AN INTRODUCTION TO CARBON PRICING

WHAT IS CARBON PRICING?

Simply put, carbon pricing refers to measures that require a producer or consumer to pay for the damage their behaviour is causing to the natural world as a result of carbon emissions.

Those measures include carbon taxes, carbon caps, and tradable carbon credits.

WHY IS CARBON PRICING NECESSARY?

Carbon pricing addresses an issue that takes me way back to my A-Level economics: market failure. Market failure refers to inefficiencies in the free market. Often, these inefficiencies arise because individuals act in a way that benefits themselves, to the detriment of the group.

The type of market failure that carbon pricing seeks to address is that caused by externalities. Negative externalities are costs incurred by a producer that the producer doesn’t pay for.

For instance, an oil company extracting fossil fuels generates all kinds of costs that, in the free market, it does not pay for. It contributes to global warming, biodiversity decline, and reduced public health for free.  

This generates a gap between the gain by individuals and loss to the population. The individual owners of the company get the benefit derived from the activity that causes the harm without ever having to pay for that harm – the population ends up bearing the brunt of the damage the company is causing.

WHAT ARE THE AIMS OF CARBON PRICING?

The base aim of carbon pricing is to fix the market failure: to ensure that people who profit from activities that cause harm pay for the cost of that harm. The justifications for carbon pricing go way beyond basic fairness, though. Here are some examples:

• It encourages innovation. Most organisations exist to make a profit and when something stands in the way of that, they’re pretty good at coming up with solutions. If the cost of production is higher because it more accurately represents the harms caused, companies have an incentive to invest in greener approaches.

• It might be the way to get the best outcome. Alternatives to carbon pricing include a lot of decision-making by government. For instance, subsidising instead of taxing relies on the government making scientific, commercial, and technological decisions about which green approaches or initiatives are most viable and worthwhile. Carbon pricing allows the market to decide, and some people view this as the most efficient way to get things done.

• It has a knock-on effect on individual decision-making. If carbon pricing makes carbon-intensive products more expensive, consumers have an incentive to opt for cheaper, greener alternatives – without relying solely on the bolstering of subsidies for green alternatives.

• It’s cheaper. Requiring the market to pay for the harms it’s causing and thereby prompting innovation is thought to be the cheapest way to create progress in reducing carbon emissions.

• It generates revenue that can be used for green initiatives. Subsidising green approaches is expensive, and carbon pricing can provide the funding. This way of raising funds – as opposed to general taxation – ensures that the people contributing most heavily to the climate crisis are those that pay.    

There are concerns about carbon pricing; for instance, its effect on those with lower incomes. Carbon pricing increases the cost of carbon-intensive products for consumers, including things like fuel. This would result in an increased cost burden that could put those on low incomes at risk of not being able to afford to heat their homes or travel to work.

The cost is regressive: the increased costs from carbon pricing would represent a higher proportion of the income of those on low incomes and so would have a disproportionately negative effect on those people, compared to those on higher incomes. Some or all of the money collected by government from the carbon pricing can be redistributed to individuals. There have been several suggested and implemented approaches to this – including pre-emptive cheques, increased spending on welfare benefits and public services, etc.

Essentially, the logic is that charging the producer for the carbon use then redistributing that to the customer has two important benefits: it requires the polluter to pay for the harm they cause, changing their commercial approach, and it gives individuals an incentive to make greener choices. If done properly (rather an important caveat), this can mean that low income consumers are at least no worse off and at best better off as a result of carbon pricing.

Carbon pricing mechanisms are wide-ranging and there is ongoing research into their effectiveness.