Carbon Pricing: Emissions Trading Systems and a Tax on Carbon
16 minute read
Updated on Mon Sep 13 2021
To address this, and to make emission reductions happen, some people suggest that we should put a price on our goods and services that reflect their true cost to society. This is where carbon pricing comes in.
- They can continue emitting as usual and pay up, which increases their costs
- Or, they can find a way to reduce their emissions and then don’t have to pay
The benefits of carbon pricing
There are two main ways of pricing carbon:
Let’s look at these one by one...
Energy and transport largely rely on fossil fuels, so would bear the brunt of the carbon tax. But because almost all other sectors need energy and transport too, the tax would affect the entire economy.
As well as decreasing demand for energy, a carbon tax also leads to the substitution of high carbon fuels with cleaner energy sources. This is known as the substitution effect, because individuals substitute more expensive goods for cheaper ones due to the tax.
Problems with a Carbon Tax
Although a carbon tax guarantees a price on emissions, it cannot guarantee any specific level of CO₂ reductions. This is because we don’t know whether companies will reduce their emissions, or choose to pay the tax instead.
Money can be given back to poorer households by direct payments or by cutting other taxes for them. This way, carbon taxes can actually help reduce inequalities that would otherwise be made worse by the tax. This type of carbon tax is called a revenue-neutral carbon tax.
Carbon taxes can be a relatively cheap way to reduce emissions, but their effects will depend on how they are designed. This may need adjusting for different countries, too. So, how else can we put a price on carbon?
Emission trading systems
If a company expects to produce more emissions than they have permits for, they have to purchase extra permits from other companies. Companies producing fewer emissions than their permits allow can sell their permits to other companies that emit more.
Unlike the carbon tax, carbon permits do not have a fixed price; instead, they depend on the balance between supply and demand. Supply is the number of ‘carbon permits’ available for sale, while demand is the total emissions being produced. This means that the price can go up and down.
However, provided the limit is chosen well, an emissions trading system is a good way to make sure that emissions reductions will happen. Unlike the carbon tax, this is guaranteed because of the limit on the number of carbon permits available.
So, carbon pricing is one way to include the cost of CO₂ emissions in our economic system.
However, it is not easy to implement due to the need for companies to accurately monitor and report their emissions. These reports also need checking by another organisation (so companies don’t cheat), all of which needs money and people.
As with all the policies we have looked at in this course, a carbon tax will only be part of the solution. We will still need improvements in technology, green investment and plans for emission reductions too. Nonetheless, putting a price on carbon is an efficient way to help achieve targets to reduce emissions.Next Chapter