What is Carbon Pricing?

Carbon pricing refers to the method of determining what the producers of carbon dioxide should pay for the right to emit a certain amount of it. This is a feature of different regulatory plans designed to lower carbon emissions, as carbon dioxide contributes to climate change. In schemes involving a carbon tax, carbon pricing means deciding what amount of taxation would significantly lower emissions without overly harming industry or the economy. It is also a feature of some cap-and-trade plans, in which companies are able to purchase the right to emit more carbon dioxide by purchasing the credits that enable them to do so. The price of carbon dioxide is usually given as the price per metric ton.

There are a number of proposed ways to implement carbon pricing through either a cap-and-trade system or taxation. A cap-and-trade plan could at first either include the auction of emissions permits, simply give them away, or involve some combination of both. Taxation may be a straightforward price per ton or be part of a hybrid plan that includes a form of cap-and-trade. Some businesspeople see pure taxation as a penalty, while some economists argue that it provides more incentive to reduce pollution. One possible advantage of cap-and-trade is that it could encourage innovation in reducing emissions rather than encouraging industries to reduce economic output.

The discussion of carbon pricing also deals with two economic factors, one known as direct cost and the other as an externality. A direct cost is a cost normally included when calculating income and expenses, such as the purchase of equipment or the cost of labor. An externality, also known as an indirect cost, is not normally accounted for but still has a broader economic impact. Due to the negative effects of climate change, carbon emissions have the potential to produce a number of harmful externalities. Carbon pricing is seen as a way to reduce and possibly offset such externalities.

Practical problems exist when trying to determine a price for carbon. One issue is that it is difficult to determine the actual cost of any externalities before they occur. On the other hand, first determining the value of nearby natural resources such as lakes or forests is a standard part of the process of developing a particular area. Another issue is to what extent the price of carbon can or should be passed on to consumers and how this will affect the economy. Some also fear that products that go through multiple stage of development before becoming a finished product may become prohibitively expensive.