Carbon pricing

Carbon pricing — the method favored by many economists for reducing global-warming emissions — charges those who emit carbon dioxide (CO₂) for their emissions. That charge, called a carbon price, is the amount that must be paid for the right to emit one tonne of CO₂ into the atmosphere. Carbon pricing usually takes the form either of a carbon tax or a requirement to purchase permits to emit, generally known as cap-and-trade, but also called "allowances".

Carbon pricing solves the economic problem that CO₂, a known greenhouse gas, is what economics calls a negative externality — a detrimental product that is not priced (charged for) by any market. As a consequence of not being priced, there is no market mechanism responsive to the costs of CO₂ emitted. The standard economic solution to problems of this type, first proposed by Arthur Pigou in 1920, is for the product - in this case, CO₂ emissions - to be charged at a price equal to the monetary value of the damage caused by the emissions. This should result in the economically optimal (efficient) amount of CO₂ emissions. Many practical concerns mar the theoretical simplicity of this picture: for example, the exact monetary damage caused by a tonne of CO₂ is uncertain.

The economics of carbon pricing is much the same for taxes and cap-and-trade. Both prices are efficient; they have the same social cost and the same effect on profits if permits are auctioned. However, some economists argue that caps prevent non-price policies, such as renewable energy subsidies, from reducing carbon emissions, while carbon taxes do not. Others argue that an enforced cap is the only way to guarantee that carbon emissions will actually be reduced; a carbon tax will not prevent those who can afford to do so from continuing to generate emissions.

The choice of pricing approach, a tax or cap-and-trade, has been controversial. A carbon tax is generally favored on economic grounds for its simplicity and stability, while cap-and-trade is often favored on political grounds. Recently (2013−14) economic opinion has been shifting more heavily toward taxes as national policy measures, and toward a neutral carbon-price-commitment position for the purpose of international climate negotiations.

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