What is carbon pricing
Pro Research Analysisby 
Searched over 200M research papers
Understanding Carbon Pricing: Mechanisms, Benefits, and Challenges
Introduction to Carbon Pricing
Carbon pricing is a critical policy tool aimed at reducing greenhouse gas emissions by assigning a cost to carbon emissions. This approach incentivizes businesses and individuals to reduce their carbon footprint by making it financially beneficial to adopt cleaner practices. There are two primary mechanisms for carbon pricing: carbon taxes and emissions trading systems (ETS)3.
Mechanisms of Carbon Pricing
Carbon Taxes
A carbon tax sets a fixed price per ton of carbon dioxide emitted, allowing the market to determine the total level of emissions. This method provides price certainty, which can be beneficial for businesses planning long-term investments in low-carbon technologies3.
Emissions Trading Systems (ETS)
An emissions trading system (also known as cap-and-trade) sets a cap on the total level of emissions and allows the market to determine the price of emissions permits. Companies can buy and sell these permits, creating a financial incentive to reduce emissions. This system provides certainty about the total level of emissions but can result in price volatility3 10.
Benefits of Carbon Pricing
Environmental Effectiveness
Carbon pricing is recognized for its environmental effectiveness at a relatively low cost. By internalizing the external costs of carbon emissions, it encourages rapid environmental innovations and shifts towards greener production methods1.
Economic Efficiency
Carbon pricing is considered an economically efficient way to address the externalities of carbon emissions. It leverages market mechanisms to find the most cost-effective ways to reduce emissions, thus minimizing the overall economic impact1 7.
Revenue Generation
During crises like the COVID-19 pandemic, carbon pricing can provide new revenue streams for governments. These funds can be used to fill fiscal gaps or support green recovery initiatives, making it a valuable tool in both environmental and economic policy2.
Challenges and Considerations
Political Feasibility
The implementation of carbon pricing varies significantly across countries due to political feasibility issues. Factors such as governance quality, public attitudes, and the presence of fossil fuel industries can influence the adoption and effectiveness of carbon pricing policies5 6.
Distributional Consequences
Carbon pricing can have distributional consequences, potentially placing a higher burden on lower-income households. Addressing these impacts through measures like revenue recycling or targeted subsidies is crucial for maintaining social and political acceptability1.
Complementary Policies
While carbon pricing is a powerful tool, it is often insufficient on its own to achieve deep decarbonization. Complementary policies, such as technology mandates and support for innovation, are necessary to avoid lock-in of high-carbon assets and ensure a comprehensive approach to climate policy1 8.
Global Variation in Carbon Pricing
Coverage and Implementation
The coverage of carbon pricing varies widely between nations, often targeting specific sectors or fuels. This variation can affect the overall price signal and the incentives for emission reductions across different parts of the economy4 9.
Cross-Country Efficacy
Empirical studies show that countries with carbon pricing tend to have lower growth rates in CO2 emissions compared to those without. However, the effectiveness of carbon pricing can be influenced by other structural and policy factors, highlighting the need for a tailored approach in different contexts7.
Conclusion
Carbon pricing is a vital component of climate policy, offering a cost-effective and efficient means to reduce greenhouse gas emissions. While it presents several benefits, including environmental effectiveness and revenue generation, its implementation faces challenges related to political feasibility and distributional impacts. A combination of carbon pricing and complementary policies is essential to achieve the deep decarbonization required to meet global climate targets.
Sources and full results
Most relevant research papers on this topic
Carbon pricing in climate policy: seven reasons, complementary instruments, and political economy considerations
Carbon pricing is essential for effective climate policy due to its environmental effectiveness, low cost, and potential for rapid environmental innovations.
Highly CitedCarbon pricing and COVID-19
Introducing carbon pricing during the COVID-19 crisis is stronger than under normal conditions, as low oil prices reduce consumer pain, governments need diversified revenue streams, and greener production can help stabilize supply-side activities.
Reflections—Carbon Pricing in Practice*
Carbon pricing programs have learned valuable lessons about design options and context, providing insights for future climate change mitigation efforts.
Highly CitedMeasuring Total Carbon Pricing
The study develops a methodology for calculating a total carbon price, considering both direct and indirect carbon pricing, to better understand climate change mitigation incentives.
What explains carbon-pricing variation between countries?
Large coal reserves per capita negatively impact carbon-pricing levels, while corruption control, political globalization, and domestic credit help enable it, while climate change awareness is positively associated but not as a serious threat.
Political Economy Determinants of Carbon Pricing
Well-governed institutions and public attitudes are key conditions for carbon pricing implementation, while fossil fuel consumption is a barrier to its implementation.
Carbon Pricing Efficacy: Cross-Country Evidence
Carbon pricing reduces CO2 emissions from fuel combustion by around 2 percentage points in countries with a carbon price, with an additional euro per tonne of carbon price reducing emissions growth by approximately 0.3 percentage points.
Highly CitedCarbon pricing and deep decarbonisation
Carbon pricing can effectively reduce greenhouse gas emissions, but achieving net zero emissions requires a mix of multiple instruments, including technology mandates and innovation support.
Highly CitedDistributions of carbon pricing on extraction, combustion and consumption of fossil fuels in the global supply-chain
A global carbon price generates a larger share of revenue relative to GDP in non-OECD nations than OECD nations, regardless of implementation point.
Carbon pricing versus emissions trading: A supply chain planning perspective
Carbon trading mechanisms result in better supply chain performance in terms of emissions generation, cost, and service level compared to carbon pricing schemes, with trading schemes showing a linear trend and cost increase.
Highly Cited