How Countries Cut Carbon by Putting a Price on It: QuickTake Q&A

Carbon taxes and cap-and-trade are two ways countries around the globe are using economic incentives to reduce greenhouse gases. They’re based on a simple idea: if something is made to cost more, there’ll be less of it produced. Putting that idea into practice has proven to be politically and technically daunting. While some want a global pricing mechanism, others consider that to be a bridge too far. A United Nations conference in Bonn in May will debate rules to limit emissions. About half of the 194 nations that signed the 2015 Paris agreement expect to use some form of carbon pricing.

1. Who has a carbon tax?

Right now 19 countries impose levies with prices ranging from less than $1 to $131 a metric ton of carbon dioxide emitted — the equivalent weight of an elephant or a small car. They include Finland, Japan and Mexico. Australia had a carbon tax but changed its mind in 2014.

2. What’s cap and trade?

Cap and trade tries to efficiently limit emissions by putting market forces to work. The government starts by setting an overall cap on emissions, either for the overall economy or specific industries. It then gives or sells emission allowances to polluting businesses that represent the annual carbon limits they’re allowed to emit into the atmosphere. If companies take measures to be greener or more efficient, they can profit by selling extra credits left over. Companies that exceed pollution limits can buy additional allowances.

3. Who uses that? 

About 41 nations around the world, including the European Union, China’s Shenzhen province, Canada’s Ontario and California in the U.S. The EU program is the biggest by traded volume. Some countries, including the U.K., use both cap-and-trade markets and taxes or price floors.

4. Does cap-and-trade work?

So far, results are mixed. The cap-and-trade programs haven’t had a big impact on corporate behavior, but have encouraged some switching by utilities to cleaner natural gas from coal. That’s because the cost of pollution credits has been lower than expected — in the EU, the price has fallen more than 80 percent in the past decade to about 5 euros ($5.29) a metric ton. That’s about half the level needed to start biting in Germany. There are several reasons for the low price: governments implemented overlapping policies like renewable energy subsidies, economic growth was sluggish and nations handed out lots of allowances to reduce opposition from business groups.

5. How about carbon taxes — do they work?

The U.K.’s carbon tax, at about four times the EU market price, helped cut annual coal use by almost 60 percent in 2016. Emissions in Canada’s British Columbia province fell after it introduced a tax in 2008, but they’ve since rebounded. One obstacle toward a tax on carbon is the question over how high they should be. Some parties are calling for a global price, but that’s about as realistic as a global interest rate. A level making a difference in Western economies would cripple emerging markets. Emerging nations are wary of carbon taxes and climate policies that may limit their exports of manufactured goods or fossil fuels to richer countries.

6. So what’s next?

While a global price is unlikely anytime soon, negotiators at climate talks in Bonn are seeking to make progress on rules that would help nations compare climate policies and carbon prices while paving the way for international allowance trading. Under one series of debates on alternatives to markets, nations may even consider trading emission reductions achieved by taxes.

7. Where does the U.S. stand? 

Under former President Barack Obama, the U.S. came a few Senate votes away from a cap-and-trade system. Donald Trump, his successor, who questions whether mankind is to blame for warming, has so far taken that off the table. While Trump is moving to undo steps Obama took to carry out the pledges the U.S. made in the Paris accord, he hasn’t yet said if he’ll formally pull out of it. Trump’s given conspicuous backing to the coal industry, which is lobbying against carbon pricing and rallying people in fossil fuel-dependent economies.

8. Can Trump block movement in Bonn?

Trump’s administration said it’s reviewing the Paris climate deal and expects to decide on continued participation in May. While he can’t rip up the entire accord the U.S could exit by 2020 or even by 2018 should he withdraw from underlying UN rules. Most other nations are pressing ahead. But the decision to move forward isn’t Trump’s alone. Industries from utilities to steelmakers have called for carbon markets supported by clear, stable and long-term policies. Six of the world’s largest oil companies – Royal Dutch Shell, BP, Eni SpA, Statoil ASA, Total SA and BG Group — wrote an open letter to the UN in June 2015, calling for “clear, stable, long-term” policies and a price on carbon.

Reference Shelf

World Bank’s State and Trends of Carbon Pricing
Carbon Pricing Spreads Along With Debate About Payoff: QuickTake
Emissions Trading Status Report: ICAP
IMF Discussion Note

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