A market-based instrument, carbon pricing is used to tackle climate change by putting a price on carbon emissions. The idea is simple: by making it more expensive to pollute, companies and individuals will have an incentive to reduce their carbon footprint and invest in cleaner, more sustainable alternatives.

Brief history of carbon pricing

December 11, 1997 saw the formulation of a landmark agreement that set binding targets for reducing greenhouse gas emissions in industrialised countries. Creating a framework for international cooperation, the Kyoto Protocol created a market for emissions reductions known as the Clean Development Mechanism (CDM). The CDM allowed developed countries to meet their emissions reduction targets by investing in emissions reduction projects in developing countries, and receiving carbon credits in return. Having been expanded upon in the following years, it led to the development of cap-and-trade systems and carbon taxes in various countries and regions, laying the foundation for the development of carbon pricing.

How does carbon pricing work?

As should happen in an ideal world, the sins of one mustn’t be suffered by another, carbon pricing ensures the very same ideal in the flawed world of excessive carbon emissions. When companies emit carbon into the atmosphere, they do not pay for the negative impacts that pollution has on the environment and society at large. They simply get to reap the benefits of burning fossil fuels, generating energy at lower prices. Consequently, these costs get externalised, meaning that they are borne by others, such as communities affected by air pollution and heatwaves, farmers facing crop damage due to varying rainfall patterns, or future generations impacted by climate change. Therefore, to internalise these costs and return the onus of responsibility back to them, carbon pricing aims to make polluters pay for these costs by putting a price on carbon emissions. The idea here is to not only pay for buying carbon, but also to pay the cost of using carbon.

By offering an economic incentive, rather than mandating specific reductions in emissions and dictating the means of achieving them, carbon pricing provides polluters with the autonomy to decide for themselves whether to discontinue their carbon emissions, or compensate for it. This approach enables society to achieve its environmental objectives in the most efficient and flexible manner possible.

Different Instruments of carbon pricing

Multiple instruments are a part of this carbon monitoring ecosystem, out of which the two primary tools are carbon taxes and the emissions trading system (ETS) also known as the cap-and-trade system. Where carbon taxes directly penalise the entirety of emissions without providing for any upper limit, the ETS allows for buying and selling of carbon credits to shift that upper limit of carbon emissions. Carbon tax is imposed on each ton of carbon dioxide emitted, and is gradually increased over time to incentivise more reductions in emissions. ETS, on the other hand, creates a financial incentive to reduce emissions, as companies can profit by selling their permits.

Why is putting a price on carbon necessary?

The climate crisis is arguably the greatest challenge humanity has ever faced. Its impact is being felt around the world, from more frequent and severe weather events to rising sea levels, devastating wildfires, and unprecedented heatwaves. The urgency of the situation requires immediate and all hands on deck efforts to address it. One crucial tool in the fight against the climate crisis is carbon pricing. By placing a cost on carbon emissions, we can incentivise individuals and businesses to reduce their carbon footprint and shift to cleaner energy sources. Carbon pricing can also generate revenue that can be used to fund climate mitigation and adaptation efforts, creating a virtuous cycle of sustainability. It is time for policymakers to recognize the urgency of the climate crisis and implement effective carbon pricing policies that can help us build a more sustainable future.

Why is it not a one stop solution?

Despite its potential benefits, carbon pricing is not without controversy. Critics argue that it can disproportionately impact low-income households, who may be unable to afford the increased costs of goods and services resulting from carbon taxes and the ETS. It is also argued that carbon pricing may not be effective in reducing emissions if the price is set too low, or if there are other barriers to the adoption of clean technologies. For instance, in the context of automobile pollution in India, the effectiveness of imposing a tax as a means of incentivising vehicle owners and users to limit their fossil fuel consumption remains questionable. This is particularly true in urban regions, where owning multiple cars is often viewed as a status symbol, akin to owning land in rural areas. However, supporters of carbon pricing argue that it is a necessary tool for tackling climate change. The Intergovernmental Panel on Climate Change (IPCC), has stated that carbon pricing is a necessary measure for limiting global warming to 1.5 degrees Celsius above pre-industrial levels, the threshold beyond which the impacts of climate change are expected to become catastrophic.

The present and future

At present, the price of carbon ranges from as low as $0.08 in Poland to even as high as $137.30 in Uruguay. Pennsylvania, with the adoption of a carbon pricing policy, marked the first instance of a fossil fuel producing state in the United States of America implementing such a policy. Carbon pricing has been implemented in over 20 countries and 40 states, provinces, and cities around the world, including Canada, the European Union, and California. India, at present, doesn’t have an exclusive carbon pricing policy, but it has multiple programmes that impose an implicit price on carbon. It includes the Perform, Achieve, and Trade Scheme (PAT) that seeks to lower emissions from energy-intensive industrial sectors; Renewable Purchase Obligations (RPO) and Renewable Energy Certificates (REC) that call for distribution agencies to source a specific portion of energy requirements through renewable sources; and the voluntary Internal Carbon Pricing (ICP) tool that promotes investments in cleaner fuels.
By adopting similar carbon pricing systems, countries can create a level playing field for businesses operating in different regions, and promote a more equitable and efficient allocation of emissions reductions.