Pricing Carbon: The pitfalls of obligation.

Amidst rising temperatures around the globe, the United Nations (UN) warns that the world must reduce carbon dioxide emissions by ~50% by 2030 and reduce them to 0% by 2050 to keep Earth habitable. Furthermore, the Paris Agreement, negotiated at COP21, has an overall goal to limit the increase in global temperature to 1.5°C.

Carbon is one of the key culprits in global warming; it is one of the main components of fossil fuels that is released into the Earth’s atmosphere in the form of carbon dioxide, which in turn traps heat and contributes to global warming. To mitigate the risk that carbon poses to the earth, a carbon tax has long been thought of as perhaps the most efficient way to charge for carbon. A tax on carbon would essentially charge a price for carbon, with the goal to disincentivize consumers from using so much carbon.

However, to be truly effective, a carbon tax needs to be implemented on a global scale—a challenging feat. The Paris Agreement only peripherally addressed this issue. Article 6.2 allows Parties to use “internationally transferred mitigation outcomes” to achieve their mitigation targets, which encourage the linking of carbon pricing approaches. However, the Agreement falls short because of its lack of specificity. The first challenge would be setting the price of carbon per metric ton; currently, there are many discrepancies in the price of carbon across the globe. The UN is currently attempting to come up with a global set price for carbon. The second challenge would be assigning an authority to enforce the tax, including assigning revenues from the tax. The UN could potentially administer a global carbon tax. Finally, a uniform price could mean that developing countries, which theoretically emit less carbon, will be more adversely affected than other, more developed countries.

Professor William Nordhaus, who recently won the Nobel Prize for Economics for his work on the economics of climate change, warns that the 1.5°C UN goal is nearly impossible at this point because of the enormous economic costs that such a reduction would require. It is unclear what the price of carbon should be. Norhouse calculates that in order to maintain the 2.5°C ceiling, the price of carbon would have to be near $300 per ton by 2025, and at an even higher price if the ceiling were 1.5°C. This is significantly higher than any other price proposed. He argues that implementing the “wrong” policy (a reduction of 1.5 °C) could actually be more costly than not doing anything at all.

Nordhaus instead proposes “a global climate club” where a majority of countries would join to set the price of carbon (~$30 per ton) and implement this price through taxes or a cap-and-trade system. There would also be a price to pay for not joining the club, which could include tariffs on goods from the country. Again, developing countries who simply cannot afford to join such a carbon club may be at a disadvantage. In any case, Nordhaus acknowledges that even this plan may be too little, too late.

Thus, determining a price for carbon is extremely complicated, because of the incentives involved, as well as the difficulty in assessing what price to put on the damage that carbon is doing (the social and environmental costs). What is more sure, is if we do set the right price for carbon, we have a good shot at achieving the goals of the Paris Agreement. What that price is, remains to be seen.


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