I am sure many people (including us) have told you to switch to clean energy or eat less meat in the past, and for good reason, too. These are important solutions to incorporate into a successful climate change strategy, but many of these solutions are limited to very specific niches of climate change and cannot lead to widespread transformation. I mean, how many Tesla’s can we buy?
There is one solution, however, that has increasingly been gaining traction that would be able to control greenhouse gas emissions from various angles: carbon pricing. Admittedly, carbon pricing may seem like a complicated concept at first but, as you will understand through this article, it can serve as a major step toward climate change mitigation.
What is Carbon Pricing?
As you may have inferred from its name, carbon pricing is a system where companies have to pay a price for their carbon dioxide emissions, but it can also be applied to other greenhouse gases as well. The price for these emissions is determined in various ways depending on the pricing system in place but generally serves as an incentive to switch away from activities that emit greenhouse gases. In theory, this would eventually lead to the elimination of greenhouse gas emissions and bring the climate crisis much closer to an end.
Types of Carbon Pricing
Carbon Tax
Carbon taxes are exactly what they sound like, government taxes on businesses and organizations for every ton of greenhouse gas emissions. The tax rate would be increased every year, which makes emitting greenhouse gases an unwanted expense for the company and serves as an incentive to stop doing so. This is a straightforward system that would be relatively simple to implement in comparison to other systems. However, the word “tax” in the name of this policy may be a difficult hurdle to cross.
Cap-and-Trade
In a cap-and-trade system, the government sets a cap, or limit, on the amount of total greenhouse gas emissions for the year. Then, the government allocates a certain amount of permits to companies, each permit representing one unit of emissions. If the company’s emissions end up exceeding the threshold set by the number of permits they own, they will be penalized harshly. The interesting part about these permits is that they can be traded (a.k.a. bought) between companies in exchange for money, effectively placing a price on emissions. This can be thought of as creating an entirely new economy where greenhouse gas emissions are essentially a scarce resource that is bought and sold based on each company’s wants and needs. Year by year, the government decreases the cap on emissions which, therefore, reduces the total number of permits in circulation. Eventually, as the government continues to reduce the cap, emissions will reach such a low level that it puts the country in a better position to reach net-zero emissions.
I know, the first time I heard about cap-and-trade my head was spinning a bit, too. So let’s go through an example.
In 2021, let’s say Company A had a total of 10 million tons of greenhouse gas emissions in the United States. Meanwhile, Company B emitted 15 million tons of greenhouse gases. Starting from 2022, the United States implements a cap-and-trade system and gives companies tradable permits, each representing 1 ton of emissions and worth $20 individually. Company A receives 9 million permits while Company B receives 13 million permits. This means that with the permits they currently own, Company A has to reduce its emissions by 1 million tons from the previous year and Company B has to reduce its emissions by 2 million tons. Unfortunately, Company A does not see a way to reach this emissions target by the end of the year. But luckily, Company B has been preparing for this emissions reduction beforehand and sells 1 million permits to Company A at a price of $20 million (1 million permits x $20 each). This leaves Company A with 10 million permits and $20 million lost while Company B has 12 million permits and an extra $20 million in revenue. The total emissions between the two companies remain the same, but both end up in more favorable circumstances. Overall, this system really just has more flexibility in terms of where the emissions come from and provides a softer cushion to companies who are not adequately prepared for the shift away from greenhouse gases.
Major Concerns
One of carbon pricing’s weaknesses is that it covers only certain sectors of the economy. Greenhouse gas emissions can be summarized by the following sectors: transportation, electricity, industry (manufacturing), commercial & residential buildings, and agriculture. On the whole, carbon pricing systems can mainly be applied to sectors that are primarily encompassed by companies since any regulations placed on individual people would have a limited chance of being passed in many places. Therefore, emissions from private transportation and residential buildings will be difficult to account for in carbon pricing measures.
Carbon pricing also proves difficult on the political front because, in general, companies don’t like it when governments place regulations on them. This means that there will be a significant amount of pushback on carbon pricing policies from political leaders with corporate backing. Additionally, like any other policy, this system can only be implemented on a case-by-case basis since one piece of legislation can’t be applied to the entire world at once. Instead, the fight for such a system has to be fought individually in a tedious and challenging process.
Another questionable area of carbon pricing is regarding how emissions would be priced. For example, people have proposed costs for carbon dioxide emissions ranging anywhere from $10-$50 per ton. These estimates incorporate the economic impacts of carbon emissions as well as the social and environmental impacts. Along the same lines, the question emerges of how heavily other greenhouse gases should be priced. Methane is estimated to have an impact of 25 times that of carbon dioxide, so should it be priced 25 times more? At the same time, methane lasts for less time in the atmosphere, so how should that be factored into the price?
On top of all these concerns, one major question remains: should the government gain revenue from carbon pricing measures? When the government initially hands out the permits in a cap-and-trade system, they have the choice to make companies pay for each permit. Similarly, under a carbon tax, the government would collect money from companies that emit greenhouse gases. So what should the government do with this money? They could use it as additional revenue to pay off debt and fund other policies. But a lot of people see this revenue as something that should not be used by the government but, instead, given back to the community for purposes related to combating climate change. This can take the form of setting aside this money for climate-specific policies or local environmental projects or even clean technology subsidies. With such a variety of options, nevertheless, there is sure to be a whole lot of debate.
Existing Carbon Pricing Systems
Canada Carbon Pricing
Canada’s carbon pricing system has multiple layers that would take a separate article in itself to unpack properly, but a general overview is that the system is split into two parts: the fuel charge and the Output-Based Pricing System. The fuel charge is simply an additional price paid for fuel applied to all consumers due to its fossil fuel and natural gas sources. The Output-Based Pricing System is a price on greenhouse gases applied to companies. These parts combine to create the foundational carbon pricing system in Canada, though each province has the ability to implement other systems as long as they meet the basic federal standards.
EU Emissions Trading System
The European Union’s Emissions Trading System (ETS) is a cap-and-trade system applied to all EU countries plus Iceland, Liechtenstein, and Norway. According to the official EU website, this program “covers around 40% of the EU’s greenhouse gas emissions” including electricity and heat generation, energy-intensive industry sectors, and commercial aviation, among others. This is a decent amount of emissions covered but shows the potential limitations of such systems.
Conclusion
Carbon pricing is particularly unique since, despite its grandeur, it seems to be a bit more realistic than other solutions mentioned in some of our other articles. I say this knowing that carbon pricing could prove to be effective at significantly reducing emissions over the next few decades while also keeping in mind that it never helps to look too far ahead without focusing on the present. I think such efforts will take time to mature but, once they do, they will be acknowledged as some of the most important catalysts for large-scale emissions reduction.
Additional Resources
We talked about a lot in this article but there’s definitely still some more information that you should take a look at if you want to dive further. Here are some of our favorite resources:
Resources for the Future’s Carbon Pricing all-in-one webpage: https://www.rff.org/topics/carbon-pricing/
“Carbon Pricing: What is it?” video by Devex: https://www.youtube.com/watch?v=v7EDrPzRb7w
Canada Carbon Pricing: https://www.canada.ca/en/services/environment/weather/climatechange/climate-action/pricing-carbon-pollution.html
EU Emissions Trading System: https://ec.europa.eu/clima/eu-action/eu-emissions-trading-system-eu-ets_en
Great content! Keep up the good work!