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No more business as usual: the case for carbon pricing

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The writers are IMF managing director, European Commission president and WTO director-general

At COP28, the world must face the reality that business-as-usual is not delivering the needed cuts to greenhouse gas emissions. For most countries, squeezed public finances and the new era of “higher for longer” interest rates present a terrible trade off: short-term financial health versus the long-term health of our planet. 

It is against this backdrop that a growing number of countries are looking to carbon pricing to achieve climate objectives while raising new revenues. The concept is simple: make polluters pay for what they emit, providing a strong nudge to clean up their act. It can take the form of a tax or an emissions trading scheme (ETS) that requires companies to purchase tradable allowances to cover their emissions.

Carbon pricing’s growing appeal boils down to three factors. First, it works. As the centre of a broad strategy to cut emissions, a robust carbon price provides incentives to shift to cleaner energy sources, reduce overall energy use and invest in clean technology. Emissions in sectors covered by the EU’s Emissions Trading System have declined by over 37 per cent since 2005. 

Second, it is the most cost-efficient solution. Carbon pricing is easy to administer when it builds on existing energy fuel taxes (countries can start by phasing out fossil fuel subsidies that have risen to $1.3tn in direct costs annually). It also generates revenues — more than €175bn in the case of the EU scheme — rather than making the green transition a fiscal drain. These can be used to reduce taxes, fund public services or clean energy infrastructure. Prices can scale up over time, minimising abrupt dislocations.

Third, with the right design, it’s fair: those companies and consumers responsible for the most emissions pay the most. Any distributional implications, within and across countries, can be addressed. 

At the domestic level, the price impact on poor households can be covered with only a modest share of carbon price revenues. The IMF estimates around 20 per cent of these are required to compensate the poorest 30 per cent of households, making the reform work for vulnerable consumers and small emitters. 

At the global level, carbon pricing revenues could also contribute to climate finance in developing countries. This is one way to address equity issues — others include differentiated carbon price floors and net zero trajectories that reflect countries’ current and historical emissions. African leaders recently called for a global carbon taxation regime covering fossil fuel trade, maritime transport and aviation, with revenues directed to climate investments in poorer countries.

Momentum is growing. There are now 73 carbon pricing schemes in nearly 50 countries and covering a quarter of emissions — a doubling since the Paris Agreement was signed in 2015. But to get emissions on track, the global price of carbon will need to reach an average of $85 a tonne by 2030, compared with just $5 today. 

What’s stopping wider adoption? Political feasibility is often cited. But experience shows that, once the first step is taken, countries can make steady progress. Popular support can build as revenues are used to boost public investment or cut other taxes. 

It will be important to help those doing business across jurisdictions manage compliance costs, particularly smaller companies in developing countries. Here, co-ordination can help to streamline processes and see-off potential trade frictions, where countries have different approaches.

Conversely, the more countries that adopt a carbon price, the lower the risk of trade distortions or reduced competitiveness. Top emitters could pave the way for others by aligning robust carbon price regimes as part of an international framework: a strong signal to the rest of the world.  

For countries moving at different speeds, the Paris Agreement sketched out how exchanging carbon credits could complement national pricing instruments. But these markets can’t operate effectively until nations have more ambitious climate goals and apply clear, credible and comparable standards. The same applies to voluntary markets in carbon credits. 

So we must look to COP28 to deliver a robust benchmark for co-operation on international carbon markets. Carbon pricing must be a transparent tool for reducing emissions, not just a cover for continuing business as usual.  And that returns to the crux of the matter: business as usual is not delivering what we need to prevent catastrophic consequences. We can — and we must — step back from the brink. That means a fair price on pollution to cut emissions for our children and their children, without emptying coffers or fragmenting global trade.

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