Carbon Pricing and Emissions Trading

by

Michael Pollitt

• LAST REVIEWED: 27 October 2021
• LAST MODIFIED: 27 October 2021
• DOI: 10.1093/obo/9780199363445-0135

Introduction

Carbon pricing is about the explicit pricing of greenhouse gas (GHG) emissions, of which carbon dioxide is the most important. GHG emissions, which are normally measured in tonnes of carbon dioxide equivalent units, are responsible for global warming and hence the greatest environmental externality of our age. Carbon pricing is a mechanism for making society account for the external damage caused by carbon emissions in economic decision making. There are two main ways of pricing carbon dioxide emissions, either via a carbon tax or via the introduction of an emissions trading scheme whereby those emitting carbon into the atmosphere are required to surrender permits which reflect the quantity of emissions they are responsible for. These emission permits are tradeable and hence command a price and, in some respects, operate in a similar way to a carbon tax. Thus, we will discuss both carbon pricing and emissions trading, as the literature on both is closely related. Emissions trading exists for certain other pollutants (such as sulphur dioxide) and we will discuss some of the literature related to this. However, most of the literature on emissions trading relates to carbon dioxide emissions, as these are by far the most valuable traded emissions globally. The literature on carbon pricing and emissions trading is wide ranging and constantly being updated with new analyses. Much of the literature is written by economists who are seeking to apply market-based approaches to the solution of environmental problems. The article starts by looking at the general context in which carbon pricing and emissions trading sits before discussing introductory texts which relate to the subject and going on to introduce the relevant classic literature in environmental economics. It then proceeds to more applied literature, beginning with discussions of early examples of emissions trading and carbon taxation, before continuing to studies of the impact of carbon pricing and emissions trading and those which explain the nature of the schemes we observe. The article continues with literature which looks at the Europe Union Emissions Trading Scheme (EU ETS) for GHGs and other important carbon pricing schemes. It then moves on to the literature on the prospects for a global carbon price, on interactions with other climate policies, on distributional concerns about the imposition of a price on carbon. Finally, it concludes with an introduction to relevant official publications and sources of data on carbon emissions and carbon prices.

Introduction to Carbon Pricing and Emissions Trading

Carbon pricing and emissions trading needs to be put in context. Allen, et al. 2009 discusses how much emissions are to be allowed if damaging climate change is to be avoided. IPCC 2014 puts this reality in accessible language for policymakers. The basic economics of climate change is well summarized in Stern 2008. Current policy commitments to reducing emissions remain inadequate. This is nicely discussed in Boyd, et al. 2015. Any carbon policy needs to be credible for private investors (see Brunner, et al. 2012), while a carbon price should bear some relationship to the external costs of carbon emissions to the global economy (the shadow price of carbon) as explained in Hope and Newbery 2008. It is not enough to reduce the demand for carbon, the supply must be reduced as well. This is discussed in Sinn 2008. The world’s greatest economists continue to advocate for market-based solutions to climate change, for example, Tirole 2012. It is even possible that higher carbon prices will allow other taxes to be reduced and produce a “double dividend” for the economy (Smith 1998).

• Allen, M., D. Frame, C. Huntingford, C. D. Jones, J. A. Lowe, M. Meinshausen, and N. Meinshausen. 2009. Greenhouse-gas emission targets for limiting global warming to 2°C. Nature 458:1163–1166.

  DOI: 10.1038/nature08019

  An important article which sets out the overall global limits on GHG emissions, which provides the background context for the need to price carbon and limit emissions.

• Boyd, R., J. C. Turner, and B. Ward. 2015. Intended nationally determined contributions: What are the implications for greenhouse gas emissions in 2030? Policy Paper. London: ESRC Centre for Climate Change Economics and Policy and Grantham Research Institute on Climate Change and the Environment.

  Analysis of how national policy intentions to reduce carbon emissions fall short of that required by the climate science and hence how further rises in carbon prices and reductions on the greenhouse gas (GHG) emissions quantities are required.

• Brunner, S., C. Flachsland, and R. Marschinski. 2012. Credible commitment in carbon policy. Climate Policy 12.2: 255–271.

  DOI: 10.1080/14693062.2011.582327

  Emphasizes the importance to investors of credibility in the setting of carbon policy goals.

• Hope, C., and D. Newbery. 2008. Calculating the social cost of carbon. In Delivering a low carbon electricity system. Edited by M. Grubb, T. Jamasb, and M. Pollitt, 31–63. Cambridge, UK: Cambridge Univ. Press.

  This authoritative chapter discusses what large-scale integrated assessment modeling suggests the shadow carbon price is, providing the context for why most of the carbon prices we have observed in the world to date are a long way short of where they need to be.

• IPCC. 2014. Climate Change 2014: Synthesis Report. Contribution of Working Groups I, II and III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change. Summary for Policy Makers. Geneva, Switzerland: IPCC.

  This is a clear statement of why policymakers need to limit carbon emissions, written in as accessible way as it is possible for climate scientists to write. Core writing team, R. K. Pachauri and L. A. Meyer, eds.

• Sinn, H. W. 2008. Public policies against global warming. International Tax and Public Finance 15.4: 360–394.

  DOI: 10.1007/s10797-008-9082-z

  This paper warns that the supply as well as the demand for carbon must be reduced. Carbon taxes or emissions trading can both do this, but points out that carbon demand reduction alone will not reduce emissions.

• Smith, S. 1998. Environmental and public finance aspects of the taxation of energy. Oxford Review of Economic Policy 14.4: 64–83.

  DOI: 10.1093/oxrep/14.4.64

  This paper discusses the double dividend possible from raising environmental taxation, such that other taxes could be reduced allowing aggregate economic efficiency to further improve.

• Stern, N. 2008. The economics of climate change. American Economic Review 98.2: 1–37.

  DOI: 10.1257/aer.98.2.1

  Excellent short summary of the findings on the much longer original Stern Review, pointing out the benefits of pricing carbon in order to mitigate climate change.

• Tirole, J. 2012. Some political economy of global warming. Economics of Energy and Environmental Policy 1.1: 121–132.

  DOI: 10.5547/2160-5890.1.1.10.TROTIGNON

  A clear statement of policy proposals aimed at creating a global carbon market to reduce GHG emissions at the global level, from a Nobel laureate in Economics.