Carbon Pricing Basics

Recently I have been talking to people about different ways of implementing carbon pricing thinking that they knew what I was talking about. Mostly I was wrong. I usually had to explain the fundamental concepts before getting to what I wanted to talk about.

This over-simplified summary explains the concepts well enough that people are able to get it in a few minutes. There are many variations on both approaches.

Carbon Price Concept  – increase the price on CO2 emissions thereby decreasing demand. A carbon pricing plan will work well as long as it is provides a strong economic signal to switch to cleaner energy. There are 2 main forms of this, Carbon Tax and Cap & Trade. As the diagrams show they both behave in a similar way causing the price of fossil fuels emissions to increase while increasing the emissions reduced. Diagrams from Nick Rivers’ presentation.

ScreenHunter_04 Mar. 08 15.51Carbon Tax – impose a fee on fossil fuel use and emissions starting low and gradually rising. This will increase reductions as pictured to the right.

BC implemented a carbon tax of $10 per tonne in 2008 that rose to $30 per tonne of carbon dioxide by 2012; that amounts to about 7 cents per litre of gas and. BC’s is revenue-neutral, so the government is obliged to cut an equal amount from other taxes (including income tax) to what it raises from the carbon tax, although there are other ways the revenue could be used. The BC carbon tax has reduced CO2 emissions by 16% with no effect on GDP, while in the same period Canada’s emissions rose 3%. The BC policy enjoys 64% voter approval.

ScreenHunter_05 Mar. 08 15.51Cap and Trade – the government sets annual caps on CO2 emissions for companies that are major emitters of CO2.  These companies can buy and trade the pollution permits so the ceiling on greenhouse gases allowed is lowered annually. This will increase the price of the emissions as shown on the right.

Quebec and California are the first jurisdictions in North America to bring in a mandatory cap and trade system as part of the Western Climate Initiative. Other countries, particularly in Europe have also implemented similar programs.

Comparison points

  • Cap & Trade sets emissions limits (caps) and decreases caps until emissions targets are achieved. The costs of implementing CO2 reductions are usually passed on to the consumers.
  • Carbon Tax increases price directly until emissions targets are achieved
  • Carbon Tax is simpler and faster to enact and administer
  • Cap & Trade has an allowance for purchasing offsets (such as funding tree planting), but it is unclear how to evaluate the benefit of an offset
  • Cap & Trade is vulnerable to manipulation and corruption. It takes longer to implement and is more expensive to administer
  • The OECD has highlighted BC’s carbon tax as a text book example of good climate policy
  • Most economists prefer the simpler, more direct, and more transparent implementation of a carbon tax
  • Most economic studies show that the economy can continue to grow under either scenario – it is not a job-killing carbon tax
  • A revenue-neutral carbon tax may be more politically acceptable, especially if it is called a pollution fee similar to a garbage disposal fee.


Most of the references that I found on the web go into a lot more detail and many explain the variations in the two approaches.

Here is a small sample of external links.

  • CCL – Citizens’ Climate Lobby Canada explains their recommended Fee and Dividend.
  • IETA – International Emissions Trading Association explains the benefits of Cap and Trade.
  • Comparison of Carbon Pricing models from an economics point of view.
  • David Suzuki Foundation compares the two systems.
  • Economics Help – simple economics discussion of the two models.
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