Editing IPCC:AR6/WGIII/Chapter-13 (section)

==== 13.6.3.3 Evaluation of Carbon Pricing Experience ====

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A carbon tax or GHG ETS increases the prices of emissions intensive goods thus creating incentives to reduce emissions ( [[#Stavins--2019|Stavins 2019]] ) for a comparison of a tax and ETS). The principal advantage of a pricing policy is that it promotes implementation of low-cost reductions; for a carbon tax, reductions whose cost per tCO 2 -eq reduced is lower than the tax and for an ETS the lowest cost (per tCO 2 -eq) reductions sufficient to meet the cap. Both a tax and an ETS can be designed to limit adverse economic impacts on regulated sources and emissions leakage.

The corresponding limitations of pricing policies are that they have limited impact on adoption of mitigation measures when decisions are not sensitive to prices and do not encourage adoption of higher cost mitigation measures. Their effectiveness in influencing long-term investments depends on the expectation that the policy will continue and expectations related to future tax rates or allowance prices ( [[#Brunner--2012|Brunner et al. 2012]] ). Other policies can be used in combination with carbon pricing to address these limitations.

The number of pricing policies has increased steadily and covered 21.5% of global GHG emissions in 2020 ( [[#World%20Bank--2021a|World Bank 2021a]] ). Effective coverage is lower because virtually all jurisdictions with a pricing policy have other policies that affect some of the same emissions. For example, a few jurisdictions reduced existing fuel taxes when they introduced their carbon tax thus reducing the effective tax rate, and many jurisdictions have two or more pricing policies

There is abundant evidence that carbon pricing policies reduce emissions. Statistical studies of emissions trends in jurisdictions with and without carbon pricing find a significant impact after controlling for other policies and structural factors ( [[#Best--2020|Best et al. 2020]] ; [[#Rafaty--2020|Rafaty et al. 2020]] ). Numerous assessments of specific policies, especially the EU ETS and the British Columbia carbon tax, conclude that most have reduced emissions ( ''robust evidence'' , ''high agreement'' ) ( [[#Narassimhan--2018|Narassimhan et al. 2018]] ; [[#Haites--2018|Haites et al. 2018]] ; [[#Aydin--2018|Aydin and Esen 2018]] ; [[#Pretis--2019|Pretis 2019]] ; [[#Andersson--2019|Andersson 2019]] ; [[#FSR%20Climate--2019|FSR Climate 2019]] ; [[#Metcalf--2020|Metcalf and Stock 2020]] ; [[#Rafaty--2020|Rafaty et al. 2020]] ; [[#Bayer--2020|Bayer and Aklin 2020]] ; [[#Diaz--2020|Diaz et al. 2020]] ; [[#Green--2021|Green 2021]] ; [[#Arimura--2021|Arimura and Abe 2021]] ).

Estimating the emission reductions due to a specific policy is difficult due to the effects of overlapping policies and exogenous factors such as fossil fuel price changes and economic conditions. Studies that attempt to attribute a share of the reductions achieved to the EU ETS place its contribution at 3–25% ( [[#FSR%20Climate--2019|FSR Climate 2019]] ; [[#Bayer--2020|Bayer and Aklin 2020]] ; [[#Chèze--2020|Chèze et al. 2020]] ). The relationship between a carbon tax and the resulting emission reductions is complex and is influenced by changes in fossil fuel prices, changes in fossil fuel taxes, and other mitigation policies ( [[#Aydin--2018|Aydin and Esen 2018]] ). But the effectiveness of a carbon tax generally is higher in countries where it constitutes a large part of the fossil fuel price ( [[#Andersson--2019|Andersson 2019]] ).

Few of the world’s carbon prices are at a level consistent with various estimates of the carbon price needed to meet the Paris Agreement goals. In modelling of mitigation pathways that limit warming to 2°C (&gt;50%)( [[IPCC:Wg3:Chapter:Chapter-3#3.6.1|Section 3.6.1]] ) marginal abatement costs of carbon in 2030 are about 60 to 120 USD2015 per tCO 2 , and about 170 to 290 USD2015 per tCO 2 in pathways that limit warming to 1.5°C (&gt;50%) with no or limited overshoot ( [[IPCC:Wg3:Chapter:Chapter-3#3.6|Section 3.6]] ). One synthesis study estimates necessary prices at USD40–80 per tCO 2 by 2020 ( [[#High-Level%20Commission%20on%20Carbon%20Prices--2017|High-Level Commission on Carbon Prices 2017]] ). Only a small minority of carbon pricing schemes in 2021 had prices above USD40 per tCO 2 , and all of these were in European jurisdictions ( [[#World%20Bank--2021a|World Bank 2021a]] ). Most carbon pricing systems apply only to some share of the total emissions in a jurisdiction, so the headline carbon price is higher than the average carbon price that applies across an economy ( [[#World%20Bank--2021a|World Bank 2021a]] ).

Where ETS or carbon taxes exist, they apply to different proportions of the jurisdiction’s greenhouse gas emissions. The share of emissions covered by ETSs in 2020 varied widely, ranged from 9% (Canada) to 80% (California) while the share of emissions covered by carbon taxes ranged from 3% (Latvia and Spain) to 80% (South Africa) ( [[#World%20Bank--2021a|World Bank 2021a]] ).Where carbon pricing policies are effective in reducing GHG emissions, they usually also generate co-benefits including better air quality. For example, a Chinese study of air quality benefits from lower fossil fuel use under carbon pricing suggests that prospective health co-benefits would partially or fully offset the cost of the carbon policy ( [[#Li--2018|Li et al. 2018]] ). Depending upon the jurisdiction (for example, if there are fossil fuel subsidies) carbon pricing could also reduce the economic distortions of fossil fuel subsidies, improve energy security through greater reliance on local energy sources and reduce exposure to fossil fuel market volatility. Substantial carbon prices would be in the domestic self-interest of many countries if co-benefits were fully factored in ( [[#Parry--2015|Parry et al. 2015]] ).

Economic theory suggests that carbon pricing policies are on the whole more cost effective than regulations or subsidies at reducing emissions ( [[#Gugler--2021|Gugler et al. 2021]] ). Any mitigation policy imposes costs on the regulated entities. In some cases entities may be able to recover some or all of the costs through higher prices ( [[#Neuhoff--2019|Neuhoff and Ritz 2019]] ; [[#Cludius--2020|Cludius et al. 2020]] ). International competition from less stringently regulated firms limits the ability of emissions-intensive, trade-exposed (EITE) firms to raise their prices. Thus, a unilateral mitigation policy creates a risk of adverse economic impacts, including loss of sales, employment, profits, for such firms and associated emissions leakage ( [[#13.6.6.1|Section 13.6.6.1]] ).

Pricing policies can be designed to minimise these risks; free allowances can be issued to EITE participants in an ETS and taxes can provide exemptions or rebates. An extensive ''ex post'' literature finds no statistically significant adverse impacts on competitiveness or leakage (13.6.6.1).

An ''ex post'' analysis of European carbon taxes finds no robust evidence of a negative effect on employment or GDP growth ( [[#Metcalf--2020|Metcalf and Stock 2020]] ). The British Columbia carbon tax led to a small net increase in employment ( [[#Yamazaki--2017|Yamazaki 2017]] ) with no significant negative impacts on GDP possibly due to full recycling of the tax revenue ( [[#Bernard--2021|Bernard and Kichian 2021]] ). Few carbon taxes apply to EITE sources ( [[#Timilsina--2018|Timilsina 2018]] ), so competitiveness impacts usually are not a particular concern.

Government revenue generated by carbon pricing policies globally was approximately 53 billion USD in 2020 split almost evenly between carbon taxes and ETS allowance sales (World Bank 2021). Revenue raised though carbon pricing is generally considered a relatively efficient form of taxation and a large share of revenue enters general government budgets ( [[#Postic--2020|Postic and Fetet 2020]] ). Some of the revenue is returned to emitters or earmarked for environmental purposes. Allowance allocation and revenue spending measures have been used to create public support for many carbon pricing policies including at every major reform stage of the EU ETS ( [[#Klenert--2018|Klenert et al. 2018]] ; [[#Dorsch--2020|Dorsch et al. 2020]] ) (Box 5.11).

The most commonly studied distributional impact is the direct impact of a carbon tax on household income. Typically it is regressive; the tax induced increase in energy expenditures represents a larger share of household income for lower income households ( [[#Grainger--2010|Grainger and Kolstad 2010]] ; [[#Timilsina--2018|Timilsina 2018]] ; [[#Dorband--2019|Dorband et al. 2019]] ; [[#Ohlendorf--2021|Ohlendorf et al. 2021]] ). Governments can rebate part or all of the revenue to low-income households, or implement other changes to taxation and transfer systems to achieve desired distributional outcomes ( [[#Jacobs--2019|Jacobs and van der Ploeg 2019]] ; [[#Saelim--2019|Saelim 2019]] ; [[#Sallee--2019|Sallee 2019]] ) (Box 5.11). The full impact of the tax – after any distribution of tax revenue to households and typically adverse effects on investors – generally is less regressive or progressive ( [[#Williams%20III--2015|Williams III et al. 2015]] ; [[#Goulder--2019|Goulder et al. 2019]] ). Where the tax revenue is treated as general revenue the government relies on existing income redistribution policies (such as income taxes) and social safety net programmes to address the distributional impacts.

Carbon taxes on fossil fuels have effects similar to the removal of fossil fuel subsidies ( [[#Ohlendorf--2021|Ohlendorf et al. 2021]] ) ( [[#13.6.3.6|Section 13.6.3.6]] ). Even if a carbon tax is progressive it increases prices for fuels, electricity, transport, food and other goods and services that adversely affect the most economically vulnerable. Redistribution of tax revenue is critical to address the adverse impacts on low-income groups ( [[#Dorband--2019|Dorband et al. 2019]] ) (Box 5.11). In countries with a limited capacity to collect taxes and distribute revenues to low-income households, such as some developing countries, carbon taxes may have greater distributional consequences.

Distributional effects have generally not been a significant issue for ETSs. Equity for industrial participants typically is addressed through free allocation of allowances. Impacts on household incomes, with the exception of electricity prices, are too small or indirect to be a concern. Some systems are designed to limit electricity price increases ( [[#Petek--2020|Petek 2020]] ) or use some revenue for bill assistance to low-income households ( [[#RGGI--2019|RGGI 2019]] ).

Carbon pricing, especially an ETS that covers industrial sources, stimulates technological change by participants and others ( [[#Calel--2016|Calel and Dechezleprêtre 2016]] ; [[#FSR%20Climate--2019|FSR Climate 2019]] ; [[#van%20den%20Bergh--2021|van den Bergh and Savin 2021]] ) ( [[#13.6.6.3|Section 13.6.6.3]] and Chapter 16). The purpose of pricing policies is to encourage implementation of the lowest cost mitigation measures. Pricing policies therefore are more likely to stimulate quick, low cost innovation such as fuel switching and energy efficiency, rather than long term, costly technology development such as renewable energy or industrial process technologies ( [[#Calel--2020|Calel 2020]] ; [[#Lilliestam--2021|Lilliestam et al. 2021]] ). To encourage long-term technology development carbon pricing policies need to be complemented by other mitigation and research and development (R&amp;D) policies.

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