By: Sara Chemello
International cooperation on climate change has not yet managed to incentivize governments and corporations to stop the continuous rise in global carbon emissions. However, immediate action is needed to contain global temperatures rise below 2°C, as established by Article 2 of the Paris Agreement. The following article highlights the need for an international carbon pricing mechanism, specifically a global carbon tax, to achieve the goals set by the Paris Agreement and discusses its economic as well as legal viability under Article 6 of the Paris Agreement.
What are Carbon Pricing Mechanisms?
Carbon pricing refers to any climate policy set by either a governing body or market, which charges emitters for each ton of released greenhouse gas (GHG) through a tax or a fee. It was coined under carbon given that carbon dioxide is the most common GHG, and other GHG are measured in carbon dioxide equivalents units. The aim of any carbon pricing mechanism is to create financial incentives to decrease emissions. According to the World Bank Database, there are currently 70 direct carbon pricing instruments in use in 47 national jurisdictions worldwide.
There are two major types of carbon pricing mechanisms: carbon taxes and emissions trading systems (ETS). The former is a fixed price levied on each ton of emission whereas the latter firstly caps the total amount of emissions and then market players trade emission units which in turn sets the price of emissions.
A carbon tax is designed to correct the market distortions which arise from the exclusion of social and environmental costs (negative externalities) from the prices of polluting economic activity. According to Pigouvian economics, carbon taxes should be proportional to the social costs of fossil fuel emissions. Carbon taxes are theoretically effective at promoting behavioral change because they are direct price increases on fossil fuels, electricity, and general consumer products. Price increases should thus promote the transition to more sustainable energy sources and products. And in fact, research has found carbon taxes to be an efficient instrument for reaching domestic emission reduction commitments. For example, the C$30 per tonne British Columbia Carbon Tax, which covers most types of fuel use and carbon emissions, has reduced fuel use by 16% since its introduction in 2008.
Emission Trading Systems (ETS) or Cap-and-Trade Program
An alternate method of carbon pricing is through emission-trading systems. Under this system, a governing jurisdiction regulates the overall supply of GHG emission allowances thus setting a limit on the total level of GHG emissions. Liable entities such as corporations are then required to obtain these allowances which can be traded, thus creating a market which sets an emission price. Therefore, whilst a carbon tax guarantees a fixed price per each emission, an ETS guarantees a certain degree of environmental benefit but leaves the emission price to be set by independent market forces. ETS have also been found to be effective at lowering emissions. For example, a study on the European Union’s ETS found that the system, which regulated roughly 50% of EU carbon emissions from mainly energy production and large industrial polluters, saved more than 1 billion tons of CO2 between 2008 and 2016.
The need for Global Cooperation on Carbon-Pricing Mechanisms
The UNEP 2022 Emission Gap Report shows that current unconditional nationally determined contributions (NDCs) of the Parties to the Paris Agreement point to a 2.6°C increase in temperatures by 2100. This exceeds the goals of the Paris Agreement and demonstrates that unilateral climate policies and the Paris Agreement’s “bottom-up approach” have failed to bring countries on track of global emission goals. Yet, we need to cut emissions by 30% by 2030 to get on track to limiting global warming to 2°C. In order to overcome these international coordination challenges, a global carbon-pricing mechanism is an ideal solution to reduce global GHG emissions and to divest spending and investment from fossil fuels into sustainable alternatives.
Domestic carbon pricing mechanisms have been shown to be effective in lowering climate emissions, but are not yet widespread, covering only about 20% of global CO2 emissions. A reason for this is international incoordination in carbon pricing mechanisms which have raised concerns over free-riding and competitiveness loss. In fact, countries have been skeptical of domestic carbon pricing mechanisms for fear of losing international competitiveness in high emission sectors such as steel or chemicals. Given the lack of international agreements, some countries have considered imposing carbon border adjustments measures (CBAM), which are tariffs on carbon emissions of imported products to protect those industries that are affected by carbon prices. These proposals are inefficient and problematic both from an international trade rule standpoint and in their inability to incentivize a decrease in global emissions. Hence, international cooperation on carbon pricing is necessary to avoid losses due to competitiveness. This however would only be achievable if every country cooperated on introducing a global carbon pricing mechanism.
Economists and scientists alike agree on the effectiveness of such mechanisms. The IMF for example supports the introduction of a global minimum carbon price which would be higher for developed countries . According to World Economic Forum estimates, the impact of such a proposal would be very small on global economic growth. Assuming countries invest in low-carbon energy, global gross domestic product would decrease by 1.5% by 2030 in the case of the IMF proposed carbon price floor. This makes economic sense when compared to the costs of mitigation and adaptation in the case of failure to curb carbon emissions.
The case for a Global Carbon Tax
Compared to a global ETS, a global carbon tax would be preferred because it raises revenues, whilst offering higher administrative simplicity and transparency.
Firstly, carbon taxes generate constant revenues for government bodies, and provide a certain revenue certainty which can be used to fund climate-related initiatives or to offset the impact of the tax on lower-income households. Moreover, a carbon tax provides a predictable price signal for carbon emissions, which can help liable entities smooth their consumption and plan future emissions reduction decisions accordingly. An ETS, on the other hand, given its price fluctuations offers more uncertainty due to its variability.
Secondly, a carbon tax is a simpler, and more transparent policy instrument that is easy to understand and administer. In contrast, an ETS involves complex market mechanisms and can be more difficult to implement and manage. This in turn implies that a carbon tax requires fewer administrative costs compared to an ETS. Moreover, if the tax is levied "upstream,"meaning at the point of extraction or importation, it is an easier and more transparent instrument for tracking emission. A global cap-and-trade system, on the other hand, raises collateral difficulties in both collection and in transparency, such as the implementation of a complex trading system and the risk of carbon leakage during trading of permits.
How could a Global Carbon Tax be legally viable?
Under Article 6 of the Paris agreement, there is the potential to include provisions for international cooperation on climate change mitigation, including through market-based approaches, such as carbon pricing. However, its interpretation skews to a preference for a coording ETS system, which would not be ideal in terms of simplicity, transparency and would still allow for carbon leakage to occur. This is majorly highlighted in Article 6.2 and 6.5. The former, establishes the potential of trading emission reduction credits across borders, between nations or jurisdictions. The latter, puts in place robust accounting measures to avoid double counting of emission reductions and increase transparency, thereby ensuring the integrity of the proposed market-based approaches.
Although there is the potential to interpret this article to introduce a global carbon tax, an amendment would have to be proposed in order to change such provisions. The procedure for any Amendment to the Paris Agreement would follow Article 15 of the United Nations Framework Convention (UNFCCC) which states that any Party can propose amendments to the Convention (Article 15.1). Amendments can be adopted at an ordinary session of the Conference of the Parties (Article 15.2) and must be adopted by a three-fourth majority vote (Article 15.3). Any amendment would enter into force on the ninetieth day after the date of receipt by the Depositary (Article 15.4).
Challenges and Limitations
There are major challenges facing the viability of implementing a global carbon tax.
Firstly, a major challenge would come down to agreeing on the design and the appropriate tax rate. A global carbon tax could be designed in many ways: an approach would be to introduce a global carbon tax at a uniform tax rate (e.g., 75 USD per ton of CO2 emissions). This already raises a debate regarding the appropriate carbon tax rate, which correctly incentivizes a reduction in greenhouse gas emissions, whilst not being too burdensome for businesses and consumers. Alternatively, each country would pay a tax proportional to its CO2 emissions and/ or developmental status. A governing body would collect and redistribute the tax revenue (minus administrative costs) according to some specified rules. This would require further cooperation and is another challenge.
Secondly, the approval of the design would center around a debate of equity and redistribution both at the domestic and global level. Domestically, carbon taxes could disproportionately affect certain groups that are more sensitive to changes in energy prices, such as low-income households. Globally, whether a fixed global carbon tax should be levied or whether a variable tax depending on the development level of the country, depends on the interpretation of the principle of common but differentiated responsibility and respective capabilities (CBDR-RC) that underlies the Paris Agreement.
Thirdly, it always comes down to a ‘tragedy of the commons’ problem. Under the principle of sovereignty, Article 15 of the UNFCCC states that even if an Amendment to Paris was voted by more than three-fourth majority, those countries that do not want to join are not obliged to commit to a global carbon tax. This would skew incentives and reiterate the competition loss and free-riding concerns that are present at the moment. Nonetheless, there is an increase in the potential for cooperation after recent international cooperation in international taxes such as the ‘OECD Two-Pillar Solution to Address the Tax Challenges Arising from the Digitalization of the Economy’.
There is an urgent need to introduce an international carbon pricing mechanism for the Parties to honor their commitments in the Paris Agreement. An international carbon tax is preferred to an ETS system because of simplicity, transparency, and efficiency in redistribution. Legally, this could be viable within the Paris Agreement if an Amendment to Article 6 was proposed and voted on by a two-thirds majority. Although there are various challenges to such a proposal, recent international cooperation developments as well as the increase in urgency regarding global solutions to the climate crisis, make the case for a global carbon tax as relevant and urgent as ever.