Introduction
Basics of Cap-and-Trade
A cap-and-trade system, or emissions trading system (ETS), sets a limit on total emissions or emissions intensity, measured by emissions per unit of GDP This system can encompass all greenhouse gases or focus solely on carbon dioxide Governments allocate allowances, either for free or through auctions, corresponding to the established cap A common practice in ETS markets is a hybrid approach that combines both auctioning and free allocation of emission allowances To effectively manage these markets, firms establish new trading registries that monitor and track carbon allowance transactions, account for carbon offsets, facilitate international linkages, and promote stakeholder engagement.
Basics of Carbon Tax
A carbon tax is a type of Pigouvian tax that aims to internalize the public costs associated with pollution, global warming, and various health and environmental impacts linked to climate change caused by greenhouse gas (GHG) emissions This tax can be applied solely to carbon dioxide emissions, which account for approximately 76% of global emissions, or it can be broadened to encompass all greenhouse gases, including methane.
A carbon tax can be levied based on total emissions, the carbon content of fuel sources, or the volume of fuel produced or supplied This approach, similar to an excise tax, recognizes that different fuels emit varying levels of carbon dioxide (CO2) relative to their energy output Consequently, carbon-intensive fuels like coal face higher effective prices, while less carbon-intensive options, such as natural gas, are priced lower Additionally, the tax may target specific sectors and fuel products to enhance its effectiveness.
When designing an effective carbon tax system, key considerations include selecting the right price for carbon emissions, determining the scope of emissions coverage, and deciding whether to implement taxation upstream or downstream Additionally, it's important to establish a planned escalation of the tax rate over time to ensure stringency, while allowing for flexibility in pricing based on updated information regarding the marginal cost of abatement Furthermore, the allocation of the revenue generated from the tax should be carefully considered, whether for general public spending or targeted emissions-reducing initiatives Lastly, achieving harmonization across jurisdictions is crucial for the overall effectiveness of the carbon tax.
Hybrid Approaches
Countries are increasingly recognizing the benefits of implementing both carbon taxes and cap-and-trade schemes, or creating hybrid policy instruments that incorporate elements of both While some governments may opt for a carbon tax to showcase their commitment to emission reductions, others might view new taxes as politically risky and instead choose to adopt cap-and-trade systems for specific sectors Additionally, regions that engage in emissions-trading at higher governance levels, such as supranational regimes, often also implement domestic carbon taxes.
Four distinct hybrid approaches in carbon pricing regimes have been identified The first involves countries that implement a carbon tax in certain sectors while employing cap-and-trade in others, with examples like Norway and Ireland, where the carbon tax applies to sectors not fully covered by the EU ETS The second approach features cap-and-trade systems with a price collar, creating an effective carbon tax at both minimum and maximum permit prices, as seen in the United Kingdom The third approach is characterized by the simultaneous use of cap-and-trade and carbon tax without coordination, potentially leading to cost inefficiencies Lastly, there are programs where a carbon tax jurisdiction is linked to a cap-and-trade jurisdiction, though no instances of hybrid international linking currently exist between these two systems.
A carbon offset is a tradable certificate representing the reduction of emissions achieved through environmentally focused investments, including landfill methane capture, reforestation, renewable energy projects, energy efficiency improvements, and the elimination of harmful pollutants like HFCs and PFCs To be valid, these offsets must meet specific criteria, ensuring that the carbon emissions reductions are additional and would not have occurred without the investment project.
In a linked market, total allowable emissions represent the combined limits across interconnected regions Allowances can be traded among covered entities within these regions, leading to similar allowance prices across the linked areas.
National and Sub-National Policies: Cap-and-Trade Systems
EU ETS
Launched in 2005, the EU Emissions Trading System (EU ETS) serves as a key policy instrument for the European Union to fulfill its commitments under the 1997 Kyoto Protocol to the UN Framework Convention on Climate Change (UNFCCC) Currently, the program encompasses 28 member states.
The EU Emissions Trading System (ETS) includes EU member states along with Iceland, Liechtenstein, and Norway, covering approximately 11,000 entities responsible for 45% of the EU's greenhouse gas emissions (1,988 MMT CO2e) across various sectors The ETS has undergone three trading phases, with phase three (2013–2020) implementing a yearly allowance cap reduction of 1.74% Key features of this phase include the introduction of a market stability reserve (MSR) in 2019, restrictions on banking and borrowing to one year, a cap on offsets at 50% of total emissions reductions, and a noncompliance penalty of €100 per ton of regulated emissions Additionally, 50% of auction revenues are allocated to climate and energy-related investments.
The EU ETS has introduced significant features such as declining allowance cap rates and a market stability reserve (MSR) to enhance liquidity management, addressing challenges faced during its initial phases Additionally, the program's strategy to progressively increase allowance auctioning has proven successful, generating approximately €14 billion from 2012 to 2016, with over 50% of the revenue allocated to climate and energy initiatives, according to the European Commission (2017).
The persistent low prices of allowances in the EU ETS system raise significant concerns, particularly due to over-allocation, which has impacted total emissions reductions since the system's inception The European Commission reports a 4.5% decrease in emissions from 2011 to 2015, with studies estimating reductions of 2.5 to 5% during phase one and 6.3% from 2008 to 2009 in phase two However, much of this reduction is linked to the 2008 economic crisis rather than the effectiveness of the EU ETS itself With the implementation of new measures to address the allowance surplus in phase three, the ETS is expected to drive more substantial emission reductions post-2025.
Switzerland ETS and Carbon Tax Hybrid
Switzerland follows a hybrid approach to reducing its GHG emissions with a carbon tax (i.e., the CO levy
Switzerland's innovative approach to carbon taxation, which exempts businesses from its CO2 levy in exchange for participation in the voluntary emissions trading system (ETS), is a significant factor in gaining political support for transitioning to a comprehensive ETS Additionally, aligning its ETS regulations with those of the EU for the second compliance period and including aviation under an emissions cap further strengthens Switzerland's strategy to connect with the EU ETS In January 2016, the Swiss government officially agreed to link its ETS with the EU ETS market, marking a pivotal step in its climate policy.
Switzerland faces high marginal abatement costs, making it essential to implement cost-effective policies to achieve its 2020 goal of reducing greenhouse gas emissions by 20% compared to 1990 levels The Swiss Emissions Trading System (ETS) has not proven to be more cost-effective than the existing carbon tax, with minimal trading activity observed during the initial years of the 2013-2020 commitment period A report from the Swiss Federal Audit Office revealed that the allocation of 80% of allowances for free and low market prices have diminished incentives for emission reductions among participants Currently, there is a lack of literature assessing the impact of the Swiss ETS on the nation's overall emissions reduction efforts.
Regional Greenhouse Gas Initiative (RGGI)
The Regional Greenhouse Gas Initiative (RGGI) addresses 23% of greenhouse gas emissions from nine northeastern U.S states, representing 2% of total U.S emissions, by regulating CO2 emissions from 165 electricity-generating units This transparent system employs full auctioning of allowances, with a cap that decreases by 2.5% annually until 2020 and by 3% thereafter It includes a price floor of $2.15, an allowance reserve to stabilize permit prices, and allows unlimited banking of allowances Additionally, RGGI permits offsets of up to 3.3% of emissions obligations and undergoes periodic adjustments through consultative reviews.
The Regional Greenhouse Gas Initiative (RGGI) stands out for its transparency and dedication to regular program evaluations, allowing for necessary adjustments to its emissions trading system (ETS) (Rahim 2017) With a focus on full auctioning of allowances, RGGI has generated significant revenue, totaling $2.7 billion to date, which is reinvested into various emissions-reducing initiatives (Ramseur 2017; RGGI Inc 2005) This initiative has successfully contributed to a remarkable 57% reduction in regional greenhouse gas emissions.
Between 2005 and 2016, CO2 emissions experienced notable reductions, with estimates suggesting that without the Regional Greenhouse Gas Initiative (RGGI), emissions could have been 24% higher Although these decreases cannot be exclusively credited to RGGI due to the influence of other policies, the program has played a significant role in mitigating carbon emissions during this period.
The Regional Greenhouse Gas Initiative (RGGI) primarily focuses on CO2 emissions from electricity generation units with a capacity of over 25 megawatts However, its limited scope excludes other greenhouse gases and sectors, which restricts the program's overall effectiveness in reducing emissions across the region.
California Cap-and-Trade
The California cap-and-trade program, initiated in 2013 under the Global Warming Solutions Act of 2006 (AB 32), mandates a reduction of greenhouse gas emissions to 1990 levels by 2020 In its first compliance phase (2013–2014), the program addressed 35% of the state's emissions across all six major greenhouse gases By the second compliance period (2015–2017), the program expanded to regulate 85% of California's emissions, offering free allowances to electric utilities and industrial facilities, while auctioning or providing fixed-price allowances for sectors like transportation Revenue from these auctions is dedicated to climate change projects Additionally, the program features a $10 price floor with a 5% annual increase and permits offsets for up to 8% of a firm's emissions.
The California CAT program features a well-structured ETS that includes a price-containment reserve, enabling regulators to adjust market allowances as needed It also links internationally with the Québec cap-and-trade program and provides free allowances to energy-intensive and trade-exposed industries to mitigate leakage With rigorous monitoring of allowances, offsets, and emissions reductions, the program has led to a 9% decrease in emissions below the 2014 cap of 160 MMTCO2e Furthermore, CARB estimates that California is on track to achieve 1990 emission levels by 2020.
The CAT program has encountered legal challenges and issues related to carbon leakage due to resource reshuffling by electric utilities, jeopardizing its integrity (Cullenward 2014) Additionally, California's complementary emissions reduction policies, including vehicle emissions standards, renewable portfolio standards, and energy efficiency programs, may undermine the effectiveness of the CAT program This situation creates market uncertainty for regulated entities, as they remain uncertain about the state's ability to meet its future policy goals and the potential impact on allowance prices (Diamant 2013).
Québec Cap-and-Trade
In 2009, Québec adopted a GHG emissions reduction goal of 20% below 1990 levels by 2020 In 2011, Québec initiated its emissions trading scheme with its first compliance period beginning in 2013 Subsequently in
In 2014, the program established a formal connection with California's cap-and-trade system, resulting in the largest carbon market in North America and the first sub-national program to achieve international linkage As of now, the program sets an emissions cap at 65 million metric tons of CO2 equivalent (MMTCO2e) with a scheduled annual reduction of 4%.
In Québec, 132 entities are responsible for 85% of the province's greenhouse gas (GHG) emissions, receiving free allowances that decrease by 1 to 2% annually The auction revenues are directed to the Québec Green Fund, while a price floor is established, averaging the highest minimum price between California and Québec markets Additionally, the province maintains an allowance price containment reserve and employs rigorous and transparent monitoring, reporting, and verification (MRV) processes to ensure compliance and effectiveness.
Noteworthy Features: Québec’s stringent MRV process ensures the integrity of the cap-and-trade program
Severe monetary and criminal consequences are possible for non-compliance, fraud, under-reporting, or failure to surrender credits (Environmental Quality Act 2017) The program is also notable for its dedicated
The "Green Fund" is designed to allocate funds from auctioned revenues towards initiatives that reduce emissions Although definitive data on the program's impact on provincial emissions is not yet available, estimates from 2013 indicated a 7.5% reduction compared to 2005 levels (Government of Canada 2016).
Québec's cap-and-trade system faces limitations in finding appealing opportunities for emissions reduction, primarily because of its already low emissions levels However, connecting with California's cap-and-trade program is expected to enhance trading options and lower the marginal costs of emissions abatement.
New Zealand ETS
In 2008, New Zealand established the Emissions Trading Scheme (NZ ETS) through legislation to fulfill its international commitments under the Kyoto Protocol, aiming to achieve cost-effective emissions reductions while enhancing the economy's long-term resilience Initially, the ETS encompassed all sectors without a national emissions cap until 2015 Starting in 2016, the scheme introduced a nationwide emissions-intensity cap, implemented upstream regulations in the energy sector, and allowed voluntary participation for downstream users, alongside output-based grandparenting of allowances for eligible energy-intensive trade-exposed (EITE) sectors like agriculture, with a gradual phase-out of free allowances set for 2030.
Despite meeting its Kyoto obligations during both commitment periods, New Zealand's Emissions Trading Scheme (NZ ETS) has not achieved substantial domestic emissions reductions due to its structure Research by Bertram and Terry (2010) indicates that emissions decreased by only 23 MMTCO2e in 2008 and 19 MMTCO2e in 2009 Bullock (2012) highlights that the integrity of the ETS has been compromised by agricultural interest groups, hindering necessary technological advancements and emissions reductions Additionally, the provision of free allowances to emissions-intensive trade-exposed (EITE) firms, a lack of a nationwide emissions cap, and an international offset cap until 2015 enabled many participants to fulfill their obligations without making significant reductions in their emissions.
Republic of Korea ETS
In 2012, South Korea established the 'Allocation and Trading of Greenhouse Gas Emissions' Act, which initiated the Korean Emissions Trading Scheme (KETS) in January 2015 The KETS allocates emissions allowances based on historical greenhouse gas emissions, both at the electricity generation level and at the consumption stage, while also benchmarking allowances for various sectors Key features of KETS include an allowance price containment reserve, a reserve auction price of €12, credits for emissions reductions achieved before joining the scheme, unlimited banking with a borrowing limit of 20% within phases, offsets up to 10% of a firm's obligations, and a non-compliance penalty of up to $70 per ton of regulated emissions.
The Korean ETS has implemented key features, including well-defined timelines and a strategic governance framework, alongside an independent allowance committee These measures aim to stabilize the market and offer support for losses experienced by participating entities.
In 2016, a notable program was established that introduced a Greenhouse Gas (GHG) and Energy Target Management System (TMS), facilitating firms in the monitoring and verification of emissions data before the implementation of the Korean Emissions Trading System (KETS) This initiative reflects important lessons learned from previous emissions trading system (ETS) implementations, enhancing the overall effectiveness of the program.
Constraints: It is too early to tell whether KETS has helped Korea achieve its NDC commitment of
By 2030, emissions are expected to be reduced by 37% compared to business-as-usual (BAU) scenarios However, issues such as emissions leakage due to noncompliance in downstream electricity consumption, insufficient market liquidity, and the politically influenced allocation of allowances have undermined confidence in the emissions reduction system (Kim 2015; PMR and ICAP 2016).
China — Provincial ETS Pilots
In 2011, the Chinese government launched seven pilot ETS programs for CO2 emissions in regions including Beijing, Tianjin, and Shanghai, with full implementation expected by 2015 These pilots addressed indirect electricity emissions and included allowances for imported electricity While most regions allocated allowances for free, Guangdong, Shenzhen, and Hubei incorporated a small percentage of auctioning, differing in their allocation methods Additionally, all pilots accepted offsets through Certified Emission Reductions (CERs) and implemented market stabilization mechanisms such as price ceilings, allowance reserves, and buy-back options to manage surplus allowances effectively.
Chinese ETS pilots stand out for their unique allowance allocation and distribution methods, which are tailored to the specific structural and economic conditions of each jurisdiction.
Key challenges identified in the seven pilot programs include incomplete reporting practices, a lack of a legal framework for compliance enforcement, and weak penalties (Yu and Lo 2015) A 2015 survey of Chinese firms indicated that the carbon price did not effectively encourage companies to adopt advanced mitigation technologies; instead, most firms viewed participation in the ETS pilots primarily as a way to strengthen government relations and enhance their social reputation (Yang, Li, and Zhang 2016).
Table 1: Design Details of Cap-and-Trade Systems
California Québec New Zealand Republic of
Jurisdiction 28 EU-member states, plus
Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont
California Québec New Zealand South Korea Beijing, Tianjin,
Shanghai, Chongqing, Shenzhen, Guangdong, Hubei
Federal Office of the Environment RGGI, Inc California Air
Minister of Sustainable Development, the Environment and the Fight Against Climate Change
Ministry of the Environment, Environmental Protection Authority, Ministry of Primary Industries
Ministry of Strategy and Finance
Development and Reform Commissions of each region
1st period (2013-14), 2nd period (2015-17), 3rd (2018-20)
1st period (2013-14), 2nd period (2015-17), 3rd (2018-20)
Cap, metric tons of CO 2 - equivalent
Cap equals the amount of free allocations.
Although in phase 3 auctioning is the default method for allocating emission allowances to companies participating
Free allocation based on industry benchmarks, similar to EU ETS Free allocation to non-exposed sectors to be
Full auction Allowance Alloca- tion method is mixed between auction and free allocation
Electric utilities, industrial facili- ties, and natural gas distributors,
Mixed, electricity and fuel distributors must buy 100% of allowance requirements; sectors exposed to international competition
Mixed, 90% free allocation for high EITE entities, 60% free allocation for moderately EITE
For Phase I, 100% of allowances have been freely allocated In Phase II, 97% of allowances will be freely allocated; and in
Tianjin: Mixed, free allocation (major) auction and fixed price distribution
California Québec New Zealand Republic of
Borrowing Banking is allowed since phase 2, borrowing is restricted to within one-year
Inter and intra- phase banking of allowances is allowed
Borrowing is not allowed in the current period
Compliance entities may bank CO 2 allowances, without limitation, until the allowances are used to satisfy compliance or transferred to another account
RGGI prohibits regulated entities from using future allowances to satisfy compliance in advance of the year associated with the allowance
Banking is allowed but the emitter is subject to a general holding limit Borrowing of future vintage allowances is not allowed.
Banking is allowed but the emitter is subject to a general holding limit Borrowing of future vintage allowances is not allowed.
Banking allowed of allowance credits, except for those purchased under the fixed price option
Banking of allowances between years and compliance periods is allowed
Borrowing between compliance periods is not allowed, whereas entities may borrow up to 10% of allowances from within the compliance period
No borrowing, Banking is allowed during pilot phase
Reserve will begin operation in 2019, aims to stabilize market and price of allowances
Allowances added to reserve is total circulation higher than
No price containment provisions currently exist
Cost Containment Reserve (CCR) is a fixed additional supply of CO 2 allowances that are only available for sale if CO 2 allowance prices exceed $4 in
2016, and $10 in 2017, rising by 2.5 percent each year thereafter.
The auction reserve price increases annually by 5% plus inflation, as measured by the Consumer Price Index
Price ceiling for allowances tiered at
$63.37 Tier prices increase by 5% per year, plus inflation
The auction reserve price increases annually by 5% plus inflation, as measured by the Consumer Price Index
Price ceiling for allowances tiered at
$63.37 Tier prices increase by 5% per year, plus inflation
67% allowance surrender obligation from 2017, increases to 83 in 2018, and full surrender obligation in 2019
According to the Phase I National Allowances Allocation Plan, an allowance reserve of approximately
88 million tCO2e of allowances, has been created for market stabilization measures and distribution to new entrants
Regulating authority can auction extra allowances if average weighted price exceeds $22.75 and buy back allowances if price falls to $3
Price floor set at roughly $1.5
Offsets The overall use of credits is limited to
50% of the EU wide reductions over the period
Covered entities can utilize either the amount permitted in Phase II or up to 11% of their allocated allowances from Phase II, depending on which option is greater.
Up to 4.5% of actual emissions between 2013–2020
Up to 3.3% of regulated entities allowance commitment
Up to 8% of each entity's compliance obligation
Up to 8% of each entity's compliance obligation
Unlimited, international offsets are not eligible
Up to 10% of their allowance submission obligations
Beijing: Tianjin: 10% Shanghai: 5% Chongqing: 8% Shenzhen: 10% Guangdong:
10%, of which 70% of offsets must be located in Guangdong province
California Québec New Zealand Republic of
(individual states may add more GHG emissions)
CO 2 , NO 2 , CH 4 , HFCs, NF 3 , SF 6 , PFCs
SF 6 , HFC, PFCs CO 2 , CH 4 , N2O,
Tianjin: 197 Shanghai: 191 Chongqing: 230 Shenzhen: 635 Guangdong: 830 Hubei: 107
Tianjin: 45% Shanghai: 60% Chongqing: 40% Shenzhen: 40% Guangdong: 60% Hubei: 33%
Coverage overlap with carbon taxes
Switzerland has a carbon levy that covers some entities if they are not covered under the Swiss ETS Entities can voluntarily participate in the ETS
No carbon taxes exist in RGGI states
No carbon taxes exist in California
No carbon taxes exist in Québec
No carbon taxes exist in New Zealand
No carbon taxes exist in South Korea
No carbon taxes exist in China
California Québec New Zealand Republic of
The sectoral coverage includes power plants with a thermal rated input of over 20MW, as well as energy-intensive industries such as oil refineries, coke ovens, and the production of iron and steel Additionally, it encompasses the manufacturing of cement clinker, glass, lime, bricks, ceramics, pulp and paperboard, aluminum, and various petrochemicals, including ammonia, nitric acid, adipic acid, glyoxal, and glyoxylic acid.
CO 2 capture, transport in pipelines, geological storage of CO 2 , flights between
Cement, chemicals, refineries, paper, heat and steel over 20MW of thermal input.
CO 2 emissions from fossil fuel-fired power plants with a capacity of 25
MW or greater within a RGGI state
Large industrial facilities in California encompass a diverse range of sectors, including cement, glass, hydrogen, iron and steel, lead, lime, nitric acid production, petroleum and natural gas systems, refining, and pulp and paper manufacturing, along with co-owned cogeneration facilities Additionally, the state's energy landscape includes electricity generation, imports, and various forms of stationary combustion Key players in this ecosystem are CO2 suppliers, natural gas providers, suppliers of reformulated blend stock for oxygenate blending (RBOB), distillate fuel oil, liquid petroleum gas, and liquefied natural gas, all contributing to California's industrial and energy supply chain.
≥25,000 tCO2e (metric) per data year
Electricity, Industry with emissions greater than 25,000
CO 2e /year, transport and building sectors
Sectors gradually phased-in, forestry (2008), stationary energy, industrial processing, liquid fossil fuels (2010), waste and synthetic GHGs (2013)
The industry, power generation & energy, building, transportation and waste sectors are covered, which are further divided into
Beijing: 17 manufacturing industries, commercial buildings, public utilities Greater than 10,000 tons
CO 2 per year Heat and electricity production, iron, steel, nonferrous metal, petrochemicals, pulp and paper, glass, cement Tianjin: Oil and gas exploration, buildings Greater than 20,000 tons/
CO 2 per year for industry, 10,000 tons/CO 2 per year for other sectors Heat and electricity production, iron, steel, nonferrous metal, petrochemicals, pulp and paper, glass, cement
Shanghai: Textiles, commercial buildings, airlines Greater than 20,000 tons/CO 2 per year Heat and electricity production, iron, steel, nonferrous metal, petrochemicals, pulp and paper, glass, cement
CO 2 per year Heat and electricity production, iron, steel, nonferrous metal, petrochemicals, pulp and paper, glass, cement.
Shenzhen: 26 manufacturing industries, commercial buildings and transportation Greater than 5,000 tons/
CO 2 per year Heat and electricity production, iron, steel, nonferrous metal, petrochemicals, pulp and paper, glass, cement.
Guangdong: Textiles, commercial buildings, transportation Greater than 20,000 tons/
CO 2 per year Heat and electricity production, iron, steel, nonferrous metal, petrochemicals, pulp and paper, glass, cement.
Greater than approximately 120,000 tons/CO 2 per year Heat and electricity production, iron, steel, nonferrous metal, petrochemicals, pulp and paper, glass, cement.
California Québec New Zealand Republic of
At least 50% of auction revenues must be distributed for climate and energy related purposes
At least 25% must be allocated for
"consumer benefit or strategic energy purposes"
The allocation of funds includes 25% for high-speed rail projects, 20% for affordable housing and sustainable community programs, 10% for intercity rail initiatives, and 5% for low-carbon transit options Additionally, at least 25% of the proceeds must be invested in projects that directly benefit disadvantaged communities, with a minimum of 5% specifically aimed at low-income communities and another 5% targeting other disadvantaged groups.
Climate Change Action Plan, waste and recycling, water protection, and other environmental issues, administrative costs, and environmental permits, dams
Auction revenue allocated to individual state authorities
Auction revenue allocated to individual state authorities
Greenhouse Gas Reduction Fund (GGRF)
California Québec New Zealand Republic of
Current allowance price per ton of CO 2e
Current allowance price per ton of CO 2e
Coverage adjusted carbon price per ton of CO 2e
California Québec New Zealand Republic of
EITE protection Receive free allowances for transition assistance and to prevent leakage
2018, transition assistance declines The amount of free allocation is determined by leakage risk (measured through emissions intensity and trade exposure) and sector-specific benchmarks
90% free allocation for high EITE entities, 60% free allocation for moderately EITE
Manufacturing sub-sectors deemed at high risk for carbon leakage receive 100% free allocation
Sectors not deemed to be at risk of leakage will draw down free allowance allocation from
Sectors that qualify for free allowances include those with production costs of 30% or higher, trade intensity levels of 5% or more, or a combination of production cost rates of 5% or above along with trade intensity levels of 10% or more.
International linking Soon to be linked with
Soon to be linked with EU ETS markets
No international linkage Linked with
Linked with California ETS in 2014
No international linkage No international linkage No international linkage
(Z Zhang 2015); (Xiong et al 2017); Swartz, J 2016)
Comparative Analysis of Cap-and-Trade Systems
Emissions Cap
Emissions caps can be set as absolute limits on greenhouse gas (GHG) emissions or as caps on GHG intensity relative to GDP The cap level can be determined through a top-down approach, which imposes calculated emission reductions across an entire economy, or a bottom-up approach, where participating entities report their potential emissions reductions For an effective top-down cap, regulators need accurate data on current and projected emissions, while a reliable bottom-up cap requires comprehensive information on the emissions-reduction capabilities of participating entities However, an information asymmetry exists, as firms possess crucial data that regulators lack Both the EU Emissions Trading System (ETS) and the Swiss ETS initially utilized a bottom-up method for setting emission targets, with the EU allowing member states to establish national caps based on historical emissions In contrast, Switzerland assessed the emissions-abatement potential of each firm before distributing allowances, although this approach led to significant over-allocation issues.
The EU ETS has responded to a significant price collapse by consolidating emissions caps from all member states into a unified EU-wide cap that decreases annually by 1.74% To facilitate this, the EU implemented the EU Transaction Log (EUTL) to monitor allowance trading among member countries Similarly, Switzerland has adopted a mandatory emissions cap for all participants in its second compliance period, also reflecting the annual 1.74% reduction.
RGGI, California, Québec, and KETS established top-down emissions caps based on projected levels influenced by anticipated economic growth Despite these projections, RGGI's initial cap of 188 million tons in 2005 was too high, as actual emissions reached only 124 million tons at the program's 2009 launch Factors such as improved energy efficiency, an economic downturn, a shift from coal to natural gas, and a transition to nuclear, wind, and solar energy contributed to this over-allocation Consequently, RGGI adjusted its approach, implementing a 44% lower cap for the next compliance period with a 2.5% annual reduction until 2020 In contrast, while the EU ETS and RGGI faced issues with miscalculated caps, the credibility of Korea's ETS was questioned due to its reliance on manufacturing for abatement targets, overlooking the input from environmental groups and civil society.
The New Zealand Emissions Trading Scheme (NZ ETS) has implemented an intensity-based nationwide cap since 2016, which may result in fluctuating abatement costs annually due to the economy's heavy reliance on weather-dependent agriculture, contributing 47% to the GDP Even if the NZ ETS transitions to an absolute emissions cap in the future, it will still need to forecast agriculture-driven GDP growth in advance to determine a suitable cap level.
Finally, the Chinese ETS pilots vary significantly in the way they set their emissions targets with
Between 2013 and 2015, Chinese cities adopted varying approaches to emissions caps, with Guangdong implementing an absolute cap to support industrial growth, while Hubei adjusted its cap downward to align with emerging economic trends In contrast, Chongqing consistently reduced its cap by 4.13% annually, and cities like Beijing, Shanghai, Tianjin, and Shenzhen maintained their existing caps The economic assessments regarding current and future CO2 emissions in these regions remain unclear, highlighting the diverse economic conditions across Guangdong, Shanghai, and Shenzhen during this period.
Allowance Allocation and Distribution
After establishing the emissions cap, policymakers face the choice of auctioning or freely allocating allowances Common methods for free allocation include grandfathering, fixed sector benchmarking, and output-based allocation Allowance calculations are based on factors such as historical emissions, emissions intensity, industrial benchmarks, early-action incentives for emissions-reducing activities, and rolling baseline years for updated benchmarking Each Emissions Trading System (ETS) employs a unique combination of these elements to determine free allowance allocations for firms.
The EU ETS began with a free, grandfathered allowance allocation method based on historical emissions reporting by firms, but has since evolved to a benchmarking system that factors in product emissions and historical production while considering potential carbon leakage Similarly, California started with free allocations calculated from a three-year moving average of industry output, adjusting for carbon leakage and progressively reducing the cap In its second trading period (2013–2020), California adopted a combination of free allocations, auctions, and fixed price allowance sales across sectors Québec initially allocated free allowances based on historical emissions intensity, but later harmonized its ETS with California in anticipation of linking the two systems The Swiss ETS enhances protections for its energy-intensive and trade-exposed sectors by providing most allowances for free, along with early-action credits and redistribution benefits from CO2 levy revenues for participating firms exempt from the levy.
The New Zealand Emissions Trading Scheme (NZ ETS) has provided preferential treatment to its emissions-intensive and trade-exposed (EITE) sectors, such as agriculture and land use, by allocating free allowances based on historical emissions data These allowances were fixed until 2018, with a gradual phase-out beginning in 2019, leading to a complete transition to auctioning by 2030.
In 2012, following a government change, New Zealand implemented a "transition period" allowing non-forestry sector participants to meet only half of their emission obligations, with a price cap of 25 NZ dollars and limited convertibility of allowances to international offset units This measure aimed to shield emitters from the full compliance costs However, to align with climate change targets and encourage firm-level emissions reductions, the government decided to phase out the one-for-two transitional measure by 2019.
Korea’s ETS established its emissions target primarily by consulting with its EITE sectors In addition, in
In 2015, the KETS program began by allocating allowances freely and providing early action credits to new entrants, with allowances determined at the firm level based on historical emissions (Song, Lim, and Yoo 2015; Park and Hong 2014) The program utilized regional benchmarks for electricity intensity, applying a decline coefficient to the historical average carbon intensity (Xiong et al 2017) Similarly, Shanghai incentivizes early movers with a rolling baseline year, allowing enterprises to benchmark their emissions against the latest data if their emissions increased significantly from 2009 to 2011 In contrast, Guangdong and Hubei follow Shanghai's model without early-action incentives, while Chongqing relies on self-declared emission reductions Shenzhen allocates 90% of its allowances for free, using industrial benchmarks and implementing a post-allocation adjustment process based on actual versus expected emissions, requiring firms to report annually (Ye et al 2015) Among the seven pilots, Beijing, Shenzhen, and Hubei adopt California's hybrid approach of distributing allowances through free allocation, auctions, and fixed price sales, while Shanghai, Tianjin, and Chongqing provide allowances entirely for free, and Guangdong employs a mix of free distribution and auction methods (Xiong et al 2017).
Liquidity and Price Control Mechanisms
Liquidity in secondary markets is crucial for ensuring that allowance prices accurately reflect the true marginal cost of abatement The turnover ratio, which compares total allowances traded in the secondary market to total allocations issued, provides valuable insights into the liquidity of emissions trading systems (ETS) After 2014, the EU, RGGI, and California exhibited average turnover ratios exceeding 15%, demonstrating active market trading In contrast, Guangdong, Shanghai, and Shenzhen reported significantly lower turnover ratios of 0.54%, 1.48%, and 2.12%, respectively Additionally, the Korean ETS (KETS) faced severe liquidity issues, with a turnover ratio of only 0.05% during its first compliance period (2015–2017) In response, the Korean government relaxed regulations and increased borrowing limits, yet market activity has remained stagnant since 2016 Factors contributing to this lack of liquidity may include over-allocation, imperfect information for emitters, and complementary policies that lead to simultaneous emission reductions.
Table 2: Turnover Ratio of Cap-and-Trade Systems
ETS System Turnover Ratio = Allowances traded/Allowances issued
Switzerland N/A No evidence of active trading
New Zealand N/A No evidence of activing trading of domestic NZ allowance units.
China — Pilots Guangdong — 0.54%, Shanghai — 1.48% and Shenzhen — 2.12% (2013–2014)
Sources: (European Energy Exchange 2017); (Climate Policy Initiative 2017); (RGGI 2017); (Intercontinental Exchange 2017), (Munnings et al 2016)
In the initial phases of the EU ETS, RGGI, California, and New Zealand, excess allowances emerged in secondary markets due to over-allocation The EU faced a staggering over-allocation of nearly 900 million allowances, leading to a complete price collapse during its first compliance period, primarily caused by grandfathered permits tied to reported emissions from member states The second compliance period also saw over-allocation, further exacerbated by the economic downturn, despite a 6.5% reduction in allowances and the auctioning of 10% of the total.
The Market Stability Reserve (MSR) was established in 2019 to balance the supply and demand of allowances by managing surpluses and addressing shortages (European Commission 2017; Hu et al 2015) The EU plans to enhance the MSR's capacity to absorb excess allowances (Meadows 2017) Similarly, the Regional Greenhouse Gas Initiative (RGGI) and California experienced initial market liquidity issues and price volatility due to overestimated growth projections, leading to excessively high emissions caps To mitigate these challenges, both regions implemented a price floor and created an allowance price containment reserve, allowing regulators to adjust market liquidity effectively (see Table 1).
New Zealand experienced a significant surplus of liquidity due to an excess of Kyoto offset credits in its trading market, causing the NZ ETS allowance price to plummet from $20 in May 2011 to just $2 by May 2013 Unlike California's system, the NZ ETS lacked a cap or price-based circuit breaker for international offset credits until 2015 In response to this issue, the NZ ETS implemented a nationwide emissions cap and restricted access to international Kyoto offset credits during its second compliance period.
The Québec and Swiss ETS programs faced significant liquidity issues due to their small market sizes, which limited attractive emission reduction opportunities and resulted in high compliance costs In 2013, prior to linking with California, allowance prices in Québec ranged from $37 to $43 per ton, three times higher than current prices in the linked market Currently, Québec has an allowance price containment reserve that is aligned with California's system, enhancing market stability and efficiency.
Leakage and Gaming of Emissions Allowance Markets
Carbon leakage and manipulation of emissions allowance markets have been observed in various Emissions Trading Systems (ETS) In the Korean ETS (KETS), carbon leakage manifests as non-compliance, particularly as transport fleets may shift to unregulated vehicles due to reporting requirements on fuel use In New Zealand, carbon leakage has been linked to the introduction of Kyoto offsets and HFC-23-related credits from other markets, which compromised the credibility and environmental integrity of the NZ ETS While the new intensity-based allocation in the NZ ETS may mitigate domestic carbon leakage, it risks prompting international leakage, as emitters from countries with stricter emission regulations may relocate to New Zealand.
Between 2008 and 2011, certain firms exploited the EU ETS, leading to a €5 billion loss in national tax revenues by purchasing EU allowance units (EUA) in countries without value added tax (VAT) and selling them in VAT-applying countries without remitting the tax In response, the EU implemented a directive that allowed member states to adopt a VAT reverse mechanism, shifting the VAT payment responsibility to the entities purchasing the allowances Similarly, California has experienced leakage as regulated utilities maneuver resources through out-of-state electricity purchases.
International Linkage
Linkage between Emission Trading Systems (ETS) can occur in three ways: unilateral links, where one ETS accepts the compliance instruments of another; bilateral links, where both systems recognize each other's compliance instruments or share common rules; and indirect links, where an ETS connects to another through a third market These linkages can enhance cost-effectiveness, improve liquidity and price stability, reduce emissions leakage, and lower transaction costs The likelihood of establishing such linkages increases when jurisdictions share similar environmental objectives, economic conditions, a history of collaborative engagement, and familiarity with each other’s regulatory and political frameworks.
California's cap-and-trade program has been internationally linked with Québec since 2014, facilitated by extensive communication between the two governments dating back to 2008 They established a shared electronic allowance registry to prevent gaming and double-counting, while implementing strong verification measures to ensure the integrity of allowance credits and offsets To promote price stability, a price floor was set at the highest minimum price between the two regions in USD This linkage has enhanced liquidity in Québec’s cap-and-trade market, potentially allowing it to purchase between 14.4 and 18.3 million allowances from California, based on projected demand.
In 2018, Ontario plans to connect its newly launched cap-and-trade program with those of Québec and California, significantly expanding the pool of tradable allowances and offsets available in the market.
The Swiss ETS has aligned its compliance instruments with the EU ETS during its second trading period, presenting an opportunity for increased market liquidity and reduced carbon leakage, given its modest emissions cap of 5.3 MMTCO2e Linking with the EU ETS could alleviate competitiveness concerns for Swiss companies, as a significant portion of their trade—60% of exports and 78% of imports—occurs within the EU Meanwhile, the KETS has potential for linkage with neighboring systems like the Tokyo-Saitama ETS or the EU ETS, but it has shown limited learning from the Québec-California linkage regarding its liquidity challenges.
Diaz-Rainey and Tulloch (2015) highlight the complexities of the New Zealand Emissions Trading Scheme (NZ ETS), emphasizing the risks and benefits associated with its tacit connection to global carbon markets They note that the issue of carbon leakage, exacerbated by the influx of international offsets, compelled the NZ ETS to sever its ties with the Clean Development Mechanism (CDM) and offset markets.
2015 and move towards a domestic market (Bullock 2012) The EU ETS also delinked from the international CDM market in 2012.
Carbon Revenue Management
In 2015, carbon pricing policies worldwide generated $26 billion in revenue, which can be utilized for various purposes, including climate change mitigation, reducing distortionary taxes, addressing budget deficits, and enhancing government spending on public goods Additionally, these funds can help alleviate competitiveness concerns and increase climate finance flows from developed to developing countries.
The EU ETS generated about €14 billion in auctions between 2012 and 2016, with at least 50% of the revenue distributed for climate and energy-related purposes and retrofitting existing infrastructure
The European Commission plans to create two new funds: an Innovation fund to support the demonstration of innovative technologies and a Modernization fund aimed at modernizing the power sector and enhancing energy efficiency In a similar vein, the Regional Greenhouse Gas Initiative (RGGI) has generated approximately $2.7 billion in revenue, with nearly half allocated for consumer benefits and strategic energy purposes Specifically, RGGI has invested 42% in energy efficiency programs, 11% in bill assistance for low-income residents, and 9% for greenhouse gas abatement, resulting in an estimated 30,200 job-years from 2009 to 2015 Likewise, California raised $3.385 billion in revenue through 2017, directing funds towards high-speed rail, low-carbon transit, low-income weatherization, and environmental conservation initiatives.
By 2020, Québec aims to generate $3.3 billion for the Québec Green Fund, which is specifically designed to improve emissions reductions in the region Research indicates that emissions trading systems (ETS) with revenue generation mechanisms prioritize environmental effectiveness, focusing on enhancing ecological outcomes rather than allocating funds to non-environmental initiatives.
Stakeholder Engagement
Regular engagement with stakeholders is essential for the success of any Emissions Trading System (ETS) Programs such as RGGI, California, and Québec exemplify this through their commitment to transparency and periodic reviews that address key issues like cap level reductions and revenue allocation The interconnected California-Québec system promotes data transparency, thorough monitoring, and evaluation Notably, the California system enjoys significant public support, with 54% of residents backing the program even if it leads to higher consumer prices (Baldassare et al 2016).
The Korean Emissions Trading System (KETS) exemplifies the importance of learning from past experiences in stakeholder engagement and implementation strategies Before KETS, the Korean government initiated a GHG and Energy Target Management System (TMS) to help firms gradually adapt to monitoring and verifying emissions data KETS includes specific conditions that allow the Allocation Committee to intervene in the market without legislative approval Similarly, China's ETS pilots serve as a testing ground for new regulatory frameworks, allowing stakeholders to acclimate to compliance requirements before the nationwide ETS launch.
Ambition
Ambition is a crucial design feature of an Emissions Trading System (ETS), reflecting its contribution to global climate mitigation It encompasses two key aspects: the extent of emissions covered (coverage) and the market price per ton of greenhouse gas (GHG) emissions (stringency) The combination of these factors, known as the "coverage adjusted carbon price," reveals the overall ambition level of an ETS Currently, as illustrated in Figure 1, the coverage-adjusted carbon prices for the ETS systems examined are below $15 per ton of GHG emissions, falling short of the politically-acceptable lower bound of $20 per ton suggested by the Interagency Working Group and the $31 estimate from Nordhaus This highlights a significant opportunity to enhance the ambition of these ETS programs.
A well-functioning Emissions Trading System (ETS) is essential for maintaining a stable price signal, but it must be paired with sufficient ambition to fulfill the primary objectives of a carbon pricing policy The Regional Greenhouse Gas Initiative (RGGI) exemplifies a well-structured and effectively managed ETS, characterized by full auctioning of allowances and efficient utilization of carbon revenues However, it is often viewed as one of the least ambitious ETS programs, given its coverage-adjusted price.
$0.53 per ton of GHG emissions even though its emissions fell 57% between 2005 and 2016, perhaps induced
Figure 1: Carbon price per ton of GHG emissions in 2016: Cap-and-Trade and Carbon Tax
Average Price (PPP $) Coverage-adjusted Price (PPP $)**
Carbon Tax and Hybrid SystemsCap-and-Trade Systems
National and Sub-National Policies: Carbon Tax and Hybrid Systems
Norway’s Carbon Tax with EU ETS — Hybrid
In 1987, following the Brundtland report, the Norwegian government implemented an upstream carbon tax targeting oil and gas extractors, as well as HFC/PFC importers, alongside a downstream tax on oil and gas suppliers Certain sectors, including pulp and paper, fishmeal, domestic aviation, and shipping, benefit from reduced tax rates, while sectors covered by the EU ETS and external aviation are exempt from the carbon tax Notably, there is considerable overlap between the carbon tax and the EU ETS, particularly in emissions from electricity (58%), the industrial sector (54%), and off-road transport (30%) (OECD 2015).
Norway's carbon tax, introduced in 1991, features an ambitious tax rate ranging from $3 to $58 per ton of CO2e across various sectors, while also taxing non-CO2 greenhouse gas emissions such as NOx, SO2, and HFC/PFC The government has ensured policy stability and provided clear price signals, encouraging private sector investment in clean energy technologies Since 2013, approximately 30% of the carbon tax revenue has been allocated to a special fund dedicated to climate initiatives, renewable energy, and energy efficiency measures.
To achieve the EU's target of a 30% emissions reduction in non-EU ETS sectors by 2030, Norway needs to significantly increase its carbon tax on motor fuels The Green Tax Commission has proposed a uniform tax rate of $49 per ton of CO2e for these sectors However, strong political opposition to raising carbon tax rates has hindered potential policy changes Since the implementation of the tax, it is estimated that Norway's total emissions have been reduced by 6–7 million tons of CO2e compared to what they would have been without the tax.
In 2008, Norway experienced a 15% increase in total CO2 emissions, despite a 70% growth in GDP, with emissions from petroleum and natural gas extraction rising by 86% This disparity is attributed to inelastic European demand for oil and gas, coupled with tax exemptions for exported resources Although Norway's energy mix is largely composed of hydropower and renewables, the carbon tax has had limited impact across different income levels for electricity and petrol consumption Additionally, the carbon tax was implemented during a period of global recession and austerity in Ireland, contributing to approximately 12.4% of the cumulative tax increases mandated by the IMF between 2010 and 2012.
The Irish carbon tax has significantly contributed to emissions reductions, generating over €2 billion in revenue and leading to a 15% decrease in non-EU ETS covered emissions from 2008 to 2012 Although not all reductions can be directly linked to the tax, it is evident that the carbon tax has effectively lowered emissions beyond the impact of the EU ETS alone.
Despite notable reductions in emissions, a government report indicates that Ireland is falling short of its decarbonization objectives and may encounter increased challenges with new emissions reduction requirements after 2020 There are worries that non-ETS sectors, which are subject to the carbon tax, are projected to achieve only a 14 to 16% reduction in emissions by 2020, missing the target of 20% set by the Ireland EPA.
2017) due to the difficulty of decarbonizing the agriculture and transport sectors Additional policy incentives and a higher carbon price are necessary to achieve decarbonization in these sectors
British Columbia (BC) has the longest running carbon tax policy in Canada The economy-wide tax rate is
$30/ton of CO 2e , covering more than 70% of the region’s GHG emissions with sectoral exemptions for the remaining 30% of GHG emitting sources (see Table 3) (Government of British Columbia 2016).
A key aspect of British Columbia's carbon tax is its revenue neutrality, which garnered support from the business community by redistributing funds to lower industrial property and corporate taxes for affected industries Evidence suggests that this carbon tax has successfully reduced emissions while minimizing negative economic impacts Various analyses indicate that emissions decreased by 5% to 15% without any additional policies, compared to a business-as-usual scenario.
2015) The province decreased per capita emissions by 12.9% by 2013 when compared to pre-carbon tax levels, more than three-and-a-half times the 3.7% per capita decline nationwide (Metcalf 2015) As of 2015,
Between 2008 and 2013, British Columbia achieved a significant reduction of 2.8 million metric tons of greenhouse gas emissions while experiencing a GDP growth rate of 1.55%, surpassing the national average of 1.44% (Komanoff and Gordon 2015).
Constraints: The defining feature of revenue neutrality is by itself a constraint for BC’s carbon tax system
The current system lacks plans to shift from revenue neutrality to allocating funds specifically for reinvestment in emissions-reduction initiatives Furthermore, sector-specific exemptions and the political dynamics surrounding carbon taxes may jeopardize public support for the policy.
In 2013, Mexico became the first Latin American nation to implement a carbon tax, supported by domestic think tanks and NGOs, as part of a broader fiscal reform initiative This tax is rooted in the national climate change law passed in 2012, aiming to reduce greenhouse gas emissions by 30% by 2020 and 50% by 2050 An effective average tax of $3.21 per ton of CO2e is applied upstream at the production stage, targeting the carbon content of fuels, while exempting natural gas production and import Additionally, an offset mechanism allows eligible Mexican projects to utilize certified emissions reduction (CER) credits The carbon tax operates alongside a voluntary carbon exchange market, MexiCO2, facilitating the exchange of CER offsets with tax obligations.
The Mexican carbon tax design features a variable rate tax based on fuel carbon content, the establishment of a carbon tax market alongside a voluntary carbon exchange market (MexiCO2), and the creation of a national emissions inventory registry, which is essential for future carbon trading By 2018, the Mexican government aims to establish a voluntary emissions trading system (ETS) involving 60 national and international companies from various sectors, while exploring cooperation within Latin America through the Pacific Alliance and considering a North American carbon market linking with California and Québec Additionally, Mexico plans to liberalize domestic fuel prices by 2018, enhancing the carbon tax's effectiveness and potentially generating 10% of total tax revenues from the carbon tax and retail price reforms.
Mexico has the lowest tax rate among OECD countries and one of the lowest globally, which significantly impacts its efforts to reduce fossil fuel-related emissions Natural gas, which contributes about 30% of the nation's energy-related CO2 emissions, is exempt from this tax, meaning that only two-thirds of fossil fuel emissions are taxed This low tax rate, combined with natural gas exemptions, hinders Mexico's ability to implement a more ambitious carbon pricing strategy The expected annual revenue from this tax is approximately $1.1 billion, accounting for less than 1% of total federal tax collections Currently, there are no plans to increase the tax rate, aside from annual adjustments for inflation, and the existing low rate is projected to reduce CO2e emissions by only 1.6 million tons per year, which is merely 0.33% of Mexico's total emissions.
In 2014, Chile enacted a carbon tax set to take effect in 2018, aiming for a 20% reduction in carbon emissions by 2020 compared to 2007 levels This tax specifically targets the electricity sector, which saw emissions more than double from 1990 to 2010 The primary objective is to decrease energy demand and shift the energy grid towards less carbon-intensive fuels The implementation of this tax is projected to increase energy costs by approximately 3%, equating to around 2% of the current residential tariff.
Noteworthy features: The creation of an emissions inventory registry is a notable feature of the
Chile's carbon tax policy facilitates a smooth transition towards a future Emissions Trading System (ETS) In 2015, the Minister of Environment highlighted that as the nation develops its emissions monitoring, verification, and reporting infrastructure for carbon tax implementation, there may be potential for scaling up the carbon tax or establishing an ETS in the future (Szabo 2015).
Chile's current low tax rate of $5 per ton of CO2e hampers the transition to cleaner energy sources, as energy companies are likely to transfer increased costs to consumers and small businesses Experts López, Accorsi, and Sturla (2016) suggest that raising the CO2 tax to $26 per ton would be more effective, ideally paired with a goal of achieving a 50% carbon-free energy mix, supported by investments funded through the tax revenues.
In 2010, the Japanese government passed the Basic Act on Global Warming Countermeasures (GW
British Columbia’s Carbon Tax
British Columbia (BC) has the longest running carbon tax policy in Canada The economy-wide tax rate is
$30/ton of CO 2e , covering more than 70% of the region’s GHG emissions with sectoral exemptions for the remaining 30% of GHG emitting sources (see Table 3) (Government of British Columbia 2016).
A key aspect of British Columbia's carbon tax is its revenue neutrality, which garnered support from the business community by redistributing revenues to lower industrial property and corporate taxes for affected industries Data demonstrates that this carbon tax has successfully reduced emissions with minimal adverse economic impacts, with studies indicating a reduction of emissions by 5% to 15% compared to a business-as-usual scenario, without the need for additional policies.
2015) The province decreased per capita emissions by 12.9% by 2013 when compared to pre-carbon tax levels, more than three-and-a-half times the 3.7% per capita decline nationwide (Metcalf 2015) As of 2015,
Between 2008 and 2013, British Columbia achieved a significant reduction of 2.8 million metric tons of greenhouse gas emissions while experiencing a GDP growth of 1.55%, surpassing the national average growth rate of 1.44% (Komanoff and Gordon 2015).
Constraints: The defining feature of revenue neutrality is by itself a constraint for BC’s carbon tax system
The current system remains focused on revenue neutrality without plans to allocate funds specifically for reinvesting in emissions-reducing initiatives Furthermore, sector-specific exemptions and the political dynamics surrounding carbon taxes may jeopardize public support for the policy.
Mexico’s Carbon Tax
In 2013, Mexico became the first Latin American nation to implement a carbon tax as part of its fiscal reform, receiving strong backing from domestic think tanks and NGOs This initiative is rooted in the national climate change law enacted by the Mexican Congress in 2012, aiming to cut greenhouse gas emissions by 30% by 2020 and 50% by 2050 The tax imposes an effective average rate of $3.21 per ton of CO2e at the production stage, focusing on the carbon content of fuels, while providing exemptions for natural gas production and imports Additionally, it includes an offset mechanism that permits eligible Mexican projects to utilize certified emissions reduction (CER) credits The carbon tax operates alongside a voluntary carbon exchange market known as MexiCO2, facilitating the exchange of CER offsets with tax obligations.
The Mexican carbon tax design features a variable tax on fuel based on carbon content, a carbon tax market alongside a voluntary carbon exchange market (MexiCO2), and the establishment of a national emissions inventory registry, which is essential for future carbon trading By 2018, the government aims to launch a voluntary emissions trading system (ETS) involving 60 national and international companies from various sectors, while also exploring cooperation within Latin America through the Pacific Alliance Additionally, there is an interest in creating a North American carbon market that links Mexico's voluntary ETS with California and Québec's cap-and-trade programs To enhance the carbon tax's effectiveness, Mexico plans to liberalize domestic fuel prices by 2018, potentially generating 10% of total tax revenues from the carbon tax and retail price reforms.
Mexico has the lowest tax rate among OECD countries and one of the lowest globally, which significantly impacts its ability to address fossil fuel-related emissions Natural gas, accounting for approximately 30% of the country’s energy-related CO2 emissions, is exempt from taxation, meaning the current tax only addresses about two-thirds of these emissions This low tax rate, coupled with exemptions, limits the potential for a more ambitious carbon pricing strategy, with anticipated annual revenues of only $1.1 billion—less than 1% of total federal tax collections Currently, there are no plans to raise the tax rate, aside from annual adjustments for inflation, resulting in a modest reduction of CO2e emissions by 1.6 million tons annually, which is merely 0.33% of Mexico’s total emissions.
In 2014, Chile implemented a carbon tax set to take effect in 2018, aiming for a 20% reduction in carbon emissions by 2020 compared to 2007 levels This tax targets the electricity sector, which saw emissions more than double from 1990 to 2010 The primary objective is to decrease energy demand and facilitate a shift toward less carbon-intensive fuels The tax is projected to increase energy costs by around 3%, equating to approximately 2% of the current residential tariff.
Noteworthy features: The creation of an emissions inventory registry is a notable feature of the
Chile's carbon tax policy facilitates a smooth transition to a future Emissions Trading System (ETS) In 2015, the Minister of Environment indicated that as the nation develops its emissions monitoring, verification, and reporting infrastructure for the carbon tax, there may be opportunities to increase the carbon tax rate or establish an ETS (Szabo 2015).
Chile's low carbon tax rate of $5 per ton of CO2e hinders the country's efforts to promote cleaner energy generation among utilities Analysts suggest that energy companies may transfer increased costs to households and small businesses To effectively drive the transition to cleaner energy, experts recommend raising the carbon tax to $26 per ton, coupled with a goal of achieving a 50% carbon-free energy mix This approach could be bolstered by reinvesting tax revenues into sustainable energy initiatives.
In 2010, the Japanese government passed the Basic Act on Global Warming Countermeasures (GW
Japan's Basic Act established climate policy as a key element in its policymaking, alongside energy and environmental policies The proposed measures included a carbon tax, a nationwide cap-and-trade system, and a feed-in tariff scheme In October 2012, the Japanese government implemented the Global Warming Countermeasures Tax (GW Tax), an upstream carbon tax on fossil fuels that imposed an additional surtax.
The GW tax plan in Japan does not indicate any future increase in the $3 per ton CO2 tax, which, despite funding emissions-reducing initiatives, is insufficient to meet the country's goal of a 26% reduction in emissions from 2013 levels by 2020 The current tax rate fails to leverage the price effect necessary for substantial emissions reductions, especially as the post-Fukushima closure of nuclear power plants has led to a greater reliance on imported coal for electricity generation This shift has rendered the GW tax less effective in addressing the inelastic demand for coal, further complicating efforts to achieve significant emissions reductions.
Achieving 1990 levels of carbon emissions without utilizing nuclear energy would necessitate an exceptionally high carbon tax of $506 per ton of CO2 equivalent, significantly exceeding the current rate of $3 per ton.
In 2010, the Indian government implemented a "Clean Energy Cess," which is a tax levied on coal, starting at $1 per ton This tax has progressively increased to $6 per ton of coal, equating to approximately $3.29 per ton of CO2 equivalent today.
The tax system is distinguished by its rigorous Measurement, Reporting, and Verification (MRV) process, allowing excise officers to conduct inspections of registered coal producers during audits It enforces a significant non-compliance penalty, set at three times the current price, amounting to $18 per ton of coal Furthermore, all revenue generated from this tax is allocated to the National Clean Environment Fund (NCEF), which aims to promote energy innovation and investment.
India's ambitious goal of achieving a 40% non-fossil fuel energy mix by 2030 is unlikely to be met solely through the existing coal tax, which may not be sufficient Increasing the coal tax to $18 per ton and reallocating the revenue towards solar, wind, and climate-smart agriculture could potentially boost the renewable energy share to at least 16% while positively impacting GDP However, concerns persist regarding the National Clean Energy Fund's (NCEF) effectiveness, as there are discrepancies between its stated objectives and actual implementation Challenges such as a lack of proposal development capacity, unclear eligibility criteria, and insufficient support for public-private partnerships hinder the NCEF's mission.
Table 3: Design Details of Carbon Tax and Hybrid Systems
British Columbia Mexico Chile India Norway Ireland Japan
Jurisdiction Provincial National National National National National National
Ministry of Environment and Natural Resources and Ministry of Finance
Ministry of the Environment, Ministry of Finance
General Excise Office, Ministry of Finance
Norwegian Tax Administration, Norwegian Petroleum Directorate
10,000 tons CO 2e 50MW or more of thermal generation
Point of Taxation Downstream Upstream Midstream (power producers) Upstream Upstream and
Tax Type Emissions-based Carbon content of select fuels
Carbon content of select fuels
Carbon content of select fuels
Carbon content of select fuels
Fuels Covered 23 fossil fuels All fossil fuels, except natural gas
All fossil fuels All domestic and imported coal, lignite, peat
Heating oil, diesel, natural gas, gasoline, LPG
Oil, gas, and coal, peat, LPG not covered by EU ETS
Offset Allows for use of
Tax Compliance The Ministry of
Finance has been given significant inspection and audit powers, with the ability to assess interest and penalties (ranging from 10–100% of the tax amount owed)
The Federal Attorney General’s Office for the Protection of the Environment can impose a fine of 3,000 days of minimum wage for a violation
Excise officers are allowed to inspect the premises of registered producers and audit records to determine compliance
Failure to comply with the law is subject to fines and up to three months imprisonment
The Revenue Commissioners can revoke the license of any license holders who do not comply with regulations
Furthermore, any person who tries to contravene or fails to pay the tax is subject to a penalty of €5,000
Taxpayers face penalties and interest for late payments, while tax officials have the authority to audit individuals suspected of tax evasion In cases of nonpayment, they can file criminal charges and seize assets.
GHGs Covered CO 2 , CH 4 , NO 2 ,
SO 2 , HFC, PFC CO 2 CO 2 , SO2, NO 2 ,
Sectoral Coverage Fuel producers and importers
Electric Sector Coal importers and producers
PFC importers, oil, natural gas and LPG suppliers
Fuel suppliers Fuel producers and suppliers
British Columbia Mexico Chile India Norway Ireland Japan
Annual Escalator Yes ($4 per year until max tax rate of $30, 2012)
None None None None Yes ($3 per year, maxed out at $24) None
Current Tax Rate per ton of CO 2e
& personal income tax cuts, low-income tax credits, direct grants to rural and native communities)
Revenue is directed towards the national budget
Revenue is directed towards the General Treasury
Revenue directed toward the National Clean Energy Fund
Revenue directed toward the Global Government Pension Fund and national budget
Revenue is directed towards the general budget, most revenue has been used to pay public deficit
Tax revenue is used to promote low-carbon technologies, energy efficiency improvements and renewable energy
Exemptions for fuel exporters, international travel, non- fossil fuel GHG emissions from industrial processes, i.e., cement, landfills, forestry, and agriculture
Coal mined by local tribes in the State of Meghalaya
Exemptions for international air and maritime transport, exported gas, freight and passenger transport within domestic shipping sector
Emissions from agriculture are excluded
Fossil fuels exempt from the general Petroleum and Coal Tax prior to October 2012 remain tax-exempt This includes imported coal utilized in the manufacturing of iron, steel, coke, and cement, as well as volatile oil feedstock used in petrochemical production.
Talks ongoing of adopting ETS mechanism and linking with California and Canada
Linked with EU ETS, emissions covered by EU ETS are exempted from carbon tax
Linked with EU ETS, emissions covered by EU ETS are exempted from carbon tax
(Carbon Tax — Ley Del Impuesto Especial Sobre Produccion y Servicios 2014)
(PMR 2017); (Irish Finance Act of 2010)