Role of carbon pricing in climate protection

The world is in a crisis, particularly due to climate change and there is an urgent need to undertake measures, and at a low cost.

In the current regime under the Paris Agreement, countries depend on the decarbonisation of highly polluting sectors by incorporating renewable energy and enhancing its efficiency to meet climate goals.

However, like in the pre-Paris Agreement regime, carbon pricing instruments are being extensively used today by different countries in various forms. The notion behind putting a price on carbon stems from the goal to internalise the external cost of GHG emissions, and consequently address the market failure as one pollutes while the other is being affected.

In other words, the basis for carbon pricing lies with the "polluters pay principle". Most commonly used instruments under carbon pricing are carbon tax and emissions trading scheme (ETS), also known as cap and trade, which have theoretical underpinnings, as discussed in the literature of environmental economics.

According to a report by The World Bank, around 22 percent of global GHG emissions are covered by the 61 carbon pricing schemes, including ETS and carbon tax, of which some are just in the planning stage, to be implemented in the foreseeable future.

In ETS, the trading between entities ( for example industries) takes place in the market, with the target of reducing emission as set out by the government. In an ideal scenario, some entities should be able to reduce emissions more than its obligation, while others might find it non-viable to meet emission targets.

In a market of entities, there would be a demand-supply gap for emissions and therefore, a price would appear, resulting in the trading.

Overall, a trading-based system is more complex to implement compared to a carbon tax scheme. That is because the carbon tax is a price-based market instrument, where a fixed price is being put on a given tonne of CO₂ equivalent (CO_2eq), and thus a constant price signal to the polluting entities is provided to reduce their emissions. It is a fixed fee inflicted upon the polluting entities to encourage them in undertaking GHG mitigation projects/actions or to pay the tax for their carbon emissions.

Such a tax could be both explicit and implicit. When tax is being levied upon per unit of emission, say CO_2eq, we treat it as explicit carbon tax and on the other hand, tax per litre/kg/tonne of fossil fuel usage or kilowatt-hour of electricity consumption is usually known as an implicit carbon tax.

Different jurisdictions have benefited from the carbon tax. For example, India levied a tax (cess) on coal in 2010 to support GHG mitigation activities, including, among other things, promotion of renewable energy and energy efficiency.

The National Clean Energy and Environment Fund (NCEEF) was created based on the tax on coal to meet the high cost of GHG mitigation. A Rs 50 tax was imposed initially on per tonne of coal and with time it was increased up to Rs 400.

A total of Rs 12,430 crore out of the total revenue generated from coal cess was allocated for renewable energy promotion in India during 2010-11 to 2016-17. Such funding has significantly catalysed renewable energy dissemination and market transformation in India.

It has been reported that currently, India has more than 88 GW (88,000 MW) of renewable energy installations. While the coal cess has been replaced with goods and services tax, it has also been an enabling instrument in the country's pursuit for energy transition to tap into significant power from renewables and thereby reducing its reliance on fossil fuels.

Mexico has also embarked on the carbon tax, apart from ETS, aimed at GHG mitigation under the general law on climate change of the country. Initiated with a tax of US$ 3 per ton of CO_2eq, generated from coal and petroleum, excluding natural gas, the fee has been increased to the range of US$ 3.5 to 3.7.

The estimated emission reduction, attributable to the carbon tax, is in the order of 1.8 million tons of CO_2eq per annum. 

As discussed, a carbon tax can drive emission reduction and promote sustainable energy. Another notable advantage of such instrument is the flexibility that the polluting entities have in deciding on as to whether they would cut their carbon emissions or simply pay tax to the government exchequer.

They would further have the autonomy of choice on a suitable time to opt for GHG mitigation instead of continuously paying to the government on account of carbon tax liability.

Either way, if monitored by the government, the carbon tax would lead to GHG mitigation, be it directly by the polluting entities or by the government through channelling revenue to climate protection projects.

Besides, as the adoption of energy-efficient technologies increases, people would have more money left at disposal compared to the business-as-usual situation and hence, they may use energy-efficient technologies more than usual even if behavioural changes are not achieved. 

Experts claim that with a carbon tax in place, the chance of rebound effect in energy consumption is low. Along with this, a carbon tax may help remove energy price distortion in a country.

It has also been evidenced that carbon pricing instruments help spur research and development to take place and as such, carbon pricing regime is highly likely to stimulate technological innovations on the GHG mitigation front.

Last but not the least, revenue from a carbon tax could be distributed to climate change adaptation projects in a country where tax to GDP ratio is low and allocation of public funding to such projects is, to some extent, difficult.

Therefore, carbon pricing has precise impacts on climate protection. If properly flanked with other policies and targets, such as renewable energy, energy efficiency and Nationally Determined Contributions (NDC), the results could be even better.

As we discuss in international and local forums on socially just climate protection, carbon tax is one of the policy instruments that can help achieve much, when distributional impacts of a carbon tax on the poor are assessed and measures are being taken accordingly.

The design of a carbon tax scheme, as a result, is something very crucial in effectively delivering goals on climate protection. Perhaps, in another opinion piece, I would expatiate on the design features of a carbon tax.  

Shafiqul Alam is a Humboldt Scholar. He is an engineer and environmental economist. Within the framework of International Climate Protection Fellowship, Germany, he conducted a study on Carbon pricing, which is available at: https://www.ecologic.eu/16644)