricing," F&D Magazine, September 2021 — IMF Fiscal Affairs Department
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