Carbon Pricing Rooting for Net Zero World

Climate change has far-reaching impacts on nearly all aspects of human life. It profoundly affects our environment, ecosystems, human societies, and the global economy. Climate change is a significant risk for both current and future generations and carries heavy costs. Drawing on scientific evidence, limiting global warming to 1.5 °C pre-industrial levels calls for the reduction of greenhouse gas emissions (GHG) by 43 percent before 2030. According to the Intergovernmental Panel on Climate Change (IPCC), net zero emissions need to be realized globally by the early 2050s. Otherwise, our world shall face extreme consequences. The international framework for climate change sets the stage for the achievement of this objective and requires all countries to adopt a selection of mitigation measures. Yet, each state is free to choose what works best for its specific circumstances. Carbon pricing has been identified as one of the key policy tools facilitating the transition to decarbonized economies. 


Defining carbon pricing and its Objectives


Carbon pricing is a policy approach aimed at reducing GHG. Simply put, it accounts for the price of all carbon-emitting activities and targets GHG reduction. This approach creates economic incentives primarily for businesses to transition to cleaner alternatives. The principle of carbon pricing is to internalize the social and environmental costs of GHG that are normally not reflected in the market price of goods and services. A price on carbon shifts the burden of damage on those who are responsible for it. 


Types of Carbon Pricing


There are two major forms of carbon pricing. These are emissions trading systems (ETS), also referred to as cap-and-trade systems, and carbon taxes. With emissions trading systems governments set a limit on the total amount of GHG allowed in a specific jurisdiction, such as a country or a region. Carbon allowances equaling the set cap are auctioned to entities engaged in GHG-emitting activities. These entities are allowed to buy and sell among themselves as well. This way the country creates a market for emission allowances where supply and demand regulate the price. The intention is to gradually reduce the cap and transition to a cleaner economy. The Chinese national carbon trading system is the largest ETS in the world. It is an intensity-based system that took start in 2021. EU-ETS is the biggest multinational GHG trading scheme with its phase I instituted in 2005.


A carbon tax directly sets a price on each ton of carbon dioxide. The tax is normally levied at the point of emission or more commonly on the carbon content of fossil fuels. The higher the emissions, the higher the tax payment. The goal is to discourage carbon-intensive activities by making them more expensive. Unlike ETS, with carbon tax the emission outcome is not pre-defined. 


The choice between the two policy instruments relies on the specific national and economic circumstances of a country. It is worth noting that there are other ways for carbon pricing as well. These may include crediting systems, fuel taxes, removal of fossil fuel subsidies, or payments for emissions reduction. However, currently, the two approaches described above dominate the market due to their effectiveness. 


Challenges with carbon pricing 


Carbon pricing policies can sometimes generate outcomes that are not necessarily reflected in the assessment of their cost-effectiveness. This is true both at national and international levels. For example, domestically they can lead to distributional tensions. Pricing emissions can negatively affect the poorest of society if a high share of their income is spent on carbon-intensive goods and services. Internationally, these policies can impact competitiveness i.e., companies in countries with carbon taxes may lose their competitive edge on export markets as their produce gets more expensive. Additionally, some enterprises may consider relocating their production into those states and regions where carbon pricing is not present as a response to production cost growth. Thereby, decarbonization policy may trigger trade consequences that must not be overlooked. 


One shall remember that carbon pricing is the most effective when more countries adopt it. Broader coverage translates into greater opportunities for the transition to a net zero world. It is through strong international cooperation that countries can be consistent about green technologies and communication with investors. 


Trends in Carbon Pricing Worldwide


Carbon markets and mechanisms have rapidly evolved throughout the last decade. As of October 2022, there are 68 direct carbon pricing initiatives implemented in 46 national jurisdictions across the globe. According to the World Bank, the share of global emissions covered by carbon taxes or ETS has grown from 7 percent to 23 percent. Carbon pricing instruments foreseeably dominate in high-income countries. However, they are growing in emerging economies as well.


More and more jurisdictions continue to introduce pricing instruments. For example, Indonesia put ETS in place just this year. Moreover, a greater variety of emission sources are being covered by carbon policies e.g., aviation. Government revenues from carbon prices have increased significantly. They have grown nearly fivefold alongside the evolution of policies. These funds are commonly earmarked for green spending.


What’s more, carbon pricing is being viewed in a broader context. Not only as a GHG mitigation tool, but also as an instrument for revenue enhancement, innovation promotion, and the achievement of global sustainable development goals. 

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