Carbon pricing is an instrument that captures the external costs of greenhouse gas (GHG) emissions—the costs of emissions that the public pays for, such as damage to crops, health care costs from heat waves and droughts, and loss of property from flooding and sea level rise—and ties them to their sources through a price, usually in the form of a price on the carbon dioxide (CO2) emitted. A price on carbon helps shift the burden for the damage from GHG emissions back to those who are responsible for it and who can avoid it. Instead of dictating who should reduce emissions where and how, a carbon price provides an economic signal to emitters, and allows them to decide to either transform their activities and lower their emissions, or continue emitting and paying for their emissions. In this way, the overall environmental goal is achieved in the most flexible and least-cost way to society. Placing an adequate price on GHG emissions is of fundamental relevance to internalize the external cost of climate change in the broadest possible range of economic decision making and in setting economic incentives for clean development. It can help to mobilize the financial investments required to stimulate clean technology and market innovation, fueling new, low-carbon drivers of economic growth.
There is a growing consensus among both governments and businesses on the fundamental role of carbon pricing in the transition to a decarbonized economy. For governments, carbon pricing is one of the instruments of the climate policy package needed to reduce emissions. In most cases, it is also a source of revenue, which is particularly important in an economic environment of budgetary constraints. Businesses use internal carbon pricing to evaluate the impact of mandatory carbon prices on their operations and as a tool to identify potential climate risks and revenue opportunities. Finally, long-term investors use carbon pricing to analyze the potential impact of climate change policies on their investment portfolios, allowing them to reassess investment strategies and reallocate capital toward low-carbon or climate-resilient activities.
Carbon pricing can take different forms and shapes. In general, both the State and Trends of Carbon Pricing series and the Carbon Pricing Dashboard focus on direct carbon pricing instruments – that is, those that apply a price incentive directly proportional to the greenhouse gas emissions generated by a given product or activity (primarily carbon taxes, ETSs, and carbon crediting mechanisms). However, some jurisdictions, including Argentina, Mexico, and Uruguay, have introduced carbon taxes with varying tax rates (per metric ton CO2) across fuels. While these policies are called “carbon taxes” and have been historically included within the State and Trends Reports, they are closer to the definition for indirect carbon pricing, due to non-uniform carbon prices across fuels.
"Climate Countdown: Carbon Pricing"
by Kaia Rose & Eric Mann, USA
This short film was selected for the "Put a Price on Carbon Pollution Award" of the Film4Climate Global Video Competition.
Carbon pricing can take different forms and shapes. In the State and Trends of Carbon Pricing series and on this website, carbon pricing refers to initiatives that put an explicit price on GHG emissions, i.e. a price expressed as a value per ton of carbon dioxide equivalent (tCO2e). Considering different carbon pricing approaches, an emissions trading system (ETS), on the one hand, provides certainty about the environmental impact, but the price remains flexible. A carbon tax, on the one hand, guarantees the carbon price in the economic system against an uncertain environmental outcome. Other main types of carbon pricing offset mechanisms, results-based climate finance (RBCF) and internal carbon prices set by organizations. Scaling up GHG emission reductions and lowering the cost of mitigation is crucial to decarbonize economies. Given the size and urgency imposed by the climate challenge, a full range of carbon pricing approaches will be required, alongside other supporting policies and regulations.