Climate Policy and Carbon Pricing Mechanisms
Carbon pricing has emerged as a central policy tool for addressing climate change. Two main approaches dominate the landscape: carbon taxes and cap-and-trade systems. Carbon taxes set a direct price on emissions, providing certainty about costs but uncertainty about emission reductions. In contrast, cap-and-trade systems set a limit on total emissions and allow trading of permits, providing certainty about environmental outcomes but uncertainty about costs.
The effectiveness of carbon pricing depends on several factors including price levels, coverage, and revenue recycling. Research suggests that carbon prices need to reach $40-80 per ton of CO2 by 2030 to align with Paris Agreement targets. However, most existing carbon pricing initiatives fall short of these levels. As of 2023, only a handful of jurisdictions have implemented prices above $50 per ton.
Revenue recycling is critical for political acceptability and economic efficiency. Revenues can be used to reduce distortionary taxes, invest in clean energy infrastructure, or provide rebates to households. British Columbia's carbon tax is often cited as a success story, using revenue neutrality to maintain political support while achieving emission reductions.
Border carbon adjustments have gained attention as a tool to prevent carbon leakage and maintain industrial competitiveness. The European Union's Carbon Border Adjustment Mechanism, proposed in 2021, represents the most ambitious effort to date. However, such mechanisms raise concerns about trade law compatibility and impacts on developing countries.
Critics argue that carbon pricing alone is insufficient and must be complemented by regulations, subsidies, and technology policies. The debate continues over the optimal policy mix for achieving deep decarbonization while ensuring just transitions for affected workers and communities.
