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Carbon Pricing, Carbon Market, Carbon Taxation: What are those?

Updated: Oct 22, 2023

Untangling the Confusing World of Carbon Pricing

Sky high clouds overlooking fields of wind turbines

Ever found yourself puzzled by terms like carbon pricing, carbon taxation, carbon offsetting, and carbon market when reading news or publications about sustainable initiatives? What do they mean? How are they different?


The Carbon Pricing Trend

Carbon pricing has become an increasingly popular term when talking about green initiatives and policy. Based on Google Books Ngram Viewer, the word “carbon pricing” was almost never mentioned in any printed sourced published (books, journals, etc), The trend significantly increased by the year 2000 with the use of “carbon pricing” term has increased to 22% just in 5 years (2015-2020).

Carbon Pricing Trends Graph from Google Books Ngram Viewer

Carbon pricing is a mechanism that charges the costs of damage from GHG emissions to the stakeholders responsible for producing those emissions. The idea is that without carbon pricing, the public bears the cost of damage caused by GHG emissions, including harm to crops, healthcare expenses from heatwaves, air pollution, droughts, and the loss of property due to flooding and rising sea levels. So, carbon pricing is a way to hold companies accountable for their greenhouse gas emission by putting a price tag on the greenhouse gasses emitted (The World Bank, n.d.).


Carbon Pricing Instruments: Carbon Taxation and Carbon Market

There are two types of instruments of carbon pricing, which are carbon taxation and carbon market.


Carbon taxation is a mechanism that charges the cost of carbon emissions directly to the carbon emitter, which is done by the government setting a tax rate on the amount of greenhouse gas emissions emitted. The goal of carbon taxation is to motivate businesses to curtail their emissions following the financial burden of the tax (Diedrich, 2022).


On the other hand, the carbon market is seemingly more complicated than carbon taxation. But, the end goal is still the same: to price carbon emissions so businesses have incentives to lower their emissions. The carbon market is a trading system in which nations, companies, and individuals transact some amount of money to offset their carbon emissions in green projects or buy and sell the permit to emit a certain amount of carbon emission to align with the required emissions limits (Diedrich, 2022).

Smoking chimney in red and white

The result of the carbon market transaction is the reduction, removal, or avoidance of greenhouse gas emissions, which is measured as a unit called carbon credit. One carbon credit is equivalent to reducing or avoiding one metric ton of CO2 or other greenhouse gasses (Gupta, 2011).


There are two mechanisms in the carbon market, which are compliance markets and voluntary carbon markets (VCMs).


- Compliance carbon markets

Compliance markets are carbon emission permit markets created and regulated by the government, making it a mandatory requirement for companies to be part of the market system. The compliance markets are generally referred to as cap-and-trade markets or emission trading systems (ETS) (UNDP, 2022). In which, companies get permits for their greenhouse gas emissions. If they exceed their limit, they can buy extra permits from companies emitting less.


- Voluntary carbon markets

A voluntary carbon market usually refers to the trading system of carbon credit where participation is optional. There is a lack of viable enforcement to enforce emission limits. Instead, organizations join willingly to cut emissions on their own (Diedrich, 2022).


An example of voluntary carbon markets is carbon offsetting. Carbon offsetting is a mechanism in which organizations can purchase carbon credit in the form of payment to green projects to compensate for the emissions they produce. Organizations usually participate in carbon offsetting to meet emissions targets or voluntary GHG reduction goals (Goodward & Kelly, 2010).

CarbonEthics farmer planting mangrove plants in the sea

How is Everything Related?


Carbon Taxation and Carbon Market Relationship

Although each carbon pricing instrument seems like a distinct mechanism, they are all closely related. Carbon taxes directly charge the company with a certain amount of money they have to pay, while a carbon market is created in which carbon emission is charged with the price set by the market following the fundamental law of economy, supply, and demand. The synergy of both carbon taxes and the carbon market can lead to more efficient action to reduce carbon emissions.


For example, carbon taxes can act as the floor price and are effective for sectors that are challenging to reduce emissions due to high costs or lack of advanced technology, such as cement, chemical, trucking, and shipping industries (Filmanovic, 2022). The funds collected from the carbon tax can be invested in developing green technologies for these challenging sectors. On the other hand, the dynamic of the carbon market based on supply and demand can set the price ceiling, which ensures emission reductions are achieved at a balanced cost according to the market dynamic.


The combination of carbon instruments is complex due to the effectiveness of carbon taxation, and the carbon markets vary between different countries depending on each countries’ unique circumstances such as the socioeconomic condition, cultural norms, and political landscape (Filmanovic, 2022).


Benefits of Carbon Pricing

Lines of solar panels on a dry desert

Whatever the carbon pricing instruments policymakers choose, putting a price on carbon is considered the best way to cut emissions cost-effectively (UNFCCC, n.d.).


First of all, carbon pricing makes companies realize they need to reduce GHG emissions and forcibly think of any way to reduce their carbon emission, if not, the companies have to pay more funds to the carbon taxation mechanisms or carbon market mechanisms.


By putting a price on carbon emissions, it helps monitor and report emissions. Companies take more consideration when emitting carbon emissions. Also, the funds collected from carbon pricing can be utilized for green sustainable developments, such as stimulating clean technology and promoting low-carbon economic growth.


Additionally, embracing sustainability through carbon pricing can positively enhance a company's reputation. This is important due to the increasing demand for sustainable practices and changing government regulations. Companies adapt to this demand by looking after their operations and incorporating sustainable practices into their facilities. Consequently, leads to the reduction of operational expenses. For instance, adopting energy-efficient technologies, minimizing waste, and recycling water all lead to saving money.


Why Carbon Pricing


The Myth of Carbon Pricing and Its Implementation

Despite the benefits of carbon pricing, there are still many challenges in its implementation. Many believe that carbon pricing could hinder economic growth as it seems expensive and leads to job losses due to the shift to sustainable technology.


Research by Metcalf (2023), challenges this idea by showing no evidence that carbon pricing can hinder economic growth. Instead, he found that once firm creation and technology adoption are incorporated, carbon pricing, especially carbon taxes, could generate positive economic output in the long run. Similarly, Yamazaki (2017) shows that carbon pricing does not destroy jobs, but instead creates more job opportunities, especially in clean industries.


Some studies look at the effectiveness of carbon tax in British Columbia, Canada showing positive changes like less fuel used per person and lower greenhouse gas emissions after carbon pricing was introduced. Surprisingly, the economy of British Columbia was even better than other Canadian provinces after the carbon tax started, which busted the myth of a “job-killing carbon tax” (Gass, 2018).


Currently, some countries have yet to implement carbon pricing because it is seen as something new, and policymakers need time to figure out what to do. However, there is already a great example of successful carbon pricing implementation.

European Parliament establishing EU ETS in a huge and packed conference room
European Union established EU ETS, the world’s biggest carbon market

The European Union Emissions Trading System (EU ETS) is the world's oldest and largest carbon market. It consists of the EU members, the UK, Iceland, Liechtenstein, and Norway. It has been active since 2005 and works on a "cap and trade" basis (European Commission, n.d.).


The EU ETS covers many sectors like electricity generation, industries, aviation, maritime transport, and targeting greenhouse gasses such as CO2, N2O, and PFCs. The system aims to contribute to the EU's goals of becoming climate-neutral by 2050. Currently, industries and companies covered by EU ETS have shown emission reduction by 35% between 2005 and 2021 (European Commission, n.d.).


How to Contribute to Carbon Pricing

As governments aim to achieve the sustainable goals of the Paris Agreement by 2030, companies have various ways to engage with carbon pricing. Companies can comply with government regulations to reduce GHG emissions by carbon taxation or joining a carbon market system.

Delegations at COP21 standing in lines in suits
Heads of delegations at the 2015 United Nations Climate Change Conference (COP21), which led to the signing of the Paris Agreement

However, not all countries have implemented carbon pricing yet. Companies can proactively participate through voluntary carbon market mechanisms by engaging in carbon offsetting. For instance, the carbon offsetting initiative by CarbonEthics directs all collected funds for the restoration and preservation of blue carbon ecosystems, including mangrove trees, seagrass, and seaweed, working with local farmers. This helps companies to compensate for their emissions and protect the ecosystem as well as improving the livelihoods of the aforementioned farmers.


Eventually, carbon pricing hopes to push everyone toward sustainable living. Whether it's paying carbon taxes, being involved in the carbon market, or carbon offsetting, the objective is to raise awareness regarding the cost associated with our emissions and avoid the more devastating cost to our environment for future generations.


Writer: Fendy Wiedardi Limtara


References:

  1. Diedrich, G. (2022, January 24). Carbon pricing: Carbon Markets and Carbon Taxes. Michigan State University. https://www.canr.msu.edu/news/overview-carbon-pricing-carbon-markets-and-carbon-taxes

  2. European Commission. (n.d.). EU Emissions Trading System (EU ETS). Retrieved August 27, 2023, from https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets_en

  3. Filmanovic, M. E. (2022, June 16). What are the Hard to Abate Emissions and How Can These Sectors Adapt? Abatable. Retrieved August 21, 2023, from https://www.abatable.com/blog/hard-to-abate-emissions

  4. Gass, P. (2018, April 17). Carbon Pricing: Busting Four Major Myths. International Institute for Sustainable Development. Retrieved August 27, 2023, from https://www.iisd.org/articles/insight/carbon-pricing-busting-four-major-myths

  5. Goodward, J., & Kelly, A. (2010, August 1). Bottom Line on Offsets. World Resources Institute. Retrieved August 20, 2023, from https://www.wri.org/research/bottom-line-offsets

  6. Metcalf, G. E. (2023). Five Myths About Carbon Pricing. National Bureau of Economic Research. https://www.nber.org/papers/w31104

  7. Gupta, Y. (2011). Carbon credit: a step towards green environment. Global Journal of Management and Business Research, 11(5), 16-19.

  8. UNFCCC. (n.d.). About Carbon Pricing. Retrieved August 21, 2023, from https://unfccc.int/about-us/regional-collaboration-centres/the-ciaca/about-carbon-pricing#What-are-the-benefits-of-carbon-pricing?-

  9. The World Bank. (n.d.). Carbon Pricing Dashboard. Retrieved August 13, 2023, from https://carbonpricingdashboard.worldbank.org/what-carbon-pricing#:~:text=Carbon%20pricing%20is%20an%20instrument,to%20their%20sources%20through%20a

  10. UNDP. (2022, May 18). What are Carbon Markets and Why are They Important? Retrieved August 17, 2023, from https://climatepromise.undp.org/news-and-stories/what-are-carbon-markets-and-why-are-they-important

  11. Yamazaki, A. (2017). Jobs and climate policy: Evidence from British Columbia's revenue-neutral carbon tax. Journal of Environmental Economics and Management, 83, 197-216.

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