Carbon Pricing Mechanisms
There are multiple ways to price carbon – the two main mechanisms being carbon taxes and emissions trading (or ‘cap and trade’). While different pricing mechanisms should theoretically have similar impacts assuming prices are the same, each mechanism operates differently which means there are some practical differences. These mechanisms are not mutually exclusive – some jurisdictions use both carbon taxes and emissions trading to price carbon in different parts of their economy.
| Carbon tax | Emissions trading |
|---|---|
Direct carbon taxes are levied on greenhouse gas emissions and paid by emitters. For example, carbon taxes levied on coal, oil products, and natural gas in proportion to their carbon content, can be collected from fuel suppliers. These taxes are usually set as a price per tonne of carbon dioxide or equivalent greenhouse gas. Indirect carbon taxes can change the price of carbon-intensive inputs in ways that may not be directly proportional to those emissions. They include consumption taxes on specific goods that produce greenhouse gas emissions, such as fuel. Carbon taxes have the advantage of giving certainty of price, can be applied to a wide range of enterprise sizes and sectors, and can be simpler to administer than other mechanisms. However, like other taxes, they are often politically unpopular. | Emissions trading systems (ETS) are a popular way to limit emissions from the hard-to-abate sectors and determine a market price of carbon. Instead of fixing the price from the outset, governments, or groups of governments, decide on a limit to the total volume of emissions from their jurisdictions per year. They then issue or auction off ‘allowances’ in accordance with this limit. Businesses must retire allowances based on the volume of greenhouse gases they emit, and can buy or sell allowances. The market price of one allowance is the price of carbon in such a system. In a well-functioning compliance (or mandatory) emissions trading system, the environmental impact is more certain. Additionally, emissions trading can be more politically palatable than carbon taxes. However, implementation can be difficult when dealing with market fluctuations, and risks of theft and fraud. |