What Is Carbon Pricing?

Carbon pricing is an essential tool for capturing the external costs of greenhouse gas (GHG) emissions. These refer to the costs of emissions the public pays for, such as loss of property due to rising sea levels, health care costs from droughts and heat waves, and crop damage. Carbon pricing ties these costs to their sources. That means there is a price on the carbon dioxide emitted by sources.

Carbon pricing shifts the burden for damages from GHG emissions back to those responsible for it. Instead of dictating who should reduce emissions, governments set a carbon price. The carbon price sends a message to emitters, allowing them to decide between lowering their emissions or continuing to emit at the same pace and paying for it. It forces companies and businesses to make do with fewer goods and services that rely on fossil fuels. Carbon pricing helps us achieve environmental goals most flexibly and cost-effectively. When our carbon dioxide emissions cost money, we tend to produce less of it.

‘Polluter pays’ is an essential part of the carbon pricing concept. By putting a monetary price on carbon, the public can hold industries and other emitters responsible for the social and environmental cost of releasing carbon dioxide into the atmosphere. Carbon pricing is essential for addressing climate change, meeting international climate agreements, and protecting the environment. At its core, carbon pricing is a market mechanism that passes the cost of emitting back to the emitters instead of ordinary citizens.

Carbon pricing has a lot of benefits. It influences the behavior of businesses, investors, and consumers and offers them the opportunity to contribute to decarbonizing the global economy. It is a robust and strong policy tool for addressing and fighting climate change.

What Is Carbon Tax?

A carbon tax is a type of carbon pricing mechanism. Carbon taxes are fees that businesses pay due to government regulations.

A carbon tax sets an exact price on carbon emissions. It specifies a tax rate on GHG emissions. A carbon tax differs from carbon pricing. In the carbon tax mechanism, we define the carbon price in advance. On the other hand, in carbon pricing, we pre-define the outcome we want to achieve. The price of carbon in a carbon pricing system depends on market conditions and is not predefined.

Mostly, government regulations require fossil fuel burning corporations to pay carbon taxes. The primary aim of a carbon tax is to ensure that businesses monetarily pay for the cost that burning carbon creates. It ensures that companies and corporations pay for the external costs they inflict on society.

A carbon tax provides a higher level of certainty about the cost of carbon emissions. It does not define the level of emission reduction we need to achieve.

Carbon taxes come in two broad forms:

1. An emissions tax depends on the number of emissions an entity produces.

2. Governments can tax individual goods or services that are generally carbon-intensive, such as a carbon tax on gasoline.

Many countries and local governments around the world have a carbon tax or an energy tax associated with carbon content. As of 2021, there are 35 carbon tax programs across the globe. In 2006, Boulder, Colorado in the USA, became the first city in the country with a voter-approved carbon tax. Other US cities are now exploring the idea. British Columbia in Canada has had carbon taxes since 2008. In 2019, South Africa became the first African country to adopt a carbon tax mechanism.

Vital Elements of Carbon Pricing

A carbon pricing and carbon tax mechanism have many similar elements. They include

1. Scope:

The scope of the tax or price depends on the substances it covers. For example, governments could levy a carbon tax or carbon price on the carbon dioxide content of fossil fuels.

2. Point of taxation:

Relevant authorities can levy carbon pricing and carbon tax at any point in the energy supply chain. The simplest and most common approach is imposing the tax upstream. This way, much fewer entities are subjected to it (such as companies that supply coal, oil refineries, processors of natural gas, etc.). Alternatively, governments can even levy the tax midstream (electric utilities) or downstream (vehicles, households, etc.).

3. Tax, pricing, and escalation Rates

Economists say a carbon tax or price should be equivalent to the social cost of carbon. The social cost of carbon refers to the estimated value of environmental damage over the years caused by a ton of carbon emissions today. Carbon pricing and carbon tax also need to rise over the years to reflect the growing damage climate change will bring. An increasing price also tells industry players that they need to up their game and offset or lower their emissions.

4. Distributional impacts

People in lower-income groups spend a larger share of their income on energy bills than those in higher-income groups. Therefore, pricing or taxing carbon emissions that lead to a higher energy cost will impact lower-income groups more significantly than higher-income groups. To reduce this burden, governments can direct a percentage of revenue from carbon taxes toward lower-income households. This will help them compensate for the increase in energy costs, ensuring that the tax or price on carbon does not disproportionately affect the poor.

5. Revenues

A carbon tax or price can bring significant revenue. Political choices will determine the use of that revenue. Governments may return some or all of it back to customers in the form of a dividend. Alternatively, they could also use the revenue to invest in low-carbon technologies or to strengthen climate resilience. Research suggests that we can minimize economic costs and increase net economic benefits by using the revenues from carbon pricing and a carbon tax to reduce the existing taxes on labor and capital.