Carbon Pricing as a Policy Instrument to Decarbonize Economies

The analysis considered the effectiveness of carbon pricing in emissions reduction, regulatory stability, distributional effects, interactions with other policies and the impact on global trade. A set of stylistic facts are associated with the adoption of carbon pricing, with some differences between carbon tax and emissions-trading (ETS) policy regimes.

Carbon taxes may be favored in some jurisdictions because of lower cost and comparative ease of implementation and the potential to increase government revenue and offset reductions in income taxes.

Despite the slightly higher cost of implementation, due to the need to establish capacities for regulatory oversight, auctions, and monitoring, reporting, and verification (MRV) processes, ETSs are better able to set firm limits on emissions. ETSs are in principle able to reduce the marginal cost of abatement by using the market mechanism to allocate reductions to the least cost actors, but they require significant market depth and diversity of participants. ETSs may also be natural corollaries of broader socio-economic goals, such as energy market development and cross-border integration.

Revenue-neutrality and transparent/socially accepted use of proceeds are key drivers of social acceptance of carbon pricing where they have a significant regressive impact. A well-publicized implementation schedule, including a multi-phased approach to pricing, is needed to reduce economic or social shocks. Public perceptions of government effectiveness can impact the ability of a policy to be adopted, implemented, and sustained over time. Regardless of whether the burden of carbon pricing policies is real or perceived, the willingness of firms or households to accept additional taxation or emissions caps is critical for policy success.

Carbon leakage does not appear to represent an economically significant obstacle. Jurisdictions that have chosen to implement carbon pricing have higher overall export intensity than the global average, suggesting that carbon leakage is not a significant concern for export-oriented economies.

Carbon pricing policies can catalyze resource efficiency, green technology development, low-carbon intensity industries, electricity generation from renewables, and low-carbon transportation, provided that the policy objective is clear.

Chile and Colombia, which are in the process of implementing carbon pricing policies, were analyzed as case studies. They both present characteristics which could favor effective and stable implementation.

The table below summarizes the main features of ETS and Carbon Tax with reference to the key parameters analyzed in the study.

 

ETS

Carbon Tax

Policy Effectiveness

Provides certainty of abatement quantity, but renders the price per unit of abatement uncertain.

 

 

ETS are effective in reducing carbon emissions, but the instrument is yet to be proven in all sectors.

 

The advent of a market stability reserve in the EU ETS and permit import restrictions in the New Zealand ETS demonstrate the feasibility of efforts to maintain market stability.

 

Does not guarantee abatement quantity, but the certain price per unit of abatement ensures a stable price to spur decarbonization efforts.

 

Carbon taxes are effective in reducing carbon emissions and often replace or complement existing excise taxes, particularly in the energy sector.

Regulatory Stability

Reform efforts and increasingly efficient ETS policies will improve the likelihood that a stable regulatory environment can be maintained.

 

The investment required in institutional infrastructure needed for ETS implementation helps consolidate political will for regulatory stability.

 

Phased introduction of new taxes and regulations are necessary to ensure taxpayer support and investor confidence.

Cost and Distributional Effects

Costs associated with effective ETS include investment in capacity for monitoring and verification.

Lacking political will and the potential for regressive impact can hamper political vetting, implementation, and continuation.

 

Revenue neutral carbon taxes are increasingly viewed as more equitable, a view that helps consolidate wide political and public support.

 

Policy Coherence

Overlapping polices, along with the economic downturn, undermined the effectiveness of the EU ETS. Reform efforts have targeted strategies to safeguard against an allowance surplus by improving policy coherence with the Renewable Energy Directive and the Energy Efficiency Directive.

 

Carbon tax policy must be considered in the context of both environmental policies and taxes as well as fiscal policy and taxation, including individual and corporate tax rates.

 

Impact on Trade

Carbon leakage, though theoretically important has not been critical empirically.

Border carbon adjustments have been proposed as supplements to a carbon tax to address possible competitive disadvantage and emissions leakage, but many details remain to be worked out to address scope and compatibility of BCAs with international trade agreements.

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