99570 SEPTEMBER 2015 The FASTER Principles for Successful Carbon Pricing: An approach based on initial experience Download access: www.carbonpricingleadership.org Contact: info@carbonpricingleadership.org The FASTER Principles for Successful Carbon Pricing: An approach based on initial experience SEPTEMBER 2015 This is a joint report written by the Organisation for Economic Cooperation and Development (OECD) and the World Bank Group (WBG). Comments from the International Monetary Fund (IMF) and research and drafting sup- port provided by Ecofys are gratefully acknowledged. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of these organizations, their Boards of Executive Directors, or the governments they represent.   –  i  Contents Acronyms................................................................................. iv Preface................................................................................... vi ............................................ The FASTER Principles for Successful Carbon Pricing vii ............................................................................... Fairness vii AlignmentofPoliciesandObjectives....................................................... vii StabilityandPredictability................................................................ vii Transparency...........................................................................  viii .......................................................... viii EfficiencyandCost-Effectiveness ReliabilityandEnvironmentalIntegrity...................................................... viii Introduction............................................................................... 1 Figure1: Overviewofexistingemergingandpotentialregional,nationalandsub-national carbonpricinginstruments(ETSandtax).................................................... 3 Fairness ................................................................................... 4 Box1: Carbonpricesandcompetitiveness—selectedevidence .................................  5 ......  Box2: Examplesofmeasurestoalleviatecompetitivenessconcernsandsupportefficientfirms 7 Box3: LinkingtheCaliforniaandQuébecemissionstradingsystems............................ 7 Box4: SouthAfrica’scarbontaxproposal...................................................  8 Box5: Examplesofmitigatingthesocialimpactofcarbonpricing...............................  9 Alignment of Policies ........................................................................ 11 Box6: Carbontaxesandspecifictaxesonenergyuse .........................................  12 Box7: Carbonpricingandcomplementarytechnologypolicies:TheEUandUScases ..............  13 Box8: Governmentsupportforfossilfuels.................................................. 15 Box9: Managinginteractionsbetweencarbonpricingandotherpolicies.........................  16 Box10: China’salignmentofpolicies ....................................................... 17 ii Stability and Predictability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Box 11:  Academic literature provides a useful reference for the long term carbon price trajectory  that is consistent with global climate stabilization targets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Box 12:  British Columbia’s carbon tax: A phased approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Figure 2:  Development of Swedish carbon tax rate over time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Box 13:  Reinforcing stability and predictability in the EU Emissions Trading System (EC, 2015) . . . . . . . 21 Box 14:  Reinforcing stability and predictability in the emissions trading systems  of California and Québec . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Transparency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Box 15:  Ireland’s carbon tax and public acceptance during the fiscal crisis . . . . . . . . . . . . . . . . . . . . . . . . 25 Table 1:  Emission verification approaches used in different jurisdictions . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Box 16:  MRV standards under the Clean Development Mechanism (CDM) . . . . . . . . . . . . . . . . . . . . . . . 26 Box 17:  Building trust in market practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Efficiency and Cost-Effectiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Box 18:  Use of offsets in carbon-pricing scheme in South Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 Reliability and Environmental Integrity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Figure 3:  Sectoral scope and percentage of emissions covered by the regional, national  and sub-national emissions trading schemes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Contents  –  iii Acronyms AVR Accreditationandverification BAT Best-availabletechnologyortechnique BCA Bordercarbonadjustment CARB CaliforniaAirResourcesBoard CDM CleanDevelopmentMechanism CO2 Carbondioxide CO2e Carbondioxideequivalent EC EuropeanCommission EDF EnvironmentalDefenseFund ETS Emissiontradingsystem EU EuropeanUnion EU ETS EuropeanUnionEmissionTradingSystem EUTL EuropeanUnionTransactionLog GDP Grossdomesticproduct GHG Greenhousegas IETA InternationalEmissionsTradingAssociation IMF InternationalMonetaryFund IPCC IntergovernmentalPanelonClimateChange LPG LiquifiedPetroleumGas MRR Monitoringandreporting MRV Monitoring,reportingandverification MSR Marketstabilityreserve NDRC NationalDevelopmentandReformCommission NOx Oxidesofnitrogen iv OECD Organisation for Economic Cooperation and Development PMR Partnership for Market Readiness RBF Results-Based Financing R&D Research and development RD&D Research, development and demonstration RGGI Regional Greenhouse Gas Initiative SO2 Sulphur dioxide UK United Kingdom VAT Value-added Tax WBG World Bank Group WCI Western Climate Initiative WHO World Health Organization WTO World Trade Organization Acronyms  –  v Preface As global leaders prepare for the next round of cli- cannot happen overnight. This report outlines princi- mate change negotiations in Paris, it is encourag- ples for successful carbon pricing, based on economic ing that many governments around the world have principles and experience of what is already working already begun to put a price on carbon dioxide and around the world. It is intended to provide a founda- other greenhouse gas (GHG) emissions, and that tion for designing efficient, and cost-effective carbon- companies—including from the oil and gas industry— pricing instruments—primarily explicit carbon taxes are calling for widespread carbon pricing. and emissions trading systems—at the national and By 2015, 39 national and 23 sub-national juris- sub-national level. dictions, representing about 12 percent of global The Paris climate talks are a unique opportunity greenhouse emissions and an aggregate market to put the global economy on a low-carbon pathway value of almost USD$50 billion, were putting a price that will deliver more efficient economies, better on carbon. But the ambition and coverage of pricing health and a safer planet. Carbon pricing is necessary instruments needs to accelerate significantly for the to bring down greenhouse gas emissions and lower world to meet international climate goals. climate risks. It is the foundation for the necessary We know from experience that well-designed car- transition to a zero-carbon future by the end of this bon pricing schemes are a powerful and flexible tool century. that cut emissions that cause climate change. Properly designed and implemented, they can play a key role in enhancing innovation and smoothing the transi- tion to a prosperous, low-carbon global economy. Economists and investors have long argued Rachel Kyte that an economy-wide price on carbon is the best Group Vice President and Special Envoy way to reduce GHG emissions, since it requires all Climate Change market actors to properly account for their contribu- World Bank Group tion to climate change. While there are many other powerful tools in the low-carbon toolkit—such as energy efficiency standards and incentives for clean energy—an economy-wide price on carbon is criti- Simon Upton cal in shifting entire economies onto a low-carbon Director pathway. Environmental Directorate It is increasingly clear that nothing short of an OECD economic transformation is required. That transition vi The FASTER Principles for Successful Carbon Pricing Fairness Alignment of Policies and Objectives Successful carbon pricing policies reflect the Successful carbon pricing policies are part of a “polluter pays” principle and contribute to dis- suite of measures that facilitate competition tributing costs and benefits equitably, avoid- and openness, ensure equal opportunities for ing disproportionate burdens on vulnerable low-carbon alternatives, and interact with a groups. broader set of climate and non-climate policies. • Carbon pricing policies capture the costs of • Successful carbon pricing policies are supple- damage caused by emissions and so level the mented by measures that support deeper playing field between emission-intensive and emissions reductions over time. These include low-carbon economic activities. Over time, innovation policies, the removal of institutional they are expected to shift the structure of the barriers, behavioural incentives, public spend- economy towards low-carbon activities. ing reallocations and policies that encourage investment in low carbon infrastructure and • Potential risk of adverse competitiveness seek to avoid lock-in of polluting investments. impacts and carbon leakage is usually limited to relatively few exposed sectors and can be • Providing consistent signals to consumers, managed through the design of pricing poli- producers and investors require reforms to cies or complementary measures; it will be address counterproductive policies (e.g., fos- reduced as carbon pricing becomes more sil fuel subsidies). geographically extensive. • Carbon pricing policies coexist with a range • National systems that support innovation of non-climate policies that can either sup- and well-functioning labor markets can ease port or undermine the transition to a low- the transition of jobs and assets from carbon- carbon economy. Policy coherence across a intensive to low-emissions firms as the eco- range of policy areas is therefore important. nomic structure adjusts consistently with carbon-pricing policies. Stability and Predictability • If carbon pricing disproportionally burdens Successful carbon prices are part of a stable pol- poor households in some circumstances, tar- icy framework that gives a consistent, credible, geted complementary measures (e.g., fiscal and strong investment signal, the intensity of transfers) can provide protection without which should increase over time. undermining incentives to reduce emission- intensive activities. • A predictable and rising carbon price pro- motes orderly transition to a low-carbon vii economy over time, opening up new busi- flexibility to choose how and when to reduce ness opportunities and stimulating innova- emissions based on their own assessments of tive business models. It can also contribute costs and benefits. to stability of government revenues. A lower but gradually rising carbon price creates the • Carbon pricing improves resource alloca- tion in the economy by ensuring the dam- right incentives, but produces greater short- aging costs of GHG emissions are taken into term emissions than an initially higher car- account in production, consumption and bon price would. investment decisions by the public and pri- • While predictability is essential to support vate sectors, households and individuals. long-term investment decisions, incorporat- ing flexibility—by adjusting the carbon tax • Administration can be simplified and there- fore costs minimized by building on existing or rules-based interventions in an Emissions policies and institutions. Trading System (ETS)—can help economies adapt to unpredictable economic and tech- • Judicious use of revenues from carbon taxes nological developments and advances in or emission allowance auctions can produce scientific understanding of climate change. additional economic benefits, including fiscal National carbon budgets can at the same time dividends. reduce long-term uncertainties on how much abatement is targeted. Reliability and Environmental Integrity Transparency Successful carbon pricing schemes result in Successful carbon pricing policies are clear in a measurable reduction in environmentally design and implementation. harmful behavior. • Early and regular communication with • Comprehensive coverage of fuels, sectors affected stakeholders about the rationale, and gases enhances environmental impact, desired outcome, and shared benefits helps but transaction and monitoring costs for to generate support for carbon pricing and to some sources need to be managed. manage the associated change in the struc- ture of the economy. • Carbon pricing policies consistent with environmental objectives are more effec- • Systems that effectively monitor and verify tive when substitutes for emission-intensive emissions and mitigation efforts are critical activities or products are easily available at for public trust and support. low cost. • Carbon pricing policies can deliver multiple Efficiency and Cost-Effectiveness benefits, including local environmental and Successful carbon pricing improves economic effi- health benefits. ciency and reduces the costs of emission reduction. • The choice and design of pricing instrument matter for environmental outcomes. • Carbon pricing encourages emissions reduc- tions at least cost, giving affected entities viii  –  The FASTER Principles for Successful Carbon Pricing Introduction The case for climate action has never been stron- in particular.3 It will require policies that efficiently ger. Current weather extremes, including storms, promote opportunities for emissions mitigation and floods and drought, affect millions of people across clean-technology developments, while imposing the the world. Climate change is putting water security least overall burden on the economy (Stern, 2006). at risk; threatening agricultural and other supply This report focuses primarily on domestic chains1 as well as many coastal cities. The likelihood carbon-pricing mechanisms that put an explicit of severe pervasive and irreversible impacts (IPCC, price on GHG emissions—whether through taxes 2014a) will grow without action to limit and reverse on the carbon content of fuels or emissions, or simi- the growth of GHG emissions globally. Last year’s lar emissions trading systems (ETS).4 Carbon pricing Intergovernmental Panel on Climate Change (IPCC) as an instrument of international cooperation is not report makes clear the overwhelming need to take discussed, except under efficiency and cost-effective- action now on climate change and that the costs of ness, as it is addressed in depth in other reports.5 inaction will only rise. The challenge is to decarbon- It recognizes that while carbon prices are ize our economies by 2100 with action in the next critical, policymakers have a wide array of potential decades being critical.2 policy tools at their disposal, such as energy efficiency The choices made by government, the pri- standards for vehicles, buildings, lighting, appliances, vate sector, and civil society as part of the tran- and other energy-using equipment. Others include: sition to a decarbonized economy will determine taxes on electricity, and fuel-inefficient vehicles; the extent of future climate impacts but also provide emission rate standards for power generators; and an opportunity to unlock investment and build an subsidies for the development and deployment of innovative, dynamic low-carbon economy. This tran- low-carbon technologies (e.g., electric vehicles, bio- sition to a low-carbon development path will radically fuels, wind and solar power, home insulation). transform the way we produce and consume energy Economic policies such as excise taxes on energy use are strongly similar to carbon taxes because they 1 Turn Down the Heat: Why a 4°C Warmer World Must be Avoid- ed, launched by the World Bank in November 2012; Turn Down the Heat: Climate Extremes, Regional Impacts, and the Case for 3 This paper mostly focuses on energy-related CO2 emissions, Resilience, launched by the World Bank in June 2013; and Turn as they represent a significant amount of global greenhouse Down the Heat: Confronting the New Climate Normal, launched gas emissions, and they are generally more straightforward to by the World Bank in November 2014 constitute three reports. monitor than emissions from changes in land use and non-CO2 Summary for Policymakers (SPM) of IPCC Working Group III, sources (e.g., methane and nitrous oxides from agricultural 2014a: scenarios consistent with limiting warming to 2 degrees practices). are characterized by emission levels 40–70 percent lower in 4 Other documents, such as the OECD’s Taxing Energy Use, 2050 than in 2010, and emissions levels near zero GtCO2eq or address the important role of indirect carbon pricing mecha- below in 2100. nisms and how they can be harnessed more effectively for the 2 Summary for Policymakers (SPM) of IPCC Working Group III, transition. 2014 (IPCC, 2014d): scenarios consistent with limiting warm- 5 See, e.g., World Bank Group, State and Trends of Carbon Pric- ing to 2 degrees are characterized by emission levels 40–70 per- ing 2015, which provides updates and analysis on international cent lower in 2050 than in 2010, and emissions levels near zero carbon markets and climate finance, offset mechanisms, and GtCO2eq or below in 2100. corporate internal carbon prices.  1 influence market signals and greenhouse gas emis- a reduction in other taxes (e.g., on labor, and capital sions. They are already used in most countries, but income) that can distort economic activity, and harm the rates are uneven, and often very low, particularly growth. Carbon tax revenues also provide govern- for coal use. Aligning such taxes with the carbon ment with additional means to protect the poor, and content of energy, while taking account of other pol- avoid concentrating losses (either spatially or within icy objectives, is another way to introduce systematic a particular group). carbon prices (OECD, 2015). Other policies, such as For these reasons, carbon pricing mechanisms tax provisions on property or company cars or elec- are increasingly being adopted. As of June 2015, tricity market regulation, can either support a carbon- 39 national governments and 23 sub-national govern- pricing signal or work against it. These issues of pol- ments have implemented or are scheduled to imple- icy coherence are beyond the scope of this report and ment carbon pricing instruments (Figure 1). Together, are addressed in detail elsewhere (OECD, 2013). these instruments now cover about 7 Gt CO2e, or This report draws on a growing base of global about 12 percent of annual global GHG emissions. experience in implementing carbon pricing mecha- Combined, the value of the carbon-pricing mecha- nisms, as well as economic literature,6 to identify a nisms globally in 2015 is estimated to be just under set of principles for successfully steering an economy US$50 billion (World Bank, 2015). Emission-trading towards the long-term goal of decarbonization. It schemes are valued at about US$34 billion, and exist- focuses on how to achieve this in a fair, and transpar- ing carbon tax schemes at around US$14 billion. ent way that harnesses emission-reduction opportu- The “FASTER” principles presented in this report nities at least cost, provides flexibility, and is aligned lay out an approach that focuses on the emerging with other policies. design features for successful and cost-effective car- By introducing carbon-pricing policies, govern- bon pricing policies drawn from initial and growing ments, and businesses can trigger investment deci- experience around the world. By maintaining a focus sions and behavioral changes in firms and households on fairness, alignment with existing policies, stability, to support the long-term goal of de-carbonization transparency, efficiency, and reliability, the FASTER and deliver environmental protection at the lowest principles show that a well-designed carbon pricing overall economic cost. Such policies provide firms, instrument can provide the flexibility, and certainty and households with the flexibility to choose where, for a thriving business, and investment climate, while when, and how to reduce emissions in an equitable effectively reducing emissions. Case studies provide way. By reducing the use of carbon-intensive fuels, concrete examples of how the principles are being carbon-pricing policies can help alleviate local envi- implemented in practice. ronmental problems like premature deaths from The hope is that the FASTER principles will exposure to local air pollution. They can also provide guide, and inspire countries, regions, states and busi- a valuable source of government revenue, enabling nesses considering future carbon pricing systems to accelerate progress and will evolve to capture new experience with design and implementation going 6 See, for example, OECD (2013a), Effective Carbon Prices; Mooij de et al, Fiscal Policy to Mitigate Climate Change: A Guide for Poli- forward. This continual process of learning will help cymakers; IMF, Parry et al (2014), “Getting Energy Prices Right: us collectively accelerate the shift from carbon-inten- From Principle to Practice,” IMF. sive assets to cleaner, more efficient solutions. 2  –  The FASTER Principles for Successful Carbon Pricing Figure 1:  Overview of existing emerging and potential regional, national and sub-national carbon pricing Figure 1 Overview instruments (ETS and tax). emerging, and potential regional, national, and subnational carbon pricing instruments (ETS and tax) of existing, ALBERTA MANITOBA ONTARIO ICELAND KAZAKHSTAN REPUBLIC BRITISH EU UKRAINE OF KOREA COLUMBIA QUÉBEC WASHINGTON OREGON JAPAN CALIFORNIA RGGI TURKEY CHINA MEXICO THAILAND BRAZIL RIO DE JANEIRO SÃO PAULO NEW CHILE SOUTH AFRICA ZEALAND NORWAY SWEDEN REPUBLIC DENMARK FINLAND OF KOREA UK ESTONIA IRELAND LATVIA BEIJING KYOTO POLAND SAITAMA TIANJIN TOKYO HUBEI PORTUGAL SHANGHAI CHONG- GUANGDONG QING TAIWAN FRANCE SLOVENIA SHENZHEN SWITZERLAND Tally of carbon pricing instruments ETS implemented or scheduled ETS and carbon tax implemented or scheduled for implementation Carbon tax implemented or scheduled ETS implemented or scheduled, tax under consideration 14 for implementation ETS or carbon tax under consideration Carbon tax implemented or scheduled, ETS under consideration 4 1 39 21 22 23 representative of the size of the carbon pricing The circles represent subnational jurisdictions. The circles are not instrument, but show the subnational regions (large circles) and cities (small circles). Note: Carbon pricing instruments are considered “scheduled for implementation” once they have been formally National level Subnational level adopted through legislation and have an official, planned start date. Source: World Bank Group (2015). Alexandre Kossoy, Grzegorz Peszko, Klaus Oppermann, Nicolai Prytz, 11Noemie Klein, Kornelis Blok, Long Lam, Lindee Wong,   Bram Borkent. 2015. “State and Trends of Carbon Pricing 2015” (October), World Bank, Washington, DC. Doi: 10.1596/978-1-  4648-0725-1 License: Creative Commons Attribution CC BY 3.0 IGO. Introduction  –  3 Fairness Successful carbon pricing policies reflect the macroeconomic result is a shift in the structure of the “polluter pays” principle and contribute to dis- economy toward low carbon activities. tributing costs and benefits equitably, avoiding Companies do not compete only on costs, disproportionate burdens on vulnerable groups. but on overall efficiency of converting complex Carbon pricing helps level the playing field inputs (energy, material, labor, land, knowledge) between activities that impose climate change dam- into high value products, and services. However for ages and low- or zero-emissions activities that do sectors producing relatively homogenous products, not. Carbon prices can gradually lead to structural such as commodities, steel, cement and electricity, transformations by enhancing the competitiveness of cost competition is critical. low-carbon firms and increasing the costs of emis- Explicit carbon prices (emissions taxes, and sions-intensive activities. Ensuring that carbon pric- emissions trading systems) are not the only ing schemes are fair requires policies and temporary instruments that make firms internalize their protection measures that support a smooth transition emissions costs. When comparing carbon prices for affected people. This section focuses on: (i) com- across firms and jurisdictions, successful systems also petitive fairness between firms; (ii) employment fair- take into account the impact of implicit, and indirect ness during structural transformations; and (iii) social carbon prices embedded in other policy instruments, fairness for vulnerable low-income consumers. such as energy taxes, emission standards or support systems for renewable energy and energy efficiency Carbon pricing policies capture the costs of (Vivid Economics, 2010), (OECD, 2013a). damage caused by emissions, and so level Properly designed environmental policies the playing field between emission-intensive can even enhance competitiveness and business and low-carbon economic activities. Over performance by inducing technology innovation and time, they are expected to shift the structure increasing productivity, which can partly offset addi- of the economy towards low-carbon activities. tional costs of compliance with the policy (Porter, 1991), (Jaffe and Palmer, 1997). More evidence of Successful carbon pricing changes the rela- this hypothesis has been found in high-income coun- tive competitive position of firms by increasing tries that have used price-based policy instruments the financial costs of emissions-intensive activi- to address pollution from more technologically ties, which inflict climate change damages on advanced sectors, which faced prior barriers to inno- society, and favor low-emission activities that vation (Brannlund and Lundgren, 2009), (Levinson, do not contribute to climate change (Bowen, 2009), (Lanoie et al, 2011), (Copeland, 2012), (Calel 2011). This results in economically efficient and and Dechezleprêtre, 2012), (Ambec et al, 2013), socially fair impact on the relative competitiveness of (Albrizio et al, 2014), (Zhu and Ruth, 2015). firms, where they face the truer economic cost of pro- duction. It levels the playing field between emissions- Potential risk of adverse competitiveness intensive and relatively ‘clean’ firms. The expected impacts and carbon leakage is usually limited 4 to relatively few exposed sectors and can be managed through the design of pricing BOX 1:  Carbon Prices and policies or complementary measures; it will Competitiveness—Selected Evidence be reduced as carbon pricing becomes more Data from the United Kingdom production cen- geographically extensive. sus suggests that the introduction of the Climate Change Levy (an energy tax) had a significant Significant differences in climate policy impact on energy intensity, but no detectable costs experienced by firms in different jurisdic- effects on economic performance or plant exit tions can lead to potential “carbon leakage.” (Martin, 2014). Carbon leakage occurs when a domestic carbon price A study of British Columbia’s carbon tax causes economic activities (and related emissions) to found limited impacts on industrial competitive- move to jurisdictions without equivalent policies.7 ness, with the exception of two companies in the Emissions leakage may occur through two main chan- cement sector that lost market share. At the same nels—short-term changes of production volumes in time, British Columbia is also home to a growing existing facilities, and long-term shifts in new invest- clean technology sector, with more than 150 firms ment decisions. in operation in 2012—accounting for 22 percent So far research suggests that carbon prices of Canada’s clean technology presence in a prov- have not led to carbon emissions leakage on ince with 12 percent of Canada’s GDP. Several a significant scale (Partnership for Market Readi- experts have attributed the growth in the clean- ness, 2015), (Arlinghaus, 2015), (Martin et al, tech sector to the carbon tax (Demerse et al, 2014), (Flues  and Lutz, 2015), (Abrell et al, 2011), 2015). (Barker et al, 2007), (Chan et al, 2012), (Cummins, 2012), (Ellerman et al, 2010), (Graichen et al, 2008), (Lacombe, 2008), (Martin et al, 2012), (Sartor, 2012), (Sartor et al, 2013). There are a few possible reasons vulnerable as it limits their ability to pass on the for this result. First, the risk of leakage may be negli- increased carbon costs to consumers without los- gible because emissions costs have not had a signifi- ing significant market share. Providing assistance to cant impact on production and investment decisions address leakage to sectors that are not exposed or vul- compared to other factors such as the quality of nerable may lead to unwanted consequences. institutions, availability of capital, skills of workers, The risk of carbon leakage can be effec- proximity to markets, governance and tax regimes. tively managed. Some risk mitigation measures are Second, existing carbon price levels may be too low integrated into a design of carbon-pricing systems, and the systems too new to have an impact. Third, while others are complementary to them. Different governments have successfully used leakage reduc- assistance measures have their relative merits and tion measures—for example free allowances—to limit weaknesses and sometimes are combined in one leg- leakage risk (Lanzi, 2013). islative package, where different forms of assistance The risk of future carbon leakage is real as are applied to different sectors. long as carbon price signals are strong and dif- Integrated measures have been generally fer significantly between jurisdictions. This risk, preferred to date, as more transparent and directly however, is likely to be limited to a few exposed linked to leakage concerns. Broadly speaking, six dis- sectors—those that are emissions-intensive and heav- tinct types of integrated measures can be observed, ily traded. Trade intensity makes sectors particularly three of which involve free allowance allocations: (i) Free allowance allocations, based on: 7 The Intergovernmental Panel on Climate Change defines emis- sion leakage as “the increase in CO2 emissions outside the • Grandfathering: firms receive free countries taking domestic mitigation action divided by the allowances directly related to their his- reduction in the emissions of these countries” (IPCC, 2007), torical emissions (e.g. EU ETS phases I (Allwood J. M. et al, 2014). and II, Korea ETS in all but three sectors, Fairness  –  5 Kazakhstan Phases I and II, Beijing, (iii) Rebates: providing subsidies to industry Chongqing, Guangdong, Hubei, Tianjin). (direct rebates) or reducing other taxes paid Often used in the introductory stages as by the exposed industry (indirect), often by an it is easy to implement for administration equivalent amount (e.g. UK climate change and politically palatable, but provides levy, Swedish NOx charge). weak leakage protection and may lead (iv) Border carbon adjustments (BCAs): to contentious political negotiations with imposing emission costs at the border on affected industries or even an increase importers of carbon-intensive goods and/ in emissions unless it is a transition to a or providing a rebate to firms exporting to benchmark-based assistance. third countries, unless those countries have • Fixed sector benchmarking (FSB): firms an equivalent carbon pricing regime (Cos- receive free allowances related to their bey et al, 2012). BCAs effectively extend historical production and a product- the carbon pricing regime to entities outside specific benchmark of emission intensity the implementing jurisdiction. Arguably of the whole sector (EU ETS Phase III). BCA perform most strongly on grounds of environmental integrity and leakage pro- • Output-based allocation (OBA): firms tection, but face political, administrative receive free allowances related to their (Davie, 1995), and possibly legal challenges actual production and a product-specific (Laborde, 2011). The application of BCAs benchmark of emission intensity of the to carbon regulation remains untested and whole sector (e.g. California, New Zea- risky, but may be more feasible when intro- land, Korea in three sectors and Shen- duced by a coalition of partners with sig- zhen). Benchmarking assistance (either nificant market power (Condon et al, 2013), output-based allocations or fixed-sector (Nordahus, 2015) and coupled with finan- benchmarking) can protect against leak- cial transfers to support a low-carbon transi- age and convey the right incentives to tion (World Bank, 2015). improve productivity and reduce emis- sions. It favors most efficient firms in a Complementary measures usually take the sector. Makes negotiations with industry form of fiscal or financial transfers to support adjust- more transparent. Additional adminis- ment of affected sectors to higher carbon prices. For trative costs are manageable. There is a instance, European Union funds support green tech- trade-off between the two benchmark- nology innovation and member states can compen- ing approaches. OBA is more administra- sate firms for indirect carbon costs arising from the tively complex than FSB and may be more ETS through national state aid schemes. New Zealand effective at preventing leakage but can also provides support for research and development compromise the environmental integrity into emissions-reduction opportunities in agriculture. of the policy unless designed with addi- Concerns over potential competitiveness tional environmental safeguards. impacts and carbon leakage will ultimately decrease as carbon pricing becomes more wide- (ii) Administrative exemptions: exempting spread and harmonized across jurisdictions. some emissions or sectors/firms from the Such international or inter-regional harmonization carbon pricing scheme, or setting reduced can be achieved by harmonization of at least mini- rates for them (e.g. a number of carbon taxes mum rates of carbon taxes, direct linking of domestic in EU countries and proposed South Africa or regional emissions trading systems (see Box 3), or carbon tax). They are easy to apply and through indirect “networking” (World Bank, 2014). may be appropriate to secure political sup- Harmonization of carbon prices globally will be port in the early stages, but may undermine fair and more efficient if supported by cross-border the environmental objectives of the scheme resource and technology transfers to low-income especially if applied to high-emission sectors. countries to address equity concerns (Gillingam, 6  –  The FASTER Principles for Successful Carbon Pricing BOX 2:  Examples of Measures to Alleviate Competitiveness Concerns and Support Efficient Firms In the EU ETS free allocation of allowances is being gradually replaced by auctioning, with implementation at a faster pace for the sectors that are not trade exposed (such as power). Sectors exposed to leakage will con- tinue receiving a larger portion of their cap through free allocation. The arrangements for addressing carbon leakage have been designed to provide an ongoing incentive for firms to outperform others in their sector in terms of emission efficiency. The benchmark for free allowances is based on industry emission performance so that only the top 10 percent of performers receive free allowances to cover 100 percent of their emissions. Other firms receive the same volume of free allowances as best performers, but those firms that do not meet the benchmark have to purchase additional allowances at the market price to cover their actual emissions. Sweden refunds the revenues of the nitrogen oxides (NOx) charge on large boilers, stationary combus- tion engines and gas turbines to participating entities in proportion to their energy output. Although not a carbon pricing instrument, this redistribution scheme penalizes emissions and rewards efficiency at the same time, while not affecting firms’ production levels. In this way cash stays within the sector, while companies have incentives to reduce emissions and increase production efficiency (Sterner and Höglund (2000), Gers- bach (2004), Fisher C. (2011)). Since 1993 Denmark has rebated a portion of the carbon tax to various businesses, but not in propor- tion to their emissions. The Danish government provided a 97 percent reduction in carbon tax payments for some energy intensive firms of which 22 percent was conditioned on signing agreements to reduce their energy use—the rebate that was later abolished. From 2010 firms under EU ETS are exempted from the CO2 tax and the rest pay the full tax. At the time of writing this report the Danish CO2 tax was around 23 EUR/tonne, an increase from 12 EUR/tonne in 2010. (Jens Holger Helbo Hansen, Ministry of Taxation, Denmark—personal communication.) BOX 3:  Linking the California and Québec Emissions Trading Systems California and Québec, which together with British Columbia, Manitoba and Ontario, form part of the West- ern Climate Initiative (WCI), linked their emissions trading systems from January 1, 2014. Together, they form the largest carbon market in North America. Compliance units are fully fungible across both jurisdictions. Four auctions have been held to date (November 2014 and February, May and August 2015). The systems were designed to be linked, and assessed to ensure equal stringency prior to linkage, to ensure the environ- mental integrity of the scheme. In April 2015 Ontario announced its intention to join the regional program. Linkages would increase the total emissions covered by the caps, further enhance efficiencies and reduce competitiveness concerns. (Environmental Defense Fund/ International Emissions Trading Association, 2015). 2012). Results-Based Finance (RBF) can be a “tran- carbon-intensive to low-emissions firms as sition” vehicle to phase-in carbon pricing through the economic structure adjusts consistently international support. with carbon-pricing policies.8 National systems that support innovation 8 See extensive discussion on this issue in Deichmann Uwe and and well-functioning labor markets can Fang Zhang (2013), Growing Green: The Benefits of Climate Action, ease the transition of jobs and assets from World Bank Group. Fairness  –  7 BOX 4:  South Africa’s Carbon Tax Proposal South Africa’s proposed carbon tax covers CO2e emissions from fuel combustion, coal gasification, and non-energy industrial processes, as determined by the carbon content of the fuel consumed. The tax is scheduled to start in 2016 at a rate of 120 South African rand/tonne CO2e (US$10/t CO2e) and increase by 10 percent per year until 2019. It is expected to cover approximately 75 percent of total national emissions. To ameliorate potentially damaging economic impacts to South African companies, the government agreed to introduce tax-free thresholds under which business will not have to pay. The tax-free threshold will be fixed at 60 percent of tax payments due, meaning that companies are responsible for paying the tax on 40 percent of their total emissions. Trade-intensive and other sectors with limited potential to reduce emis- sions (such as the cement, iron, steel, aluminum and glass sectors) will have higher tax-free thresholds, reaching up to 90 percent. Tax-free thresholds are planned to be phased down after 2025 or replaced with thresholds based on firm-specific carbon budgets. A combination of the tax-free thresholds and an annual increase of the carbon tax rate is expected to provide a clear carbon price signal (Morden et al, 2015). Sometimes governments choose to offer Increasing adaptability involves strength- assistance to scale-down less-efficient facilities in ening the overall business environment and carbon-intensive sectors. The employment implica- increasing labor market flexibility so workers in tions of carbon pricing are part of an overall economic affected industries have incentives, and are able to transition, similar to other structural transformations, find jobs in more efficient firms and in growing sus- which ultimately leads to the more productive and tainable low-carbon sectors. Active labor-market sustainable use of resources. Immediate employment policies—such as training, employment services, pub- impacts in affected sectors can be different from the lic works or hiring, and wage subsidies—can increase economy-wide impact, as employment, and job-skill business adaptability to new opportunities. Carbon requirements change in other sectors as they adopt pricing policy can contribute to generating additional cleaner technologies and increase output. revenue, which can be channelled, for example to Jurisdictions where many people rely on facilitating strategic transformational skills develop- emissions-intensive industries for jobs, like ment through national education systems. For exam- many rapidly industrializing developing coun- ple, Chile introduced its carbon tax as a part of a much tries, will be more vulnerable to carbon price larger tax reform package with the explicit aim of pro- increases than those where these industries play a viding additional resources for education and other smaller role. Countries differ not only by vulnerabil- social needs.9 Well-designed and implemented social ity but also in their ability to adapt to labor market protection programs targeted to displaced workers can impacts. Wealthier countries typically have more provide effective safety nets for those who will find it resources and stronger institutions to smooth the more difficult to move to new jobs. structural transformation that may be caused by car- bon prices. If carbon pricing disproportionally burdens Governments can reduce vulnerability to poor households in some circumstances, the employment impacts of carbon prices by targeted complementary measures (e.g. fis- supporting technology improvements of firms in cal transfers) can provide protection without affected sectors (e.g. through providing access to undermining incentives to reduce emission- information, markets and finance, in particular for intensive activities. small and medium enterprises). These approaches can also help to reduce the impact on those less- 9 The Chilean Tax Reform was approved in Congress in September 2014. Within a comprehensive package of tax reform the carbon efficient firms that are exiting the market. Decisions tax in particular will be applied to emitters from energy genera- on which approach to take need to be balanced with tors of 50 MW and larger. The tax is set to be US$5 per ton of other factors for sectors that are otherwise competi- CO2. The tax becomes effective in 2017. Source: Chile’s Market tive or of strategic importance. Readiness Proposal at http://www.thepmr.org/country/chile-0. 8  –  The FASTER Principles for Successful Carbon Pricing Carbon pricing policies have the potential increasing consumer prices of kerosene, used for to benefit vulnerable low-income segments of lighting and heating in low-income households with- society. The distribution of damages from climate out access to electricity, usually pose a higher burden change seems to fall more heavily on poor countries, on the poorest people. Carbon taxes may even slow which often are more exposed, less able to adapt and down the switch to modern cooking fuels, such as where more people live in areas affected by local pol- electricity or LPG (Pachauri et al, 2013). Gasoline lution from burning fossil fuels (Akbar et al, 2014). usually shows a progressive pattern, with the richer However, in the transition period, where quintile losing a higher portion of their income than fossil fuels dominate energy and transport sys- poor people. Electricity price increases are in most tems and clean technologies are more expen- cases slightly regressive, although there are some sive, increasing carbon prices may translate into exemptions, such as India and other countries where increased energy costs. These increased energy many low income households are not connected to costs may fall disproportionately either on low-, or the power grid (Vagliasindi, 2012). high-income households, depending on what share Negative effects can be mitigated through of their disposable budgets are spent on different effective policy design, primarily smart rev- energy services. New evidence based on experience in enue recycling. A portion of additional revenues 21 OECD countries shows that distributional effects generated by carbon prices is usually sufficient to of pricing policies vary by fuel: Taxes on transport compensate the income loss of the poorest and most fuels are not regressive on average in OECD coun- vulnerable energy consumers (OECD, 2014). This tries, while taxes on electricity and heating fuels tend compensation can be provided as monetary support to be regressive, meaning that low-income house- through, for example, social welfare cash transfers or holds are responsible for proportionally larger tax targeted income tax adjustments (Bento et al, 2009; burdens compared to wealthier households (Flues Callan et al, 2009; Cohen et al, 2013). This type and Thomas, 2015). The impact needs to be better of support can enhance affordability and improve understood particularly in developing countries that equity, while maintaining incentives for low-income depend on fossil fuels or non-renewable biomass. households to improve energy efficiency and reduce The final impact will depend on how the tariff struc- their emissions. In contrast, consumption subsidies ture is set and adjustments can be made to benefit for electricity tend to be regressive (benefitting pri- the poorest segments of the population. marily high-income households) in the majority In developing countries impacts on house- of countries (Komives, 2007), (Vagliasindi, 2012). holds may differ because of the different patterns Implementation of targeted transfers can be chal- of consumption of fuels and electricity. For example, lenging, depending on the targeting method and BOX 5:  Examples of Mitigating the Social Impact of Carbon Pricing The Regional Greenhouse Gas Initiative (RGGI) in the Northeastern United States illustrates a construc- tive approach to deliver relief from high energy bills and make investments that capture efficiency oppor- tunities and power its economies with clean and renewable power. Collectively, RGGI has invested over US$1 billion from the proceeds of its ETS in the energy future of participating states in New England and the Mid-Atlantic region. RGGI’s investments in energy-efficiency programs are expected to return more than US$2.3 billion in lifetime energy bill savings to 1.2 million participating households. In addition, RGGI pro- vides direct bill assistance for energy and electricity customers in need. From 2008 to 2012 RGGI invested more than US$130 million in low-income rate relief and efficiency. British Columbia’s carbon tax design includes a tax credit for low-income households to offset the finan- cial burden of more expensive fuel. The credit was last increased in 2011, when it rose to Can$115.50 per adult and Can$34.50 per child. A study found that low-income households were better off after 2010 because the Low Income Climate Action tax credit was more than the amount paid in carbon tax (Lee and Sanger, 2008). Fairness  –  9 administrative capacity, including the capacity of the efforts may need to be made, however, to target the existing social safety nets. The challenge increases for poorest households. countries with large informal sectors. Environmental objectives are usually not The welfare of low-income groups can also the main reason for energy tariff increases. be improved by improving the energy perfor- Incremental tariff increases due to carbon taxes are mance of buildings, appliances and transport usually minor compared to the tariff increases imple- services. With such assistance, increasing the cost of mented in developing countries to improve the com- energy does not need to lead to higher energy bills. It mercial sustainability of energy and transport utilities also increases the comfort in buildings that are more and thus reliability of, and access to, energy and efficiently heated and insulated or improves public transport services. transport for those who cannot afford a car. Special 10  –  The FASTER Principles for Successful Carbon Pricing Alignment of Policies Successful carbon pricing policies are part of a development; behavioral challenges, inherited infra- suite of measures that facilitate competition structure that locks in higher-emitting activities; or and openness, ensure equal opportunities for simply a lack of finance (Popp, 2015). For example, low-carbon alternatives, and interact with a in the absence of public transport infrastructure com- broader set of climate and non-climate policies. muters find it difficult to change commuting habits In reality carbon pricing policies will always coex- when they face higher prices of fuels. Compliance ist with a suite of other measures designed to reach with such standards and regulations results in con- multiple social objectives. Some of these policies sumers and producers indirectly paying a price for will be complementary, supporting deeper emis- reducing emissions. sions reductions over time. Others will be counter- Complementary policies are particularly productive, weakening the carbon-price signal. important for energy efficiency, as market failures Coherence across a range of policy areas is impor- such as imperfect information and split incentives cre- tant. Overlapping policies may have merits of their ate hidden costs and risks that hinder otherwise effi- own, but also interfere with carbon-price incentives. cient projects. The removal of these barriers makes households or small firms more responsive to the car- Successful carbon pricing policies are sup- bon price signal (Alcott, 2014); (Alcott et al, 2012); plemented by measures that support deeper (Busse et al, 2013); (Helfand et al, 2011); (Sallee, emissions reductions over time. These 2014); (Sallee et al, 2009). Examples include provid- include innovation policies, the removal of ing information on energy saving opportunities and institutional barriers, behavioral incentives, benefits, aligning incentives between landlords and public spending reallocations, and policies tenants, and facilitating their ability and willingness that encourage investment in low carbon to pay higher up-front costs (IPCC, 2014). Sometimes infrastructure and seek to avoid lock-in of households or small firms are willing to invest in low- polluting investments. carbon alternatives but cannot afford it, or do not have sufficient access to finance. Often governments Carbon pricing is the cornerstone of a pack- themselves create additional barriers through coun- age of policy measures designed to achieve terproductive policies, such as energy price subsidies emissions reductions at lowest cost (Nordhaus, or fiscal rules that deprive the entities that undertook 2002); (Newell, 2015); (Parry et al, 2014). Comple- investments of the benefits of energy savings. mentary policies are often needed to advance reform Aligned carbon pricing policies improve in areas that are not sufficiently responsive to price the implementation of other policies. Many signals, or where markets do not provide price signals countries have introduced regulations with energy to individuals or organizations. Direct regulations and emission performance standards—such as those can also help support market-based instruments in commonly used for cars and buildings in China, the case of market failures, presence of institutional bar- European Union, and North America. Their imple- riers such as a lack of incentives for research and mentation on the ground is often weak, because of 11 the insufficient economic incentives for compliance. example is the choice of transport by commuters, Carbon price can make high-performance buildings which is influenced not only by price, but also by and cars less expensive than business as usual alter- convenience, safety and time spent—all of which natives, thereby aligning economic incentives with depend on the availability of transport infrastructure direct regulations. and quality of its services. Properly aligned taxes on the carbon content of Carbon pricing is not likely to induce ade- energy are another mechanism for pricing GHG emis- quate investment in research, development and sions. Explicit carbon pricing mechanisms (taxes or demonstration (RDR&D) of low-emission tech- cap-and-trade schemes) are gaining traction but remain nologies.10 The case for complementary interven- much less widespread than specific taxes on energy use. tion may be strongest for basic research, which lays Excise taxes are typically levied on quantity or energy the groundwork for future technological advances units (e.g. a liter or gallon of fuel). Since carbon emis- (Newell, 2015). Given the large funding needs for sions are proportional to the volume of fuel burned, a this type of research, carbon pricing revenues rep- fuel tax is equivalent to a carbon tax. Given differences resent only a small fraction (Box 7). Obstacles also in tax rates and in the carbon content among fuels, the arise at the technology demonstration and deploy- implicit carbon taxes resulting from excise taxes can dif- ment stage. For example, firms are often reluctant to fer strongly among fuels (Box 6). pioneer the adoption of a new technology because it For certain economic activities, price signals are not the main driver of decision-making. 10 Supplementary innovation incentives can yield significant eco- For example, some land-use decisions are primarily nomic benefits, though typically on a smaller scale to those based on cultural or social considerations. Another from carbon pricing (e.g., Nordhaus, 2002; Parry et al, 2014). BOX 6:  Carbon Taxes and Specific Taxes on Energy Use Taxing Energy Use (OECD, 2015) shows the differences in implicit carbon tax rates among fuels and uses. This OECD analysis considers explicit carbon taxes and implicit carbon tax rates from specific energy taxes, as these are economically similar, to calculate the total effective tax rate on CO2. On average, the effective tax rate per tonne of CO2 in an OECD country in 2012 equals €164 per tonne of CO2 on average for oil prod- ucts used in road transport, €24 on average for oil products used for heating and process use, and €€5 on average per tonne of CO2 for coal and peat used in heating and process use. The differences in effective tax rates are very large, with the lowest rates benefiting the most emission intensive fuels. What does this imply for the practice of carbon pricing? One approach would be to assume that some prevailing taxes include an implicit carbon component, as well as components to address other policy goals (e.g. raise revenue, combat pollution, reduce congestion, improve the political feasibility, slow adaptation to changing circumstance, etc.). Taxes could be reformed to ensure that the carbon component is made equal across fuels and user types, as would be the case with a carbon tax. The exercise may be worth pursuing when a major overhaul of excise taxes to optimize their effectiveness in curbing a range of external costs is envisaged, but may provide little guidance for the intro- duction of carbon pricing. A second approach would be to require that the tax on all sources and uses of energy is at least equal to the aspired level of carbon prices. Alternatively, the carbon price could be added to all excise taxes on energy use except where there are explicit carbon taxes or cap-and-trade schemes. The difference between these two alternatives reflects a view on whether current taxes contain some degree of implicit carbon taxa- tion. The choice between both may mainly be a matter of political expedience. The importance of the reform in both cases is that all forms of energy use would be subject to at least the intended carbon price. Given the currently low carbon prices for large portions of energy use, especially carbon-rich coal, large gains are to be had from such reforms. 12  –  The FASTER Principles for Successful Carbon Pricing BOX 7:  Carbon Pricing and Complementary Technology Policies: The EU and US Cases The EU ETS does not prescribe how member states should use the revenues from allowance auctions. How- ever, in Phase III 300 million emission allowances from the New Entrants’ Reserve (NER) were set aside to be sold at the EU level to support one of the world’s largest funding programs for innovative low-carbon energy demonstration projects. The program was conceived as a catalyst for the demonstration of environ- mentally safe carbon capture and storage (CCS) and innovative renewable energy technologies on a commer- cial scale within the European Union. In the context of the upcoming ETS review, the European Commission considers continuing to sell allowances to establish an “innovation fund” that would also promote indus- trial breakthrough technologies. In addition the “modernization fund” is proposed by dedicating a por- tion of total revenues from allowance sales to improve energy efficiency and energy systems in the poorer EU countries. In addition, the EU has agreed that at least 20% of its budget for 2014–2020—as much as €180 billion—should be spent on climate change-related action. For example, the research and innovation program (Horizon, 2020) with an envelope of €63bn has the objective of 35% climate mainstreaming (over €22bn) over the period. The focus will be on research and innovation activities on energy, climate and clean technologies. While the United States does not have a national carbon price, it has advanced a comprehensive suite of low-carbon energy technology policies and measures. For example, the U.S. government funds about half of the basic research into energy technologies, or about US$6 billion a year. A number of experts (e.g. Newell, 2015) have recommended a significant expansion of this funding (US$3 billion or more, or about 1.5 percent of revenue from an expected U.S. carbon tax) targeted strategically (e.g., for electricity storage, safer tech- nologies for nuclear power, direct conversion of solar energy into electricity), though spending should be ramped up gradually to allow time for training of additional engineers and scientists. The U.S. tax code also provides tax credits for private R&D expenditures into energy and other technologies, with resulting budget- ary costs approaching US$10 billion a year (Newell, 2015). could end up benefiting other firms; in other cases, prizes for new technologies avoid these problems, demand for the technology is insufficient to achieve but require measurable objectives that can be defined commercial viability. These sorts of problems apply to in advance. Intellectual property rights reward the a number of different low-carbon technologies,11 but commercial viability of new technologies, though may be most pronounced for solutions like carbon they limit diffusion nationally and may do little to capture and storage, which have high up-front costs reward innovators for technologies that are easily and long-range emissions savings. transferred to other countries. Technology support The most effective approaches use a port- measures need to be flexibly designed to accommo- folio of measures targeting different stages of date uncertainty over future technology costs (e.g., the technology innovation process. Instruments to avoid locking in technologies with higher than for promoting applied RD&D and technology deploy- expected costs) and then phased out as technologies ment by private firms include subsidies, prizes, and mature and penetrate the market. Box 7 discusses intellectual property protection. Each of these mea- these issues in the context of the U.S. and EU energy sures have pros and cons, and the appropriate mix technology policy. of instruments needs to be carefully considered. For If regulatory instruments target the same example, direct R&D subsidies may have the draw- sources and emissions as carbon pricing, care back of failing to distinguish between more prom- needs to be taken to ensure alignment. For ising and less promising opportunities. Competitive example, applying both emissions standards and car- bon pricing to emissions from energy or industrial 11 Numerous studies suggest that the efficient level of R&D for installations can constrain the carbon price signal and new technologies in general is several times the level actually limit the choice of emission-reduction opportuni- performed by industry (e.g., Griliches 1992, Mansfield 1985). ties. The overall policy cost would increase, without Alignment of Policies  –  13 necessarily improving environmental outcomes. On investment, taxation, innovation and international the other hand, sometimes direct regulations such as trade, as well as sectoral policies governing distinct emissions performance standards and “best-available” areas such as electricity markets, water infrastruc- technology or technique12 (BAT) standards may be a ture, urban mobility and rural land-use—can distort preferred option, and carbon pricing is not needed. the effectiveness of carbon pricing policies. Taking For example, installations covered by the EU ETS are policies relating to international trade as an exam- exempt from CO2 emissions performance standards ple, misalignments exist across three policy areas: under the EU Industrial Emissions Directive, while trade liberalisation; “green industrial policy” and its local emissions from the same sources are regulated by impact on global value chains for renewable energy; BAT and emission standards and not carbon pricing.13 and the machinery of trade itself—international Carbon pricing instruments interact with maritime and aviation transport. As one example, the underlying market designs and structures. this can create difficulties for governments in tak- When considering carbon price design, the existence ing unilateral action to price emissions from trade, of competitive markets and the ability to pass through as shipping and aviation are mainly international costs matters. If there is no electricity market, carbon industries that are covered by international conven- pricing may have no effect, and direct regulation of tions (OECD, 2015). emitting activities may have stronger impact on emis- Counterproductive policies undermine sions. An ETS may be challenging to implement in the environmental benefits of carbon pricing markets that are small and/or inflexible (e.g. with and should be scaled back. One example is fossil price controls, regulated trading and non-competitive fuel subsidies, or more general mispricing of energy, structures). In such distorted markets, existing compa- whose predominant effect is to lower energy prices, nies or facilities may use an ETS to further strengthen thereby increasing energy demand and GHG emis- a dominant market position. Countries can mitigate sions. A common example is when domestic retail this risk by facilitating competition in emissions trad- fuel prices are held down below international prices ing markets, using new entrants’ reserves, regulatory (mainly for petroleum products and natural gas) or rules, and oversight by antitrust agencies. Successful when domestic prices are below cost-recovery prices systems address this issue by using the emissions trad- (for electricity). Energy-price reforms and carbon ing to improve underlying power market design and prices are mutually reinforcing policy tools that lead enhance competition. to better energy access, improved quality of energy services and environmental sustainability. Raising Providing consistent price signals to consum- energy prices to reflect both supply and environmen- ers, producers and investors requires reforms tal costs would also help to reduce emissions (Box 8). to misaligned and counterproductive poli- Other examples of climate-harmful subsidies include cies (e.g. fossil fuel subsidies). those for company cars, parking, livestock produc- tion and crop production using fertilizers that release Policy consistency requires managing nitrogen oxides. These counterproductive policies are interactions between policy instruments, and still common in many countries. They often dispro- aligning policies across policy domains. The mis- portionately benefit wealthier groups and are costly alignment of larger policy frameworks—including to the budget and the economy. 12 EU environmental legislation uses the broader concept of Carbon pricing policies coexist with a range “technique,” which includes technologies as well as the ways of non-climate policies that can either support in which the installations are designed, built, maintained, op- or undermine the transition to a low-carbon erated and decommissioned. economy. Policy coherence across a range of 13 For more details on these policies, see http://ec.europa.eu/ policy areas is therefore important. environment/industry/stationary/ied/legislation.htm. 14  –  The FASTER Principles for Successful Carbon Pricing BOX 8:  Government Support for Fossil Fuels Taxpayers continue to bear substantial costs as governments support the exploration, extraction and con- sumption of fossil fuels, in contradiction with climate-change mitigation objectives. The International Energy Agency estimates that price-driven subsidies for the consumption of fossil fuels in a selection of emerging and developing countries amounted to US$548 billion in 2013 (IEA, 2014). The OECD estimates that support for the production and consumption of fossil fuels in advanced economies amounts to about US$55–90 bil- lion per year (OECD, 2013b). The IMF finds that pre-tax subsidies for petroleum products, electricity, natural gas, and coal reached US$ 490 billion worldwide in 2013, or 0.7 percent of global GDP (IMF, 2015). The IMF then adds a measure for “non-internalized externalities,” which are meant to account for the failure of governments to fully internalize environmental damages and other consumption-related externalities (e.g. road accidents, traffic congestion, carbon emissions, air pollution) through higher taxes on energy products. Using this approach, it finds that government support for fossil fuels could be construed as dramatically higher, even up to $5.3 trillion (IMF, 2015). Setting energy prices to levels that are commensurate with supply costs in developing and emerging countries would help reduce global CO2 emissions in the order of 2–6 percent points (IMF, 2015); (IEA, 2014). Carbon pricing policies frequently operate (Braathen, 2014) reducing incentives to invest in in parallel with other similarly motivated fiscal cleaner technologies and lowering government auc- and regulatory incentives affecting the same tion revenues. The downward pressure on emissions emissions sources. Examples include: energy- prices from other policies can be mitigated by a num- efficiency standards for vehicles, buildings, light- ber of measures (see Box 9), including floor prices ing, appliances, and other energy-using equipment; or market stability mechanisms discussed under the incentives for bio-fuels, wind, and solar power; emis- ‘Stability and Predictability’ principle. Under a car- sion standards for power generators; and subsidies for bon tax, overlapping policies can reduce emissions clean technology deployment. Some of these policies without affecting the emissions price, though raising are designed to address other market failures or to the tax may achieve the same emission reduction at achieve other policy objectives. Without proper man- lower costs. agement of policy interactions, they may interfere Policy interventions to promote deploy- with the effectiveness of the carbon price in reduc- ment of new low-carbon technologies can ing emissions (see Box 9). These policies may also be compatible with carbon prices if they are become redundant as comprehensive and appropri- phased out as technologies penetrate the mar- ately scaled carbon pricing is introduced, although ket. Successful policies create a level playing field they may still be needed to strengthen investor con- across competing technologies and avoid locking in fidence or to foster other, non-climate-related, policy a particular technology. Once market barriers have objectives (Hood, 2013). been overcome, incentives can be removed to avoid Under an emissions trading system, other favoring one technology over others. climate policies can lead to low allowance prices Alignment of Policies  –  15 BOX 9:  Managing Interactions between Carbon Pricing and Other Policies The European Union The EU climate-energy package includes a number of policies to support a triple target by 2030: reducing greenhouse gas emissions by 40 percent below 1990 levels; increasing the share of renewables in the EU’s energy mix to 27 percent; and achieving a 27 percent increase in energy efficiency above 2005 levels. This has led to national-level policies implemented in parallel to the EU ETS, e.g., feed-in tariffs and other incentives to promote new renewable power, energy efficiency obligations and subsidy programs. These policies have increased renewable energy penetration, reduced electricity demand and thus contributed to additional surplus of allowances that were not accounted for at the time ETS was designed. This has further reduced already low carbon prices, making carbon-intensive, coal-based generation more competitive in electricity markets when compared to gas-fired electricity (Böhringer et al, 2010). Renewable support systems, how- ever, achieved their objectives as industrial and energy policies—renewable energy costs decreased, pen- etration rates increased and European companies became global leaders. Recognizing these tensions, the European Commission (EC) in 2013 recommended that member states limit financial support for renewables to only the amount that is necessary to make renewables competitive in the market. The EC advised that as technologies mature, renewable support schemes should be gradually removed, while incentivizing producers to respond to market developments (EC, 2013). This was followed up by new state aid guidelines that promote a gradual move to market-based support for renewable energy. To increase cost effectiveness and limit distortions, the new guidelines foresee the gradual introduction of com- petitive bidding processes for allocating public support and also foresee the gradual replacement of feed-in tariffs by feed-in premiums (EC, 2014). At the same time, the Market Stability Reserve was introduced to reduce price fluctuations by changing the surplus if it becomes too large or too small. Some member states (e.g. UK) went further and introduced carbon price floor and CO2 emission standards for new coal generators that are comparable with gas-fired power generation. California California’s emission trading system is a key element in implementing its 2006 Global Warming Solutions Act. California Governor Jerry Brown further pledged that by 2030 the state will cut petroleum use by up to 50 percent, expand renewable energy supply to half of the state’s electricity use, double energy savings in existing building by 2030 (relative to current levels), address short-lived climate pollutants, and manage natural and working lands to store carbon. In April 2015, the governor’s Executive Order established a target of greenhouse gas emission levels 40 percent below 1990 levels by 2030. California also has complementary policies affecting sectors that are covered by the ETS as part of an overall strategy for emission reductions. Policies in capped sectors address market failures, drive technology and systems innovation and investment, and have multiple benefits that are not adequately captured by ETS itself. 16  –  The FASTER Principles for Successful Carbon Pricing BOX 10:  China’s Alignment of Policies China has considerable experience aligning carbon pricing programs along with other climate policies. In November 2014, the announcement of the joint statement regarding action plans on climate change beyond 2020 between the United States and China highlights two of China’s policy alignment priorities: (1) to peak CO2 emissions by 2030 and try to reach this peak as early as possible; and (2) raise the share of non-fossil fuels in primary energy consumption to 20 percent by 2030. China has large and growing experience with the Clean Development Mechanism voluntary emissions trading platforms, and a large-scale pilot emissions trading system. Since 2011, China has been experi- menting with seven regional carbon market pilots. Each pilot covers a large city—Beijing, Tianjin, Shanghai, Chongqing and Shenzhen—or a province—Guangdong, and Hubei. Together the pilot systems account for over 1 billion allowances per year, according to the National Development and Reform Commission, making China the world’s second largest carbon trading market following the European Union’s EU ETS. Building from these pilots, China has announced the creation of a national ETS, scheduled to begin in 2017, with the start-up phase followed by a roll-out phase in 2020. Complementary to carbon pricing, China has established a number of complementary climate poli- cies, including low-carbon city-development programs, which include pilot demonstration projects in clean transport and green industrial parks, and local air quality improvement initiatives. Furthermore, there are several subsidy programs for renewable energy. In 2014 the government announced plans to cut fossil fuel dependency, reduce carbon emissions, and increase renewable energy generation (NDRC, 2014). It also set 2020 targets for primary energy consumption, coal use and the share of non-fossil fuel energy production in the national energy mix (China State Council, 2014). Alignment of Policies  –  17 Stability and Predictability Successful carbon prices are part of a stable pol- that encourage expansion of markets for low-carbon icy framework that gives a consistent, credible businesses and discovery of new ways to mitigate cli- and strong investment signal, the intensity of mate change (e.g., Sauvage, 2014). which should increase over time. Policy stability can manifest differently under Carbon pricing policies offer stability if they are a carbon tax or an emissions trading system. part of a long-term strategy that gradually phases in a cost for emissions and explains how the gov- • With a carbon tax, the predictable increase ernment will ensure that unexpected events can of the tax rate promotes fiscal stability be addressed while maintaining the overall goal of and allows optimization of low-carbon reducing greenhouse gas emissions at low cost. This investments over time. A predictable price sort of predictability of policy and market framework allows governments to plan for the use of pro- will drive greater business support and allow firms spective carbon-pricing revenues, for example, and consumers to plan their investments in the in reducing the rates of other taxes in the fiscal necessary low-carbon infrastructure and solutions. system. Investment decisions depend not just on the carbon price in the short-term but over A predictable and rising carbon price promotes the life of an investment. Therefore investors’ orderly transition to a low-carbon economy certainty about the level of a carbon price in the over time, opening up new business oppor- future enables more efficient near-term invest- tunities and stimulating innovative business ment decisions and avoids lock-in of carbon- models. It can also contribute to the stability intensive assets. This, in turn, reduces the of government revenues. A lower but gradually overall cost of achieving the desired emission- rising carbon price creates the right incentives, reduction outcome. but produces greater short-term emissions • Under an emissions trading system, the than an initially higher carbon price would. stability of the market framework fol- lows from setting a clearly defined limit A predictable and consistent climate pol- to the quantity of allowances. Cost- icy and market framework promotes more effective optimization of low-carbon invest- orderly transition to a sustainable low-carbon ment may be influenced in the long term by economy at lower cost. Achieving zero net GHG setting and maintaining long-term targets for emissions globally by 2100 (IPCC, 2014b) requires emissions reductions and ensuring technology a clear and credible signal that the cost of emitting neutrality across a sufficiently broad set of sec- greenhouse gases will increase over time. This pro- tors, activities and countries; not necessarily motes cost-effective investments in clean technolo- by managing the carbon price directly. Under gies and new business opportunities and models that an ETS, stakeholders may consider direct price can be aligned with expected business cycles (OECD, controls (e.g. through administratively set price 2011). Climate policy consistency improves market floors or triggers for market interventions) to confidence, and enhances incentives for innovation represent a form of intervention contributing 18 BOX 11.  Academic Literature Provides a Useful Reference for the Long Term Carbon Price Trajectory That Is Consistent with Global Climate Stabilization Targets Academic studies suggest that socially efficient carbon prices should increase at the social discount rate, typically by around 2–5 percent a year in real terms, starting from the levels that are significantly higher than most existing carbon market prices (IAWG, 2013) (Stern, 2006). It is not evident from the literature and empirical experience that limiting carbon price development to a narrow bandwidth is a necessary condition for successful carbon pricing or that this optimal path needs to be strictly followed in all circumstances. In reality the phasing of financial carbon price trajectories will be shaped by political economy considerations, business cycles as well as economic and social realities in different countries. Nonetheless, incentives would be aligned and investment planning optimized if producers and consumers expected a broad-based and long-term convergence of the average international carbon price signals with what scientists suggest would be socially optimal for the global economy. to regulatory uncertainty for market partici- higher cap on the annual number of allowances at the pants, as demonstrated during the debate on outset, predictable tightening of the cap and transpar- the post 2020 revisions of the EU ETS. Expec- ent rules for how allowances will be withdrawn from tations about the development of the carbon the market. A rising trajectory of emissions prices or a price over a longer, multi-year period depend declining trajectory for the limit to the total number on the expected scarcity of emission allow- of allowances under an ETS usually implies that the ances. Genuine price discovery is a unique easiest abatement opportunities are seized first, with advantage of carbon markets, as this provides progressively more challenging emission reduction society with valuable information about the opportunities implemented over time.14 opportunities and costs of reducing emissions. Introducing carbon taxes at a low level, While predictability is essential to support then expanding coverage and price level pro- long-term investment decisions, incorporating gressively can help ease transitions to carbon flexibility—by adjusting the carbon tax or rules- pricing, while providing continuing signals based interventions in an Emissions Trading for clean technology investments. Experience System—can help economies adapt to unpre- in jurisdictions such as British Columbia (Box 12) or dictable economic and technological develop- Sweden (Figure 2) suggests that progressive introduc- ments and advances in scientific understanding tion of carbon taxes may increase political and social of climate change. National carbon budgets support by enabling households and firms to adapt can at the same time reduce long-term uncer- gradually to higher energy prices (OECD, 2013b). tainties on how much abatement is triggered. Staged expansion to different sectors is also an option. For example, Finland’s carbon tax initially covered The ability to cope effectively with scien- only heat and power generation but was subsequently tific and economic uncertainties is fundamen- extended to cover transportation and heating fuels. tal for efficient carbon pricing policies (OECD, This sort of phased implementation may sacrifice 2009). The challenge for governments is to ensure abatement opportunities in the short term. However, that pricing mechanisms are designed in such a if investors have confidence that price levels and cov- way that they can respond to unpredicted events, erage commitments will be maintained in the future, while remaining sufficiently predictable to preserve phased taxes can lead to increased investment in long- lived, low-carbon infrastructure. Phasing in emission reductions also allows time for technology develop- 14 It also means that sometimes complementary policies, such as land use planning and infrastructure investments (discussed ment to help reduce abatement costs and align adjust- under the Alignment principle) may be needed to facilitate ment with normal capital replacement cycles. Under measures that are more costly in the short term, but strategi- an ETS, this is often achieved by more a progressively cally important in the long run (Fay et al, 2015). Stability and Predictability   –  19 BOX 12:  British Columbia’s Carbon Tax: A Phased Approach The Canadian Province of British Columbia launched its carbon tax in 2008, at a rate of Can$10 per tonne of CO2. The government introduced a schedule with four annual increases of Can$5/tonne, allowing the tax to reach a pre-determined rate of Can$30/tonne in July 2012. The tax applies to the carbon content of all fossil fuels purchased or used in the province, as well as methane and nitrous oxide. Carbon tax revenue has risen from Can$306 million in the first year of the tax to Can$1,120 million in fiscal year 2012/2013, or about 5 percent of total provincial tax revenue for that fiscal year. When introduced, the carbon tax led to an increase in the price of gasoline of around Can$0.0234 per liter, a modest increase in the context of normal price fluctuations. The fact that there was little evidence of any negative impacts from the tax helped to dampen opposition and played a major role in getting the principle of the tax accepted. While the initial price of British Columbia’s carbon tax was relatively low, the legislated annual tax increases meant that the government was able to raise the tax in subsequent years with minimal political controversy, because the increases were clear and anticipated. The province was able to move from a low to a more stringent price with less opposition than might have been the case if a Can$30 rate per tonne was implemented upfront. At the same time, expectations of progressively rising prices to 2012 provided incen- tives for clean technology investments. By July 2012, British Columbia’s carbon price contributed Can$0.067 to the average Can$1.38 price per liter of gasoline in Vancouver, compared to approximately Can$0.40 contributed by other local, provincial and federal taxes. Changes in the political landscape in the province and growing business concerns regard- ing potential competitiveness impacts prompted the government to freeze the carbon tax at Can$30 per tonne for five years in 2013. Sources: Clean Energy Canada (2015), Pedersen and Elgie (2014), Harrison (2013) and Metcalf (2015). Figure 2:  Development of Swedish carbon tax rate over time Source: Swedish Ministry of Finance (NOTE: from 2008 industry outside EU Emissions Trading Scheme (EU ETS)). 20  –  The FASTER Principles for Successful Carbon Pricing incentives for innovation and long-term investments Changes in economic conditions or rapid progress in low-carbon technologies. with abatement will affect emission prices through Carbon taxes and emissions trading systems changes in the demand for allowances. This price respond differently to uncertainties. Over the uncertainty is an intended feature of a system, short term, taxes provide certainty over incremental because by design allowance prices should be estab- abatement costs—as these are pinned down by the lished through the decisions of participating entities. tax rate—while emissions will vary with changes in However, if unconstrained, this variability may have energy demand, relative fuel prices, costs of renew- detrimental effects on long-term clean technology able technologies. In emissions-trading systems, the investments by making returns more risky to inves- level of emissions is fixed by the cap, giving more tors. Price volatility in trading systems can be reduced certainty about overall environmental outcomes. as discussed in Boxes 13 and 14. BOX 13:  Reinforcing Stability and Predictability in the EU Emissions Trading System (EC, 2015) Phase I of the EU Emissions Trading System (2005–2007) relied on EU member states to issue allowances in accordance with national allocation plans because the European Union lacked sufficient information about member state emissions levels to establish a harmonized cap. The majority of member states over-allocated allowances in an effort to safeguard economic competitiveness, leading to a rapid reduction in the price of allowances in 2007. Phase I allowances could not be carried over to Phase II in order to shield future trading from the risk of potential excess allowances and to guarantee that the ETS delivers the emission reductions necessary for compliance with the EU commitment undertaken in the Kyoto Protocol. The number of allow- ances was reduced in Phase II (2008–2012) by 6.5 percent to stay below 2005 emissions levels. Phase III of the EU Emissions Trading System (2013–2020) includes an EU-wide emissions cap, in place of national caps, and uniform allocation rules to avoid potential market distortions and reduce the potential for member states to over-allocate allowances. The cap is reduced by 1.74 percent each year. When the economic crisis of 2008 eroded the carbon price level by reducing the economic output of industry, many stakeholders urged the European regulator to step in and protect the price level. Pros and cons of market flexibility versus policy predictability were extensively discussed. A wide ranging policy debate was held in Europe considering structural reforms to the EU ETS, to address the surplus of allowances on the market. A widely held view emerged that volume based measures, such as the recently adopted Market Stability Reserve (MSR), would be more suitable than discretionary price mea- sures such as a minimum carbon price floor. An extensive discussion of the merits of the options considered can be found in the Impact Assessment that accompanies the legal proposal on the Market Stability Reserve (Source: http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52014SC0017). Several options were considered as part of the discussion on structural reform of the EU ETS including increased targets, retiring allowances, an extended scope and discretionary price measures, some of which were dismissed because they would only address the issue in the long term. Discretionary price-based mechanisms, with an explicit carbon price objective, would alter the very nature of the current EU ETS from a quantity-based market instrument. Because they require a process to decide on the level of the price floor, the carbon price could become primarily a product of administrative and political decisions (or expectations about them), rather than a result of the interplay of market supply and demand. Setting the minimum price too high would just fix the carbon price, reduce the flexibility and result in higher abatement costs, while setting it too low would not be effective in addressing the surplus and create more certainty about the price. Stakeholders also indicated that a minimum price would also compli- cate linking the EU ETS to other emissions trading systems and would not result in an additional environmen- tal benefit without cancellation of allowances. More certainty for investors through a minimum price could come at the risk of imposing excessive costs on ETS participants and society if technological breakthroughs substantially lower abatement costs (European Commission, 2014). Stability and Predictability   –  21 BOX 14:  Reinforcing Stability and Predictability in the Emissions Trading Systems of California and Québec In the linked California and Québec ETS, market intervention is triggered by the price of allowances. In this system, an auction reserve price or floor price is set. If the market price falls below the auction floor price, then some allowances may not be sold at auction. The California Air Resources Board and the Québec government may only sell unsold allowances if the closing price of the auction exceeds the floor price for two consecutive joint auctions. The floor price was initially set by Québec and California at US$10 in both American and Canadian currencies for 2012, the year the two programs took effect and a year before their first compliance periods began. This price has since increased annually by 5 percent plus the rate of inflation, calculated by the Consumer Price Index in each jurisdiction. Accordingly, in 2015, the Auction Reserve Price was set at US$12.10 and at Can$12.08. For each joint auction, the harmonized regulations stipulate that the floor price is the higher of the California or Québec floor price according to the exchange rate published by the Bank of Canada on the day prior to the auction. For example, for the May 2015 joint auction, the floor price was set at US$12.10 or Can$14.78 per allowance (i.e., per ton of CO2e.) and some vintage 2013 allow- ances that had not been sold were put back on sale after the closing price of the two prior joint auctions exceeded the floor price. Mechanisms can strike a balance between 4. Safety valves, where the government sells flexible policy that adapts to new information additional permits at a fixed price to prevent and the need for policy consistency and pre- allowance prices from rising above a set ceil- dictability. For carbon taxes, pre-specified rules ing price. for periodically updating tax levels in response to 5. Price collars that combine a price ceiling new information can help to strike this balance, with a price floor. This approach turns effec- although there is little experience with such rules tively to a tax when allowance prices are low being implemented. and into a price ceiling (safety valve) when For emissions trading systems, policy and market allowance prices are too high. stability options include: 6. Banking and borrowing provisions, with 1. A predictable policy framework, includ- constrained borrowing from future trading ing setting the cap several years in advance periods to avoid a negative impact on envi- with clear rules and processes for how it will ronmental integrity. be set into the future. Governments can also provide advance notice of changes that are 7. Offsets—the transparent and predictable likely to influence price, such as extend- use of carbon credits generated outside of the ing the scope of the ETS to more sectors ETS can be used to offset the obligation to or sources, and changing rules of access to surrender ETS allowances. The ability to use international credits. This will allow the mar- offsets prevents allowance price spikes, but ket time to factor those changes into future loose offsets criteria may lead to unexpected prices and adjust their decisions accordingly. price drops. 2. Linking/networking with other ETS, 8. Timely release of price-relevant infor- since a larger market usually smooths vola- mation helps firms to make efficient price tility, while joint market rules agreed on by discovery and improves investment deci- several jurisdictions also reduce political risk sions. The price can become unstable if price of erratic changes influenced by political or sensitive information is not released to the economically vested interest groups. full market or is poorly timed. 3. Market stability reserves, discussed in 9. Clearly defined property rights (carbon Boxes 13 and 14. assets)—when property rights associated 22  –  The FASTER Principles for Successful Carbon Pricing with carbon assets are clearly defined, mar- National carbon budgets can also play a role ket actors have confidence that they will in reducing long-term uncertainties, by clarifying the receive the benefits from their investments. total amount of emissions that will be permitted for a country over a specified multi-year period and allow- 10. Wide market participation and devel- ing for regular review of progress toward the bud- opment of secondary markets supports get. For example, the United Kingdom legislated for price discovery and reduces overall transac- binding carbon budgets in its Climate Change Act 2008 tion costs. and has budgets in place to 2027, when the country 11. Market oversight and regulation ensures is legally committed to achieving a 50 percent reduc- that the market is competitive and free from tion in emissions relative to 1990 levels.15 manipulation. 15 More information on this policy is available at www.gov.uk/ 12. Extending the scope of the ETS to more sec- government/policies/reducing-the-uk-s-greenhouse-gas- tors or sources. emissions-by-80-by-2050/supporting-pages/carbon-budgets. Stability and Predictability   –  23 Transparency Successful carbon pricing policies are clear in proposed design of the system, and to receive input design and implementation. from affected groups. For example, as part of the devel- Successful carbon pricing policies involve public opment of its carbon tax, Ireland conducted extensive dialogues with affected stakeholders about the consultations with community, environmental and rationale for the policy and incorporate their feed- business interest groups to improve the public’s sup- back into the policy design and implementation. port (see Box 15). Similarly, California’s stakeholder Establishing independent and public reviews, engagement process involved hundreds of public and along with a robust monitoring and verification private meetings and workshops with affected stake- system and reporting on performance, builds pub- holders, including capped entities and other groups. lic trust in carbon pricing efforts. A comprehensive and inclusive engagement process is Given the structural changes expected in mandated through law to enable broad public partici- the economy as a result of a successful car- pation in its rulemaking proceedings.16 bon price, transparency is a prerequisite for a Once the carbon pricing system is in place, suc- social mandate to price carbon emissions. This cessful programs conduct regular independent and includes: communicating with relevant stakehold- public reviews of policy performance by checking ers about the proposed policy design early in the progress towards achieving stated objectives, identi- process and soliciting their feedback; creating clear fying any possible unwanted effects and evaluating and easy-to-understand rules, including monitoring, whether performance is aligned with policy goals. reporting, and verification (MRV) procedures; and establishing well-defined lines of regulatory respon- Systems that monitor and verify emissions sibility and market oversight, which are subject to and mitigation effort are critical for public public scrutiny. Carbon prices need to be supported trust and support. by laws and regulations that clearly define liable enti- ties and what they must do to comply; systems also Monitoring, reporting and verification (MRV) pro- must be enforceable. grams provide the backbone for successful carbon pric- ing systems. Processes to collect and organize emissions Early and regular communication with data in a manner that is complete, consistent, compa- affected stakeholders about the rationale, rable, accurate and transparent are key to gaining pub- desired outcome, and shared benefits helps lic trust. Additionally, MRV programs are the basis for to generate support for carbon pricing and understanding the reliability of the carbon pricing pol- to manage the associated change in the icy to meet environmental objectives, and to provide structure of the economy. emissions data to verify compliance and assess cost effectiveness. A number of jurisdictions—including Carbon pricing systems require a system- atic communications and stakeholder engage- 16 See www.arb.ca.gov/html/decisions.htm for more information ment program to explain the government’s aims and on California’s stakeholder engagement process. 24 BOX 15:  Ireland’s Carbon Tax and Public Acceptance During the Fiscal Crisis The adoption of Ireland’s carbon tax provides insight into the value of effective stakeholder engagement to implement a carbon tax, as well as Ireland’s effort to align implementation of the carbon tax as part of a broader fiscal reform. In 2010, in the middle of a financial crisis, the government of Ireland introduced a carbon tax that cov- ered CO2 emissions from non EU ETS sectors, and in particular natural gas and mineral oil used in transport, space heating in buildings, and by all businesses not covered by the EU ETS. Fuel use in agriculture is also included. Therefore, the tax targeted emissions associated with the general public’s day-to-day activities, e.g., driving and home heating. The carbon tax rate on natural gas and mineral oil was increased to €20 per tonne CO2 emitted on combustion in 2012. A carbon tax on solid fuels was introduced in 2013, at a rate of €10 per tonne of carbon emitted on combustion. The rate was increased to €20 per tonne of CO2 emitted on combustion in 2014. There was some opposition to the introduction of the solid fuel carbon tax on grounds of the impact on lower income households who rely more on solid fuels. To reduce the impact of the carbon tax on homes, the Government has offered generous grants for retrofitting homes to improve energy efficiency together with free upgrades for the elderly and vulnerable. Businesses dealing in solid fuels complain that they are suffering a loss of business from cross-border sales as their customers are sourcing solid fuel from Northern Ireland where it is not subject to a carbon tax. (Source: Emma Clutterbuck, Office of the Revenue Commissioners, personal communication.) One study, conducted by the University College Dublin, notes that the tax rate—set at €15 per tonne of CO2, which is high relative to the EU ETS allowance price—has been socially accepted. Along with other supporting factors, effective engagement and good planning are credited with creating circumstances that resulted in a carbon tax being proposed and subsequently introduced in Ireland. Specifically, the study states that lengthy and detailed stakeholder consultation processes carried out during the program design stage resulted in a rule that was more politically acceptable and nuanced than it would have been with- out this process. A key lesson from Ireland’s experience includes understanding main priorities across a wide spectrum of interest groups. In this case, the farming lobby was important. Furthermore, the carbon tax aligned with interest to put the climate and energy agenda at the center of Ireland’s economic revival, moving to a low-carbon economy and radically enhancing energy efficiency. An important rationale for the carbon tax was that it would stimulate new enterprises in renewables and energy efficiency and encourage innovation (Convery et al, 2013). Another important lesson (supported also by the experiences of Sweden and Chile) is that carbon taxes are easier to introduce as part of a broad fiscal reform. Alberta, California, New Zealand, Quebec, RGGI and independent third party verification to self-certification Switzerland—report emissions and compliance results with strong penalties. Additionally, many countries, annually, per covered entity, as a strategy to ensure such as the United States and Australia, have also insti- transparency of their system. tuted mandatory GHG MRV programs in the absence of With a carbon price on wholesale suppliers a carbon-pricing program. This has been done for gov- of fossil fuels, a well-designed MRV program will ernment information purposes only, or for compliance include reporting fossil fuel production and import with direct, non-price regulations. Table 1 provides a data by fuel type, along with provisions for convert- snapshot of verification approaches used in several ing fuel reports into emissions values. A robust MRV jurisdictions (WRI and WBG, 2015). program for systems that apply a price at the point The MRV rules in the EU ETS ensure the quality of emissions will account for and report emissions and of annually reported emissions and the credibility of activity data associated with the emitting facility. Dif- the underlying data, and are essential for effective ferent approaches to verification are possible—from program operation. MRV factors have been cited as Transparency  –  25 Table 1:  Emission verification approaches used in different jurisdictions Review by Program Jurisdiction Self-Certification Administratorsa 3rd-Party Certification California X Xb X Canada X X European Union X X Japan X X Mexico X X Turkey X X United Kingdom X X United States X X Notes: a. Depending on the program, this could include random checks or systematic/periodic verification. b. California audits a random sample of GHG reports in addition to a full review by the third-party verifiers. BOX 16:  MRV Standards Under the Clean Development Mechanism (CDM) Under the Kyoto protocol, the Clean Development Mechanism (CDM) developed into the world’s biggest market-based offsetting instrument, involving the largest number of developed and developing countries. The emissions accounting and reporting methodologies provide the foundation for preserving the envi- ronmental integrity of the CDM. Based on early experience, a number of reforms were enacted that led to standardized baselines, consolidated MRV rules and procedures, and enhanced communications that have significantly improved accountability issues and the transparency of the program. contributing to public confidence in the effectiveness • The required use of accredited verifiers to of the system include: check and validate the data and information included in program participant’s annual • The requirement that all installations and emissions reports.17 aircraft operators must have an approved monitoring plan, according to which they Emissions-trading programs also benefit from monitor and report their emissions during market monitoring that reviews and evaluates the the year; activities of market participants to ensure that fair trading practices occur and that the market is free of • The availability of the two primary regula- manipulation (See Box 17). tions underpinning the program and con- fidence in their technical merits, which describe the rules and procedures for emis- sions monitoring and reporting and accredi- 17 To access additional information on EU ETS MRV rules, see tation and verification; ec.europa.eu/clima/policies/ets/monitoring/index_en.htm. 26  –  The FASTER Principles for Successful Carbon Pricing BOX 17:  Building Trust in Market Practices EU ETS One of the lessons learned from the initial phases of the EU ETS is that the absence of a single, transparent trading registry contributed to a higher risk of potential market misconduct and abuse. Therefore, the EU created a system-wide registry to replace individual national registries for all ETS account holders as well as the European Union Transaction Log (EUTL), which automatically checks, records and authorizes all transac- tions that take place between accounts in the Union registry. This was supplemented by fixing the VAT rules and improved market oversight. These verification steps helped to ensure that any transfer of allowances from one account to another is consistent with EU ETS rules. (Source: http://ec.europa.eu/clima/policies/ets/ registry/index_en.htm) California’s ETS The California Air Resources Board—the agency responsible for designing and implementing the state’s ETS—utilizes another option to maintain a well-functioning market that is free of abuse. It conducts market surveillance and analysis and uses an independent market monitor to examine ETS auctions and all holding and trading of compliance instruments for the trading program. Activities in related markets are also tracked and analyzed. These actions have contributed to a widespread acceptance of a carbon price. Transparency  –  27 Efficiency and Cost-Effectiveness Successful carbon pricing improves economic reward for any additional tonne of emissions abate- efficiency and reduces the economic costs of ment across different sectors, firms, and households. emission reduction. Carbon pricing creates a continuous incentive to Carbon pricing minimizes the cost of achiev- exploit all abatement opportunities below a certain ing environmental objectives. Due to built-in flex- level of cost per tonne reduced, often discovering ibility, carbon pricing instruments also improve previously unknown, innovative, and inexpensive efficiency in the allocation of resources in the econ- means to reduce emissions (OECD, 2009); (OECD, omy by making market prices reflect the true social 2013a); (Popp, 2015). cost of emissions-intensive activities. Well-designed The cost saving potential of carbon pricing policies can also have relatively low administrative depends on two main factors. and compliance costs. Productive use of revenues additionally contains overall policy costs. One of the • Coverage of the carbon pricing mechanism: The more comprehensive the coverage in most productive uses of revenue is using it to lower terms of fuels and or sectors, the greater the burden of other more distortionary taxes. the scope for optimizing across the range of available low-cost options (OECD, 2009). Carbon pricing encourages emissions reduc- tions at least cost, giving affected entities • Heterogeneity of the sources covered: The flexibility to choose how and when to reduce greater the disparity between abatement emissions based on their own assessments of costs across firms and sectors, the greater costs and benefits. the benefits of the flexibility offered by car- bon pricing policies over regulations that, for Ability to achieve environmental protec- example, might require all firms, or all sec- tion at lower overall cost to the economy is a tors, to reduce emissions in the same propor- key advantage of carbon pricing. Carbon pricing tion or with the same technology. offers firms, people and institutions maximum flex- International cooperation can further ibility as to how, when and even whether to reduce improve cost-effectiveness. Due to the unequal emissions, taking into account their own calculations distribution of wealth and abatement opportunities of cost and benefits and their own preferences. It around the world, the countries that can afford to indiscriminately promotes a full range of opportu- reduce GHG emissions often have to pursue expen- nities for mitigating emissions across the economy, sive abatement options to meet their mitigation tar- such as shifting to clean technologies, fuels or prod- gets. On the other hand, developing countries often ucts, or just changing behavior by driving less and have abundant low-cost emission reduction or pre- economizing on the use of heating and air condition- vention opportunities because their industrial and ing (Bowen, 2011); (Krupnick et al, 2010). Carbon infrastructure assets are often older and less effi- pricing also encourages the cost-effective composi- cient. Under international cooperation facilitated tion of these opportunities, by providing the same 28 by carbon pricing, high-income countries can be relieved from more expensive emission reductions at BOX 18:  Use of Offsets in Carbon home and convert cost savings into financial trans- Pricing Scheme in South Africa fers that reduce emissions in low-income countries South Africa proposes to allow affected entities while accelerating their development. This prag- to use limited offsets in lieu of paying some of matic approach allows the climate to be stabilized at the carbon tax. In addition to enabling indus- a lower overall cost, while also improving political try to achieve carbon mitigation at a lower cost acceptance for challenging climate targets. than their tax liability and incentivizing mitigation In reality, people and governments focus activities in sectors not directly covered by the not only on efficiency but also on political and tax, carbon offset projects are expected to also equity considerations as they explore mitigation help generate additional sustainable develop- solutions. International cooperation mechanisms ment benefits by moving capital to rural devel- can foster equity and fairness through explicit agree- opment projects, providing jobs, regenerating ment and make use of bottom-up carbon-pricing landscapes, reducing land degradation and by mechanisms to increase flexibility, cost-savings and protecting biodiversity (EDF/IETA, 2014b). resource transfers. Mechanisms to facilitate international cooperation through carbon pricing may involve commonly agreed (minimum) tax rates or linking climate stabilization targets at the lowest eco- emissions trading systems (see Box 18). The former nomic cost. Prices in most existing explicit carbon would also require an agreement on rules for trans- pricing schemes (taxes and ETSs)—which are typi- ferring tax revenues to developing countries. Inter- cally around US$10 per tonne of CO2 or less (WBG, national coordination can also occur through offset 2014)—are below the bottom end of the range of markets, which transfer finance to low-cost mitiga- published estimates of efficient carbon prices in the tion options in developing countries while lessening literature. Most studies indicate that a global average the burden on countries with carbon pricing. There carbon price (explicit and implicit) between US$80 are practical challenges that need to be managed to and US$120 in 2030 would be consistent with the ensure that projects would not have proceeded any- long-term climate stabilization target. (Clarke et al, way in the absence of the offset payment. While 2014), (US IAWG, 2013), (Kriegler et al, 2013), (Nor- different countries have different preferences and dahus and Sztorc, 2013); (IPCC, 2014d), (IEA, 2014); ambitions, they can move toward a harmonized car- (Mercer, 2015). In selected instances, implicit carbon bon price through bottom-up agreements starting at prices, embedded for example in renewable support a regional or subnational level. systems in some EU countries, are already in this range (OECD, 2013a). While these carbon prices, cal- Carbon pricing improves resource alloca- culated by large-scale climate-economy models, do tion in the economy by ensuring the damag- not necessarily have to be an explicit carbon tax rate ing costs of GHG emissions are taken into or allowance price, the difference between this range account in production, consumption and and the prices currently observed gives an indication investment decisions by the public and pri- of the scale of the challenge lying ahead. vate sectors, households and individuals. Administration can be simplified and there- Efficient economies reflect environmental fore costs minimized by building on existing costs into the price of goods and services. Put- policies and institutions. ting an explicit price on emissions aligns the private and social costs of fossil fuel use. It also promotes effi- Carbon pricing instruments are often less ciency in the allocation of resources. burdensome to administer compared to direct An economically efficient carbon price regulations. Carbon pricing works with much less level reflects the present value of environmen- information needed by regulators. Governments can tal damages, and is consistent with long-run set the emission price and firms are then incentivized Efficiency and Cost-Effectiveness  –  29 to find their own costs, benefits and strategies as they Most existing emissions trading schemes seek to comply with the carbon pricing scheme. apply carbon pricing to large emitters at Successful carbon pricing systems take the point of actual emission (downstream). administrative factors into account when Although administration and monitoring costs may designing the scope and selection of a pric- be higher, downstream systems have the advan- ing mechanism. For example, several jurisdictions tage of being more targeted and visible to emitting found that placing a carbon tax on fuel content may facilities and to the public. Emissions trading systems be administratively easier to implement than emis- require empowering existing environmental agen- sions trading in some sectors, such as transport, agri- cies to issue allowances, manage an emissions reg- culture or buildings, where monitoring is a challenge istry and conduct MRV. Trading can be built upon because sources of pollution are small and dispersed existing exchanges, financial institutions and private (Parry et al, 2015). High administrative and transac- consulting companies. Governments may need to tion costs can lead to decisions to exclude some emit- extend the mandate of antitrust agencies and energy- ters or establish payment obligations “upstream” on sector regulators to cover these new responsibilities. the suppliers of fuels that cause emissions when con- Some governments are using hybrid systems, with sumed “downstream” (e.g., at the refinery gate, mine downstream emissions trading for large point sources mouth, processing plant or wholesale import); see, and upstream carbon taxes paid by sources not cov- for example systems put in place by France, Finland, ered by the ETS. For example, Sweden, Denmark, Slovenia and Switzerland (OECD, 2015). Upstream Norway, Poland, and Slovenia apply carbon taxes to carbon pricing can reduce administrative costs, espe- some sources not covered by the ETS. cially if downstream sources of direct emissions are dispersed. For example, British Columbia’s carbon Judicious use of revenues from carbon taxes tax applies to the carbon content in fuels and is paid or emission allowance auctions can produce by fuel distributors. It indirectly covers around 70 additional economic benefits, including fiscal percent of the province’s total emissions from fossil dividends. fuel combustion, including gasoline, diesel, natural gas, fuel oil, propane and coal. It affects residential, Carbon pricing can raise substantial rev- commercial, industrial and municipal fuel use.18 enues. In 2014 an estimated over US$15 billion Carbon taxes applied to upstream suppliers in government revenue was raised through carbon of fossil fuels also reduce administrative costs taxes and ETS sales. About a third of total govern- by making use of existing institutions known ment revenue, was derived from the sale of emission to program participants. For instance, procedures allowances under ETSs. The total revenue in 2014 developed for excise tax purposes—such as practices raised through carbon taxes implemented around the to ensure that fuels do not by-pass prescribed mea- world is estimated at over US$10 billion (World Bank suring points and are taxed only once, and provisions Group, 2015). Hypothetical, potential revenues can to impose levies on imports and exempt exports— be several orders of magnitude higher according to would be similar to those required to run and operate some estimates. Although fossil fuels are a stable tax a carbon tax program. Existing excise legal frame- base—i.e., consumption does not decrease rapidly as works for taxpayer registration, returns, payments, the price goes up—there may be a trade-off between audit, and dispute resolution can be adapted for a fiscal and environmental dividends. In some sectors carbon tax without significant alteration (Metcalf (e.g. power and industry) a carbon price will acceler- and Weisbach, 2009), (Calder, 2015). Moreover, the ate the switch away from fossil fuels and offer cli- training and skills of compliance officers managing mate benefits, while also eroding the revenues from excise taxes would be well suited to applying a simi- fossil fuel taxes. lar regime to a carbon tax (Parry et al, 2015). Productive use of revenues counteracts adverse effects on the economy from higher 18 British Columbia, Ministry of Finance. “Myths and Facts about energy prices and contains overall policy costs. the Carbon Tax,” see http://www.fin.gov.bc.ca/tbs/tp/climate/ One of the most productive uses of revenue is to A6.htm. lower the burden of other taxes—particularly taxes 30  –  The FASTER Principles for Successful Carbon Pricing on personal and corporate income and payroll—that weak tax administration and compliance and with a distort economic activity and harm growth. Carbon large informal sector. Revenues can also be used to pricing can ease the shift to more efficient tax sys- promote the development of clean technologies. For tems, rather than raising overall tax burdens (like example, California, Quebec and the EU allocate a in British Columbia) and reducing strongly distort- portion of ETS auction revenues to designated green ing taxes. Some models show that if the underlying technology funds (EDF/IETA, 2015a). Generally, tax system is distortionary, the smart use of carbon revenue spending possibilities should yield economic price revenues can provide a net economic gain even efficiency benefits at least as large as those from alter- before counting environmental benefits (Jorgenson native revenue uses (e.g., cutting other taxes). Suc- et al, 2015). cessful systems avoid diverting potentially valuable Carbon pricing revenues are sometimes revenues from the budget (e.g., earmarking of rev- used to pay for productive investments in enues) for low-value spending, in particular through health, education and infrastructure. This off-budgetary institutional structures. option can help those countries that suffer from Efficiency and Cost-Effectiveness  –  31 Reliability and Environmental Integrity Successful carbon pricing schemes result in countries (e.g. Ireland, Denmark, Sweden, Slovenia a measurable reduction in environmentally or Poland) have complemented the EU ETS with harmful behavior. carbon taxes covering additional sectors. Korea’s The success of carbon pricing in reducing GHG ETS—the world’s second-largest scheme—covers emissions can be influenced by a number of fac- 66 percent of the country’s emissions, with a focus tors, including the carbon price level and coverage on heavy emitting industry; all six GHGs are cov- of the pricing scheme. Carbon-pricing policies are ered.19 Starting in January 2015, California extended more environmentally effective at any rate level the coverage of its ETS to emissions from the com- when substitutes for emissions-intensive activities bustion of fuels, such as gasoline, diesel, propane and or products are easily available at low cost, reinforc- natural gas. New Zealand’s ETS is the only carbon ing the need for flanking policies to support carbon market scheme in the world that includes emissions pricing mechanisms. Benefits beyond GHG emis- liabilities for land-use sectors: deforestation of pre- sion reduction can result from carbon pricing. The 1990 forest land (as of 2008) and biological emissions choice and design of pricing instrument also matter from agriculture (EDF/IETA, 2013a). for environmental outcomes. Narrowly targeted policies may be easier to implement initially than broader mechanisms Comprehensive coverage of fuels, sectors in view of political challenges. There are often and gases enhances environmental impact, trade-offs between policy coverage and ambition level. but transaction and monitoring costs for Broader price mechanisms that cover many industrial some sources need to be managed. sectors, for example, may need to be less stringent on introduction than more targeted mechanisms. Comprehensive coverage of fuels, sectors In general CO2 emissions from fossil fuel com- and gases enhances environmental impact. The bustion are easier to price than other greenhouse extent to which various emissions sources, sectors gases and are the largest source of emissions. and greenhouse gases are covered by a carbon-pricing It makes sense to price these sources first, gradually mechanism will naturally affect its environmental extending pricing to non-CO2 greenhouse gases like impact, as will the price level. It will also influence a methane and forestry emissions as the needed exper- system’s cost-effectiveness, given that broadly appli- tise and administrative capacity is developed. cable mechanisms optimize a wider range of low-cost abatement options (as discussed under the Efficiency Carbon pricing policies consistent with envi- and Cost-Effectiveness Principle). ronmental objectives are more effective when Most current schemes target specific sectors substitutes for emission-intensive activities or and are not comprehensive (Figure 3 below). products are easily available at low cost. The EU ETS covers 45 percent of the EU’s GHG emis- sions. It focuses on large emitting sources and cov- 19 For more information on the Korean system, see https:// ers CO2 and two other greenhouse gases. Several EU icapcarbonaction.com/ets-map. 32 Executive summary Figure 2 Regional, national, and subnational carbon pricing instruments already implemented or scheduled for implementation: share of global GHG emissions covered Figure 2 Regional, national, and subnational carbon pricing instruments already implemented or scheduled for implementation: Figure 3:  Sectoral share scope of global and percentage GHG emissions covered of emissions covered by the regional, national and sub-national emissions trading schemes. 14% 14% 37 38 12% 36 37 38 12% 35 36 35 10% 31 10% 31 8% 23 8% 23 6% 6% 18 20 14 15 Share of global GHG emissions 10 4% 9 18 20 14 15 Share of global GHG emissions 10 4% 9 Number of 2% implemented instruments Number of 2% implemented instruments 2 4 5 6 7 8 0% 2 4 5 6 7 8 0% 19911991 20012001 20112011 20172017 19971997 20072007 19951995 20052005 20142014 20152015 19941994 20042004 19921992 20022002 20122012 19931993 20032003 20132013 19991999 20092009 19981998 20082008 20162016 19961996 20062006 19901990 20002000 20102010 Finland carbon tax (1990 ) Switzerland carbon tax (2008 ) Shenzhen Pilot ETS (2013 ) Poland carbon tax (1990 ) RGGI (2009 ) Shanghai Pilot ETS (2013 ) Finland carbon tax (1990 ) Switzerland carbon tax (2008 ) Shenzhen Pilot ETS (2013 ) Sweden carbon tax (1991 ) Ireland carbon tax (2010 ) Beijing Pilot ETS (2013 ) Poland carbon tax (1990 ) RGGI (2009 ) Shanghai Pilot ETS (2013 ) Norway carbon tax (1991 ) Iceland carbon tax (2010 ) Tianjin Pilot ETS (2013 ) Sweden carbon tax (1991 ) Ireland carbon tax (2010 ) Beijing Pilot ETS (2013 ) Denmark carbon tax (1992 ) Tokyo CaT (2010 ) Guangdong Pilot ETS (2013 ) Norway carbon tax (1991 ) Iceland carbon tax (2010 ) Tianjin Pilot ETS (2013 ) Latvia carbon tax (1995 ) Saitama ETS (2011 ) Hubei Pilot ETS (2014 ) Denmark carbon tax (1992 ) Tokyo CaT (2010 ) Guangdong Pilot ETS (2013 ) Slovenia carbon tax (1996 ) Kyoto ETS (2011 ) Chongqing Pilot ETS (2014 ) Latvia carbon tax (1995 ) Saitama ETS (2011 ) Hubei Pilot ETS (2014 ) Estonia carbon tax (2000 ) California CaT (2012 ) France carbon tax (2014 ) Slovenia carbon tax (1996 ) Kyoto ETS (2011 ) Chongqing Pilot ETS (2014 ) EU ETS (2005 ) Australia CPM (2012 - 2014) Mexico carbon tax (2014 ) Estonia carbon tax (2000 ) California CaT (2012 ) France carbon tax (2014 ) Alberta SGER (2007 ) Japan carbon tax (2012 ) Korea ETS (2015 ) EU ETS (2005 ) Australia CPM (2012 - 2014) Mexico carbon tax (2014 ) Switzerland ETS (2008 ) Québec CaT (2013 ) Portugal carbon tax (2015 ) Alberta SGER (2007 ) Japan carbon tax (2012 ) Korea ETS (2015 ) New Zealand ETS (2008 ) Kazakhstan ETS (2013 ) South Africa carbon tax (2016 ) Switzerland ETS (2008 ) Québec CaT (2013 ) Portugal carbon tax (2015 ) BC carbon tax (2008 ) UK carbon price floor (2013 ) Chile carbon tax (2017 ) New Zealand ETS (2008 ) Kazakhstan ETS (2013 ) South Africa carbon tax (2016 ) BC carbon tax (2008 ) UK carbon price floor (2013 ) Chile carbon tax (2017 ) Note: Only the introduction or removal of an ETS or carbon tax is shown. Emissions are given as a share of global GHG emissions in 2012. Annual changes in global, regional, national, and subnational GHG emissions are not shown in the graph. Data on the coverage of the city-level Kyoto ETS are not accessible; its coverage is therefore shown as zero. Note: Only the introduction or removal of an ETS or carbon tax is shown. Emissions are given as a share of global GHG emissions in 2012. Annual changes in global, regional, Source: World Bank Group (2015) The State and Trends of Carbon Pricing. national, and subnational GHG emissions are not shown in the graph. Data on the coverage of the city-level Kyoto ETS are not accessible; its coverage is therefore shown as zero. Alexandre Kossoy, Grzegorz Peszko, Klaus Oppermann, Nicolai Prytz, Noemie Klein, Kornelis Blok, Long Lam, Lindee Wong, 12 Bram Borkent. 2015. “State and Trends of Carbon Pricing 2015” (October), World Bank, Washington, DC. Doi: 10.1596/978-1- 12 4648-0725-1 License: Creative Commons Attribution CC BY 3.0 IGO. Reliability and Environmental Integrity   –  33 Pricing mechanisms reduce emissions tears on roads). However, policies that tackle local through a combination of lower emitting activ- problems directly (e.g., congestion charges, charges ity, technological improvement, fuel or prod- for local air pollution, or a ban of the use of solid fuels uct substitution and other behavioral changes. in a city) are usually more effective in solving them. The interaction between these different effects Nonetheless, it is useful to account for some depends both on the type of activity and the cost and domestic environmental benefits when evaluating ease with which low-carbon technologies and prod- carbon pricing proposals. The co-benefits of carbon ucts can be substituted for emissions-intensive alter- pricing will vary considerably depending on local natives. For example, poor households often do not circumstances. For example, carbon prices will have replace old inefficient appliances or insulate houses higher local environmental benefits when local air after the carbon price is passed through to their quality can be improved most efficiently and effec- energy bills. Car owners will not reduce their driving tively through fuel switching than when it can be distances significantly if cities lack convenient and best done by installation of highly efficient filters and safe public transport and bicycle infrastructure. That scrubbers to remove dust and SO2 from coal-fired “stickiness” of technologies and behaviors makes the combustion plants. presence of complementary, supporting policies— addressed in detail in the discussion under the The choice and design of pricing instrument Alignment Principle—particularly important to the matter for environmental outcomes. environmental effects of carbon-pricing policies in certain sectors. In principle, emissions trading systems offer more certainty about the environmental out- Carbon pricing policies can deliver multiple comes than carbon taxes because they rely on benefits, including local environmental and explicit emission caps (unless allocation is output- health benefits. based). The environmental effectiveness of carbon taxes depends on a number of other factors that influ- Multiple benefits result from the success- ence business decisions in emission-intensive activi- ful implementation of carbon pricing policies, ties. Often several years are needed to determine the including a reduction in premature mortal- impact of a tax on emissions. This is because it takes ity, improved air pollution and energy sav- time for businesses and consumers to respond to the ings.20 Carbon pricing can also raise road fuel charges carbon price signal. Ex ante analyses using expected towards levels that more fully reflect adverse side fuel price elasticities or energy technology models effects from vehicle use (carbon emissions, local air may provide a reasonable prediction. A tax offers pollution, traffic congestion and accidents, wear and more certainty about the maximum cost to the regu- lated entities (as discussed under the Efficiency Prin- ciple). 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