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Home / IAS Preparation / Carbon Pricing

Carbon Pricing: Purpose, Types, Effectiveness, and Challenges of Pricing Carbon

Last Updated on Feb 06, 2024
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Carbon pricing is a policy approach that puts a monetary cost on greenhouse gas emissions, primarily carbon dioxide (CO2), with the aim of reducing those emissions. It involves either a tax on carbon emissions or a cap-and-trade system. The companies are allocated a limited number of emission allowances that can be bought, sold, or traded. Carbon pricing encourages businesses to reduce their emissions and adopt sustainable practices. The goal is to incentivize the transition to a low-carbon economy and mitigate the impacts of climate change.

In this article, let us look at what carbon pricing is, types of carbon pricing, needs and types of carbon pricing, the advantages & disadvantages of a carbon tax, and the challenges of carbon pricing for the UPSC IAS Examination, since the topic is important for the Environment section, which is a part of UPSC mains GS 3 paper.

Check out the linked article to download the Environment Notes for UPSC Exams now!

What is Carbon Pricing?

Carbon pricing is a method that assesses the external costs associated with greenhouse gas (GHG) emissions and connects those costs to the sources through a price on the carbon dioxide (CO2) emitted. This method transfers responsibility for emissions and their impacts to those who produce them. This further deters producers from carelessly generating GHG gasses. It is by the UNFCCC’s Kyoto Protocol and Paris Agreement, which aim to reduce GHG emissions, prevent extreme weather, and keep global warming to 1.5 degrees Celsius by 2050.

Need for Carbon Pricing

  • Carbon pricing makes it easier for businesses to include carbon emissions in their financial planning and strategy by providing a way to describe carbon emissions in monetary terms.
  • With the aid of carbon pricing, the cost of the damage is shifted back to those who caused it and have the power to mitigate it.
  • Carbon pricing is one of the tools in the climate policy package that governments need to use to cut emissions.
  • As a planning tool, the carbon price aids in recognizing income opportunities and risks to save expenses, emissions, and direct capital investment decisions.
  • For businesses, it may include gradually changing to a more sustainable and green model, which is likely how things will go.
  • Long-term investors can reevaluate their investment strategy and reallocate capital toward low-carbon or climate-resilient activities by using carbon pricing to investigate the possible impact of climate change policies on their investment portfolios.

Check out the linked article to download the notes on Montreal Protocol for UPSC Exams now!

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Types of Carbon Pricing

One of the two methods outlined below can be used to set a carbon price.

Emissions Trading System

  • Emitters can exchange emission units in an emissions trading system to reach their targets.
  • The emitter has two options: to carry out internal emission reduction strategies or buy emission units on the carbon market.
  • The two major ETS types are baseline, credit system, and cap and trade method.
  • Cap and Trade Method: This technique involves setting an emissions limitation and allocating emission permits through auctions for the emissions necessary to reach the quota.
  • Baseline and Credit Systems: In these arrangements, a baseline emission level is established, and entities that have decreased their emissions below this level are given credits. Other entities who emit more than their baseline levels can purchase these credits.

Carbon Tax

  • The government or a regulatory body imposes a carbon tax on goods and services with a carbon cost.
  • For instance, the government might impose a carbon tax on fossil fuel use, sale, or distribution.
  • This will raise the price of these fuels and related activities, encouraging companies to use more environmentally friendly alternatives.

Check out the linked article to download the notes on What are Chlorofluorocarbons (CFCs) for UPSC Exams now!

Advantages of Carbon Tax

  • Consumers and producers would be responsible for covering the entire social cost of consumption, which has been proposed as a strategy to internalize the negative externality of carbon emissions.
  • Compared to quantitative limits, a carbon tax policy generates less volatility in carbon emissions prices.
  • It will encourage the transition to alternative and renewable resources.
  • Cutting effluents while generating income that could be employed to install other alternative resources is a wise choice.

Disadvantages of Carbon Tax

  • Different national policies could result in “carbon leakages,” as energy-intensive industries tend to shift to nations with less stringent regulations.
  • Businesses claim that taxes levied on carbon will deter investment and lower profitability.
  • It penalizes people who cannot switch to alternate sources; it particularly impacts people with low incomes and emerging nations like many African and Asian nations.
  • It is challenging to assess the proper tax since it may be difficult to quantify the amount of carbon produced accurately.

Check out the linked article to download the notes on Environmental Impact Assessment for UPSC Exams now!

International Carbon Pricing

International carbon pricing refers to initiatives that aim to apply carbon pricing globally. The Kyoto Protocol, adopted in 1997, mandated industrialized countries to collectively reduce their greenhouse gas (GHG) emissions.

Efforts made by the United Nations Framework Convention on Climate Change (UNFCCC) include:

  • International Emissions Trading (IET) where countries can trade emission allowances.
  • Joint Implementation (JI) and Clean Development Mechanism (CDM) allow companies to take part in low-carbon projects and receive credits.
  • The Paris Agreement introduced new approaches under Article 6. It allowed voluntary cooperation and the use of internationally transferred mitigation outcomes (ITMOs) to meet emission reduction targets.

Initiatives outside the UNFCCC include the following:

Voluntary Carbon Market

  • The voluntary market serves businesses that voluntarily reduce their carbon footprint.
  • In 2016, 63 MtCO2e of credits were traded on the voluntary market, worth US$191 million.
  • Some voluntary credits can be converted into compliance offsets for mandatory carbon pricing programs like the California Cap-and-Trade program.

Result-based Climate Finance (RBCF)

  • RBCF provides climate finance to recipients who achieve predetermined climate-related goals.
  • Payments are made based on outcomes such as emission reductions or the development of low-emission technologies.

Global Sectoral Initiatives

  • CORSIA is the first worldwide sectoral carbon pricing initiative for international aviation.
  • It aims to stabilize net emissions from international aviation at 2020 levels. Any new emissions above 2020 levels will require offsetting.

Check out the linked article to download the notes on the Goods and Services Tax (GST) for UPSC Exams now!

Is Carbon Pricing Effective at Reducing Emissions?

Although carbon pricing effectively reduces GHG emissions, its full potential has not yet been reached. Because of the reasons listed below, carbon pricing has only partially achieved its goals.

  • The political class has been compelled to move slowly on sustainable transitions by the political economy, particularly in developing countries. As a result, manufacturing and agriculture technology have mostly remained unchanged or have advanced slowly.
  • The member nations have not rigorously complied with their obligations under the Paris Agreement, putting their own development needs ahead of sustainability principles.
  • The COP 16 climate financing agreement called for developed nations to provide $100 billion annually for sustainable projects in underdeveloped nations. However, this commitment has not been maintained.
  • The necessary finances are unavailable in developing countries to modernize technology for sustainable development.
  • Holistic reforms are required to halt climate change. Climate change cannot be addressed by carbon pricing alone.

Check out the linked article to download the notes on the Heat Budget of Earth for UPSC Exams now!

Challenges Associated with Carbon Pricing

Although many economists believe carbon pricing is the best strategy for combating climate change, some disagree. Below is an overview of a few of the challenges carbon pricing poses.

  • This strategy treats climate change as a market problem rather than a systemic issue. To make actors pay the social cost of carbon for their carbon-intensive activities and decrease their demand for such goods and services, climate change is portrayed as the consequence of a market failure that can be corrected by imposing a price on carbon. This misses the depth and breadth of the climate change issue. They contend that to overcome this problem, the system needs to undergo fundamental adjustments.
  • This strategy prioritizes efficiency over effectiveness. There is scarcely any time left to achieve carbon neutrality to combat climate change, for instance, to keep global warming to less than 1.5 °C. Carbon pricing essentially permits polluters to select abatement techniques that are the most cost-effective for them. This is insufficient to address the severe and pervasive problem of climate change.
  • It is unknown how carbon pricing influences the exploration and creation of low-carbon innovations or technologies.
  • The premise behind carbon pricing plans is that eventually, all countries will be subject to a single price since only then can it be guaranteed that no country will benefit unfairly from the efforts of others. However, this universalist strategy ignores the facts of the disjointed nature of the global climate policy environment. This ignores that institutional structures, regulatory environments, and compliance are not uniform across all nations. Additionally, it ignores the necessity of modifying regulations to the regional context.
  • The political realities—i.e., how politicians and policymakers are connected to the sway that large firms and businesses have over them—are also ignored by carbon pricing. These “polluting” actors can influence policy in a way that lowers the price tag on carbon emissions or lessens the severity of carbon pricing for their own benefit.

Check out the linked article to download the notes on the National Mission for Enhanced Energy Efficiency for UPSC Exams now!

Suggestions and the Way Forward
  • Large economies like India should utilize their global monopoly to impose the carbon tax proposed by the European Union.
  • Since energy-intensive firms may relocate to less stringent national regimes, India’s carbon tax policy will only be effective if it is internationally harmonized and levied.
  • A market-based strategy to price and trade carbon domestically and to persuade other countries to take similar action through diplomacy and global trade.
  • In India, a carbon tax of $35 per tonne of CO2 emissions is predicted to be able to produce about 2% of GDP through 2030.
  • India has pledged to use non-fossil fuels for 40% of its energy capacity by 2030 as part of the Intended Nationally Determined Contribution and to reduce its emissions to GDP ratio by a third from 2005 levels.

We hope your doubts regarding the topic of Carbon Pricing would have been addressed after going through the above article. Testbook offers good quality preparation material for different competitive examinations. Succeed in your UPSC IAS exam preparations by downloading the Testbook App here!

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Carbon Pricing FAQs

Carbon pricing is the imposition of a price on carbon emissions as a means of forcing polluters to reduce the number of greenhouse gases they emit into the atmosphere. The goal of carbon pricing is to promote the creation of new, eco-friendly, high-performance, low-carbon technology.

A carbon tax is a type of pollution tax. Based on the amount of carbon that is released during combustion, it imposes a tax on the production, distribution, or use of fossil fuels.

The initiatives for pricing carbon that could probably be applied on a global scale is referred to as international carbon pricing.

The Carbon Pricing Act (CPA), which was passed in 2019, instituted the carbon tax, which is $5 per tonne of greenhouse gas emissions (tCO2e). The transition to a low-carbon economy will be assisted by the carbon tax, which will encourage reduction in emissions across all sectors.

Globally, there are wide variations in carbon tax rates. As of April 2021, Poland had a tax rate of less than one U.S. dollar per metric tonne of CO2 equivalent, while Sweden had the highest carbon tax rate in the world at 137 U.S. dollars per metric tonne of CO2 equivalent.

India does not impose a specific carbon price. Fuel excise taxes, an implicit method of pricing carbon, will continue to cover 58.1% of emissions in 2021, remaining constant from 2018.
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