What is Carbon Pricing?

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Carbon pricing literally means putting a price on carbon. Carbon pricing is growing momentum among countries and businesses seeking to combat climate change and reduce emissions and increase investments in cleaner energy options.

Governments price carbon by first calculating the external cost of carbon emissions. These are costs that the public pays for. They include health care costs from heat waves and droughts, damage to property from sea-level rise and flooding, and crop damage. Governments tie these events to their sources through a carbon price.

A carbon price shifts the damage charge back to those responsible for it. It turns the burden of emissions to those who can reduce it. Instead of governments dictating which businesses or industries need to reduce emissions where and how they let carbon prices do the work for them. A carbon price lets polluters decide whether they want to stop their polluting activity, reduce emissions, or if they wish to continue releasing emissions and pay for it. This way, carbon pricing forms a low-cost means of achieving environmental goals.

There are primarily two types of carbon pricing:

1. Emission Trading Schemes

These are also called cap-and-trade systems. In this system, the government sets a cap on the total level of greenhouse gas emissions for industries and businesses. Industries with low emissions can sell their permits to more prominent industries with more emissions. The cap-and-trade system establishes a market price for carbon by promoting the trade of emission allowances.

2. Carbon Tax

Here, governments can directly set a price on carbon emissions. It differs from cap-and-trade systems in that the cost of carbon is pre-defined in carbon taxes. Whereas in cap-and-trade systems, the supply and demand of allowances set the price of carbon emissions. Carbon taxes do not set a limit on emissions. They only set a price on the emissions. Industries and businesses can continue polluting as much as they want as long as they pay for causing pollution.

Now that we know what carbon pricing is let’s go on to understand if today’s carbon prices are enough to combat climate change.

The Criticism Around Carbon Pricing

The pressing challenge for policymakers today is decarbonizing society and the economy at the rate necessary to avoid the worst impacts of climate change. The result is an intense debate about appropriate policy responses. Many leaders see carbon pricing as the only way forward. Some even use carbon pricing to argue against policies like fuel efficiency standards. Many view it as the most efficient approach to cutting greenhouse gas emissions.

Carbon pricing incentivizes businesses, industries, and individuals to adopt the lowest-cost emission reduction options for their specific operations. Many economists argue carbon pricing should occupy the cornerstone of every climate policy.

However, there are five significant issues that limit the use of carbon pricing in accelerating society’s decarbonization.

1. When we argue for carbon pricing, we are accepting climate change as a market failure. In reality, climate change is a fundamental system problem. It is a result of the way our society currently functions.

2. Carbon pricing policies place weightage on efficiency as against effectiveness.

3. Carbon pricing tends to make industries think that they need to optimize their systems rather than completely transform them. Optimizing a system that is causing pollution is not the solution to climate change. We need completely new industrial systems that do not pollute the environment.

4. Carbon pricing suggests a universal policy approach rather than a context-sensitive policy approach.

5. Carbon pricing fails to reflect political realities. It does not consider real-life political scenarios.

Current Carbon Prices Fall Short of Achieving Climate Targets

We can conclude that carbon prices are simply not high enough to achieve a significant reduction in emissions. A vast majority of carbon prices around the world are below the Social Cost of Carbon (SCC). The SCC is the economic cost, or damage to the environment and health, of emitting one ton of carbon dioxide into the atmosphere. Alternatively, you can think of SCC as the economic benefits associated with reducing one ton of carbon dioxide.

Most environmental experts estimate the cost of SCC as ranging between 80-300 dollars per ton. A 2018 study priced SCC at a global mean price of 417 dollars with national variations. They say that by 2030, SCC will cost between 50 and 100 dollars.

Compared to most SCC estimates, carbon pricing falls short. The most recent survey by the World Bank reveals that more than half of the 61 carbon pricing policies worldwide have a price lower than 10 dollars. Currently, the average global price for carbon is 2 dollars per ton.

Given how dominant low carbon prices are, we must consider the few areas with carbon prices at or near the SCC. The highest carbon price in the world is in Sweden. The Swedish carbon price is 126 dollars per metric ton of carbon dioxide. Emission reduction estimates in Sweden range from 0% to 17% annually. In 2019, Finnish carbon prices ranged between 58-68 dollars per ton. Emission reduction estimates there are between 0% and 1.7%. The other two countries with high carbon prices are Switzerland (99 dollars per ton) and Lichtenstein (99 dollars per ton).

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Even these nations, with their high carbon prices, have only modest emission reductions. Therefore, we need much higher carbon prices if we want to escape the worst effects of climate change. The carbon prices today fall short of combating climate change.

Carbon pricing might work better after surpassing a certain threshold. A 2018 study found that carbon taxes start reducing emissions after surpassing 2.2% of the GDP. Yet, after nearly four decades since carbon pricing first started, data shows that low prices are a feature of this policy. This needs to change. Already the fact that nations with high carbon prices have only moderate reductions is worrisome. Our carbon prices need to increase significantly if we want to hold onto any hope of surviving climate change and global warming.