Carbon Pricing 101
Global warming is the existential challenge of our time, threatening lives, livelihoods and the future of the planet. Wildfires, extreme storms and other impacts of global warming are already causing devastation around the world. Those impacts will only become more dramatic over time unless we move to cut greenhouse gas (GHG) emissions immediately and dramatically.
To prevent the worst impacts of global warming, the United States must achieve carbon neutrality by 2050. The Intergovernmental Panel on Climate Change (IPCC) warns that world carbon emissions must reach net zero around 2050 to limit global warming to 1.5°C over preindustrial levels – the level beyond which catastrophic climate changes could occur.[i]
U.S. policymakers must use every practical policy tool to make this zero-carbon transformation a reality – promoting rapid deployment of renewable energy sources, investing in research and development of clean energy technologies and energy efficiency and taking regulatory actions to push polluters away from using dirty fossil fuels. Policymakers must act decisively, which will require securing bipartisan support.
A central element in this strategy should be putting a price on carbon pollution (known as carbon pricing) to push polluters to cut emissions and switch to clean energy. Pricing carbon pollution makes polluters pay for the damage they cause and incentivizes them to use energy more efficiently and shift from oil, coal and natural gas to clean, renewable energy.[ii]
Carbon pricing spurs investment in efficient and clean technologies. It can generate revenue that can be invested in clean energy, be returned to the public as a dividend or support other public priorities. Carbon pricing protects the interests of future generations and will accelerate the transition to a cleaner, healthier planet, working as part of a broader set of regulatory actions to reduce emissions of carbon dioxide and other greenhouse gases that cause global warming.
Carbon pricing is recognized as a valuable tool around the world. As of May 2020, 46 countries and 32 subnational jurisdictions had implemented or scheduled 61 carbon pricing initiatives, covering about 22% of annual global GHG emissions.[iii]
Governments in the United States should establish carbon pricing programs to help move the nation toward net-zero greenhouse gas emissions by 2050. There are many choices jurisdictions must make in designing carbon pricing programs – choices with important implications for program effectiveness.
Cap-and-trade programs and carbon taxes can both be effective tools to put a price on carbon pollution, but there are important differences between the two strategies. There are two key mechanisms for putting a price on carbon pollution: a cap-and-trade system or a carbon tax. Cap-and-trade (sometimes called cap-and-invest or cap-and-dividend) programs set a cap on the level of carbon or other GHG emissions allowed by specified emitters.[v] Emissions allowances (representing a specific amount of carbon pollution) are auctioned or given away to emitters, with the total number of allowances issued adding up to the cap.[vi] Polluters able to cut emissions cheaply can sell excess allowances to polluters with higher reduction costs or purchase fewer of them at auction, creating a market price for emissions.[vii] Requiring polluters to pay to emit carbon pushes companies toward cleaner fuels and catalyzes innovation.[viii] Caps drop over time to keep GHG emissions falling. As of 2020 there were 31 cap-and-trade programs implemented or planned worldwide, including in 11 U.S. states.[ix]
A carbon tax, on the other hand, sets a price directly on emissions or on the carbon content of fossil fuels.[x] Taxing emissions sends a price signal to polluters to shift to lower-emission alternatives, and to consumers to purchase products with lower carbon inputs.[xi] Individual decisions by firms and households will determine how much emissions will fall, unless tax levels are set to target specific emissions reductions. There are 30 carbon tax programs operating or planned around the world today (including one city-level program in Boulder, Colorado), but no state-level programs in the United States.[xii]
A price on carbon can be set at a level designed to drive desired reductions in emissions or to recoup the estimated damage to society caused by carbon pollution. Setting a price strategically to drive reductions toward an emissions target is more promising, since it helps governments achieve policy goals. Models can be used to estimate tax levels needed to reduce emissions along a reduction pathway, and mechanisms created to allow the price to be increased or decreased over time as needed to hit specific targets on the way toward net-zero emissions.[xiii] In contrast, some international organizations, economists, other academics and think tank experts favor using an estimated social cost of carbon (SCC) to aggregate environmental, economic and social damages from emissions.[xiv] An SCC, however, is derived via complex calculations, produces widely varying results and is ultimately subjective.
Carbon pricing is an essential tool to fight global warming, but is not sufficient on its own.
Carbon pricing programs are by themselves a proven tool for cutting emissions and can generate large revenues that can be invested into further emissions reductions (or for other purposes). Some analyses conclude carbon pricing can be more effective as part of a comprehensive regulatory strategy to reduce emissions, rather than as a stand-alone approach.[xv] A World Bank-sponsored commission, for example, concluded that climate change is driven by multiple market failures, beyond the failure to price carbon, and thus requires multiple policy tools to address.[xvi] The most promising approach supports carbon taxes within a strategy of broad regulatory actions and sets prices to target specific emission reductions, trending toward net-zero emissions over time.[xvii]
Carbon pricing has a track record of effectiveness in the United States and elsewhere, with new programs in the process of being proposed or launched. Carbon pricing programs have operated at the state level for more than a decade, with the northeastern and mid-Atlantic states’ Regional Greenhouse Gas Initiative (RGGI) and California both managing effective cap-and-trade programs.[xviii] The Transportation and Climate Initiative (TCI), a collaboration of northeastern and mid-Atlantic states, has been exploring a cap-and-trade program for transportation, and three of the states plus the District of Columbia agreed in December 2020 to launch the TCI Program in their jurisdictions by 2023.[xix] Several states – notably Oregon and Washington – have proposed ambitious carbon pricing programs through legislation or referenda, though no other state programs have yet been adopted.[xx]
More proposals are being developed at the national level. Twelve carbon pricing plans were introduced in the 116th Congress (of which 10 proposed a national carbon tax, one a national cap-and-trade program and one a hybrid program).[xxi] None of these programs passed either chamber of Congress, however.
Carbon pricing has great potential as a central part of the U.S. policy toolkit to fight global warming. U.S. policymakers should adopt carbon pricing policies with the following elements:
- Implementing carbon tax and/or cap-and-trade programs as part of a broad set of policies to address global warming.
● Strategies to address global warming also should include use of existing regulatory powers (e.g., the Clean Air Act), reduction/elimination of fossil fuel subsidies, expansion of incentives/subsidies for renewables, research and development (R&D) investments, investments in green infrastructure and others.
- Setting carbon tax rates and caps to target emissions reductions.
● Carbon pricing programs should use emission reductions timelines, rather than revenue targets or estimates of the social cost of carbon, to set tax levels or caps. This could include accepting caps at levels above emission reduction targets, but that generate revenue that is used to cut emissions further through investments.
- Investing carbon pricing revenues in renewable energy, energy efficiency, green infrastructure and broad public benefits.
● Carbon pricing programs should direct revenues across sectors as part of overall efforts to decarbonize the economy and to increase public awareness of the importance of carbon pricing in addressing GHG emissions.
● All other uses of carbon pricing revenues should benefit the public.
- Ensuring the integrity of programs and preventing loopholes.
● Carbon pricing programs should include backstops that ratchet up prices or otherwise accelerate emission reductions if emissions targets are not met.
● Programs should ideally be comprehensive, covering the entire economy.
● Programs should include measures to prevent “carbon leakage,” e.g., via a border carbon adjustment/border tax adjustment.
● In the case of cap-and-trade, policymakers should adopt tight limits on offsets and ensure that any cost-containment provisions built into the program do not interfere with progress toward needed emission reductions.
[i] Intergovernmental Panel on Climate Change, Mitigation Pathways Compatible with 1.5℃ in the Context of Sustainable Development, Executive Summary, February 2019, p. 95, available at https://www.ipcc.ch/site/assets/uploads/sites/2/2019/02/SR15_Chapter2_Lo....
[ii] Center for Climate and Energy Solutions, Options and Considerations for a Federal Carbon Tax, 28 February 2013, pp. 1-2, available at https://www.c2es.org/site/assets/uploads/2013/02/options-considerations-....
[iii] World Bank Group, State and Trends of Carbon Pricing 2020, May 2020, p. 9, archived at https://web.archive.org/web/20201214211232/https://openknowledge.worldba....
[iv] U.S. EPA, Greenhouse Gas Reporting Program, GHGRP Emissions by GHG, accessed 12 March 2021, available at https://www.epa.gov/ghgreporting/ghgrp-emissions-ghg.
[v] Center for Climate and Energy Solutions, Carbon Pricing, Cap-and-Trade, Cap-and-Trade Basics, accessed 17 March 2021 at https://www.c2es.org/content/cap-and-trade-basics/.
[ix] Worldwide programs: World Bank Group, State and Trends of Carbon Pricing 2020, May 2020, p. 9, archived at https://web.archive.org/web/20201214211232/https://openknowledge.worldba... U.S. state programs: Center for Climate and Energy Solutions, Market-Based State Policy, accessed 17 March 2021 at https://www.c2es.org/content/market-based-state-policy/.
[xii] 30 programs: See note 3, p. 9; Boulder, Colorado program: City of Boulder Colorado, Cap Tax, accessed 14 October 2020 at https://bouldercolorado.gov/climate/climate-action-plan-cap-tax.
[xiii] Noah Kaufman et al., “A near-term to net zero alternative to the social cost of carbon for setting carbon prices,” Nature Climate Change, 10: pp. 1010-1014, doi: 10.1038, 17 August 2020, archived at https://web.archive.org/web/20201214215239/https://doi.org/10.1038/s4155....
[xiv] Supporters of using an SCC include experts at the Organization for Economic Cooperation and Development (OECD), the World Bank, the IMF, the Brookings Institute, the Institute for Policy Integrity, and other policy organizations. The Canadian government, the former Obama Administration Interagency Working Group and some other national governments have employed an SCC in estimating environmental damage from carbon pollution. The Environmental Defense Fund also supports use of an SCC. However, many environmental organizations and academics support alternative mechanisms for setting carbon tax levels, and the SCC concept remains controversial.
[xv] Carbon Pricing Leadership Coalition, Report of the High-Level Commission on Carbon Pricing Executive Summary, 29 May 2017, pp. 3-5, available at https://static1.squarespace.com/static/54ff9c5ce4b0a53decccfb4c/t/59b7f2.... This report of a World-Bank sponsored commission chaired by Joseph Stiglitz and Lord Nicolas Stern strongly indicated emissions reductions are more likely to be greater as part of a package of regulatory measures aimed at reducing emissions and correcting market failures than they would be from carbon pricing alone. The analysis by Noah Kaufman et al. (note 13) also makes this point.
[xvi] See note 15.
[xvii] See note 13.
[xviii] Center for Climate and Energy Solutions, State, Carbon pricing, Market-Based State Policy, accessed 17 March 2021 at https://www.c2es.org/content/market-based-state-policy/.
[xix] Transportation and Climate Initiative, Next Steps for the Transportation and Climate Initiative, 21 December 2020, archived at https://web.archive.org/web/20201224022642/https://www.transportationand....
[xx] Oregon proposals: Ted Sickinger, “Understanding Oregon’s ‘cap and invest’ climate bills,” The Oregonian, 17 May 2019, archived at https://web.archive.org/web/20210317161819/https://www.oregonlive.com/politics/2018/01/lawmakers_debate_greenhouse_ga.html; Washington proposals: David Roberts, “Washington votes no on a carbon tax – again,” Vox, 6 November 2018, available at https://www.vox.com/energy-and-environment/2018/9/28/17899804/washington....
[xxi] Jason Ye, Center for Climate and Energy Solutions, Carbon Pricing Proposals in the 116th Congress, September 2020, p. 1, archived at https://web.archive.org/web/20201127202213/https://www.c2es.org/site/ass.... Hybrid plan: Nader Sobhani, Niskanen Center, Rep. Sean Casten’s Tradable Performance Standard Finds Middle Ground Between Carbon Pricing and Performance Standards, 28 October 2020, available at https://www.niskanencenter.org/rep-sean-castens-tradable-performance-sta....