What Is Carbon Pricing?

Carbon pricing is an effective policy to tackle climate change.

Carbon pricing refers to an approach taken in decreasing the amounts of carbon emissions. Also known as GHG, greenhouse gas, or simply emissions, carbon emissions are gases that prevent the heat from escaping the Earth. It makes the earth hotter in a phenomenon called the greenhouse effect. Effectively then, carbon pricing is aimed at reducing or getting rid of the greenhouse effect.

Carbon pricing works by placing a cost on carbon pollution thus forcing polluters to reduce the volume of emissions released into the atmosphere. It is one of the strongest frameworks in place in ensuring that the greenhouse effect is effectively tackled so that the environment is protected, climate agreements are met, and the issue of climate change is addressed.

How Does It Work?

Carbon pricing can take a number of forms including:

Carbon Tax

This places a price on emissions and every ton of carbon pollution released has to be paid for by those who release them. These economic players are then forced to look for more efficient fuels that have low emissions because it means less tax. Under this approach, the price per ton of emissions is fixed.

Crediting Mechanisms

Using this tool, emission reductions that arise from projects, the government, or businesses are given credits. These credits then work as points the same way as loyalty points work. Economic players can then buy these credits from such entities and use them. In effect, if the emissions of the economic players are above the required levels, these credits can offset the actual emissions.

Results-based Climate Finance (RBCF)

The RBCF system gives funds to those entities that have met some climate goals that had been initially laid out. This system, just like crediting mechanisms, requires a verified and independent third party to confirm that the climate goals have indeed been met.

Internal Carbon Pricing

This system works internally in entities. These entities factor in their own internal prices of emissions and make decisions based on those figures. This approach then discourages venturing into sectors where the cost of investment is too high. It also helps to prepare companies for future changes in climate policies.

Emission Trading Systems (ETS)

Also called a cap-and-trade system, an ETS works by setting a limit or a cap on emissions from certain sectors. This system works a bit like the crediting mechanism in that it sets up a market for emissions rights. Entities can be flexible with the volume of emissions they wish to produce because they can buy and sell them as they wish. Unlike the carbon tax system, which provides certainty about the price of emissions, ETS provides certainty about the volume of emissions but not the price. The price under ETS depends on the market.

Characteristics Of A Successful Carbon Pricing System

Ultimately, the design of a system varies depending on several factors like the context and the objective. Regardless, there is a guide called The FASTER Principles for Successful Carbon Pricing that helps in coming up with a successful system. The guide was written by the Organization for Economic Co-operation and Development and the World Bank. The six key characteristics are fairness, stability and predictability, aligned policies and objectives, efficiency and cost-effectiveness, reliability and environmental integrity, and transparency.


Despite its good intentions, carbon pricing can fight against itself in some cases. For example, if the policies are not in line with similar ones, inconsistencies could arise. As such, policymakers must work closely to avoid potential collisions such as energy efficiency policies and similar laws. A conflict could undermine carbon pricing thus rendering it ineffective.

Another challenge could arise from something called carbon leakage. This arises from inconsistent carbon pricing policies at different levels such as global and regional. Companies may choose to exploit such loopholes by moving operations to areas where higher emissions are allowed.

Lastly, carbon pricing raises a significant amount of revenue. To make carbon pricing even more effective, these funds have to be channeled back to the system. This can help in things like supporting cleaner technologies, protecting lower-income houses, and other ways. If these funds are not channeled properly, then carbon pricing is hurt and rendered less effective over time.


Ultimately, the effectiveness of carbon pricing rests on the people who make the policies. By working closely and coming up with consistent laws, carbon pricing can be a highly effective tool.


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