Carbon pricing policies are implemented in a steadily growing share of markets. In 2020 they covered 22% of global emissions, but only 3.76% of these are priced above 40 USD/tonne CO₂eq. The High-Level Commission on Carbon Pricing recommended that CO₂ be priced between 40-80 USD/tonne by 2020 to be consistent with the Paris Goals.^[1]High-Level Commission on Carbon Prices (2017): Report of the High-Level Commission on Carbon Prices. Edited by World Bank, Washington, D. C. Available online at … Continue reading The limited global coverage and generally low price levels mean that carbon prices have only had a small impact on emission trajectories. Several economic and political obstacles have been identified as causes. Carbon pricing creates short-term costs to consumers, but is perceived to only deliver future benefits. This often creates opposition, from both firms and consumers, reducing political acceptability. The result is often that prices are set too low to create substantial climate benefits, which may also fail to adequately consider climate risks and risk overrunning our collective carbon budget. Instead, some research suggests that, in the near term, carbon prices should be raised sufficiently to achieve rapid and substantial emissions reductions and then decrease over time. A universal carbon price has been discussed but the difficulties in finalizing the rules for Article 6 of the Paris Agreement, which creates new global mechanisms for carbon trading, are evidence of the political challenges of this approach. Sector-based carbon prices and border tax adjustments could help overcome some resistance. However, border tax adjustment policies will raise new political and economic challenges for trade, particularly for some low- and middle-income countries, and there are important equity implications.

There are also intrinsic limitations to carbon pricing as a mechanism. Carbon pricing can be regressive and impact poor households more than the rich, even if the former use less energy. This can be balanced through redistribution schemes, making sure that revenues from carbon taxes benefit low-income groups. Another limitation to the effectiveness of carbon pricing is that a large share of the world’s emissions comes from maintenance and use of large-scale infrastructures, with lock-in effects and long lead times, leading to low price elasticity. In addition, carbon pricing has been found to mainly drive efficiency improvements and fuel switching but have limited effect on decarbonization. Therefore, carbon pricing should only be seen as one tool among many for green transitions.

In order to apply the “polluter pays” principle and internalize the negative externalities of climate change, academics and policymakers have long championed carbon pricing. Carbon pricing may take the form of carbon taxes, which levy a price per tonne of carbon emitted, or an emissions trading scheme (ETS), where carbon allowances are traded. Economists view carbon pricing as efficient, since companies have flexibility in deciding how to meet the reduction requirements set by governments.