Can a universal carbon price be fair for everyone?

By George Atalla

EY Global Government & Public Sector Leader

Working with governments to address complex issues and build a better working world.

Contributors
15 minute read 5 Dec 2023

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Most governments and climate experts agree we need a carbon price to reach net zero. Delivering a just and fair transition is the hard part.

This is part of a trilogy of articles exploring the role of governments in accelerating a green and just transition.

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In brief

  • Carbon pricing can be a game changing tool to meet climate targets, but it has so far failed to scale and limit CO2 emissions globally.
  • Today, carbon schemes are inconsistent. Coordinated action across the globe will remove disparities, leakages, and the need for border adjustments.
  • Carbon prices applied equitably and flexibly could offer certainty to plan a long-term transition.

The global climate emergency is accelerating as governments fall short of their net zero targets. Despite commitments from 130 countries (representing over 80% of global emissions), only 26 have plans ambitious enough to achieve net zero, and global emissions continue to rise.1

Carbon dioxide (CO2) emissions are the primary driver of our climate emergency, making it crucial to implement a clear and binding carbon price that reflects the true cost of emitting greenhouse gases (GHG). The rationale is straightforward: a price on carbon enables business and government to calculate the true economic cost of emitting CO2 (and, by extension, other GHG), and hence accelerate the path to decarbonization and achieving net zero goals.

Climate pledges

130

Countries representing 80% of global greenhouse gases have communicated a net zero target

Climate pledges

26

of those countries that have actually followed through with more ambitious plans

Governments worldwide need to act swiftly and in a coordinated manner if we are to counter the global existential threat society now faces. They already play a critical role in catalyzing public and private investments, and they have proven ability to shape new industrial strategies, foster business partnerships and incentivize public action. How, then, can governments best shape policies that deliver a meaningful just transition away from fossil fuels rather than just well-meaning pledges?

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Chapter 1

What have we learned from existing carbon pricing strategies?

Carbon taxes and trading schemes can lead to a more just transition, but current applications are suboptimal.

The concept of carbon pricing is not new. It is a government levy that incentivizes organizations and consumers to reduce emissions by more accurately reflecting the true costs of their activities. By raising the cost of non-green behaviors and technologies, a carbon price can help shift the economic burden to those responsible for GHG emissions.

Carbon pricing schemes such as taxes and emissions trading can help governments achieve their Nationally Determined Contributions (NDCs) under the Paris Agreement.2 A successful carbon pricing mechanism encourages low-carbon behavior, drives investment and innovation in low-carbon technologies, and can provide financial benefits to emitters. Government revenues can be directed back to taxpayers, benefitting lower-income households.

To better understand the leadership role government can play, EY collaborated with academic economists and public policy experts at Politecnico di Milano in Italy to model pathways for a green transition.

Carbon pricing policies are technology-neutral, leading to fewer market distortions and a more just transition to a low-carbon economy. Efficient carbon pricing policies can realign supply chains and global trade, shifting the production of goods to the most efficient (and least carbon-intensive) regions. This can help prevent carbon leakages, which can occur when the production of goods moving from one region results in the production of more emissions.

Today, 23% of global emissions fall under carbon pricing, with levies in 39 countries and 33 subnational jurisdictions raising US$95 billion.3 Carbon prices up to US$96.3 per ton in the European Union4 show the potential for government expanding and coordinating pricing schemes — and transforming the global economy.

Carbon pricing schemes

US$95b

raised as a result of carbon pricing schemes in 39 countries and 33 subnational jurisdictions

An emissions trading scheme (ETS) ⏤ or cap-and-trade system ⏤ allows industries with low GHG emissions to sell their extra allowances to those with larger ones, creating a market price for emissions. A carbon tax sets a carbon price through a levy on GHG emissions or fossil fuels.5

For example, France has a carbon tax of US$48.5/ton CO2e, while Poland's is less than US$0.1/ton CO2e. Similarly, the price of emissions allowances traded on the EU ETS in March 2023 was US$96.3/ton CO2e, compared to US$8.15/ton CO2e in China.6

In addition to geographical fragmentation, ETS schemes also operate at different levels of government, from supranational (e.g., the EU) to national (e.g., Canada, the United Kingdom) and from province and state level (e.g., Oregon, Hubei) to city level (e.g., Beijing, Tokyo).

Carbon price

2,000

The number of companies, representing over US$27 trillion in market capitalization, that currently use an internal carbon price or plan to implement one within the next two years

Despite current flaws, the growing number of carbon pricing systems worldwide shows that it has become a core component of government policies. The introduction of large-scale schemes ⏤ such as China's national ETS, which covers 12% of global CO2 emissions ⏤ offers hope for real progress.7

Equitable carbon pricing fosters both innovation and emissions reduction. Integrating carbon price scenarios into long-term business plans will be crucial to adapt to future developments.
Amy M. Brachio
EY Global Vice Chair - Sustainability

Also, the corporate world has been applying carbon pricing internally for decades. More than 2,000 companies, representing over US$27 trillion in market capitalization, apply internal carbon pricing or plan to do so, with low carbon investment being a key driver, according to the Carbon Disclosure Project (CDP).8 Improving energy efficiency and behavior change are also crucial factors.9 “Equitable carbon pricing fosters both innovation and emissions reduction. Integrating carbon price scenarios into long-term business plans will be crucial to adapt to future developments,” reflects Amy Brachio, EY Global Vice Chair – Sustainability. “Companies that proactively prepare can gain a competitive advantage through decarbonization, driving the wider value sustainability can create and protect through their business model and strategy.”

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Chapter 2

How can we create a global carbon price framework?

Pricing carbon as a commodity and on a worldwide scale will help deliver the best results.

Coordinating individual emissions reduction efforts is crucial, and it’s starting to happen. The Organization for Economic Co-operation and Development (OECD) formed the Inclusive Forum on Carbon Mitigation Approaches (IFCMA) in October 2022 to achieve carbon reduction targets through better data and knowledge sharing.10

Carbon markets must be restructured to reduce global emissions and achieve decarbonization NDC targets. Any successful pricing scheme will need to be both fair and effective to address economic and social concerns while meeting targets. The ideal approach will price carbon as a commodity reflecting the cost of its negative externalities, and be applied globally. Accurate CO2 accounting will be crucial.

There are two types of CO2 accounting. Production-based accounting levies taxes on the industrial sector responsible for CO2 emissions within domestic borders but may lead to carbon leakages and production shifts between countries. Consumption-based accounting taxes CO2 embedded in goods regardless of where emissions are generated, eliminating carbon leakages and allowing for trading and pricing of CO2 as a commodity across borders.

If CO2 emissions measured via a consumption-based approach exceed those measured via a production-based approach, it indicates that the region’s imported products embed more CO2 emissions than the region’s exported products.

For example, if emissions are measured under a consumption-based approach, the share of CO2 emissions is 18% to 19% higher in the US and the EU than in a production-based approach. In comparison, CO2 emissions are 15% to 17% lower in consumption-based measurements than in production-based measurements in India and China, respectively.

  • Open image description#Close image description

    A horizontal bar chart. Purple bars show Gtons of CO2 emissions in different regions following the consumption-based accounting method. Green bars show Gtons of CO2 emissions following the production-based accounting method.

The case for pricing carbon as a commodity in the long term

Our research model analyzed trade patterns and carbon intensity in goods production to map CO2 emissions by origin and region, which is crucial for assessing pricing mechanisms. We focused on emissions embedded in each region’s demand, recognizing that regions may be net carbon exporters (producers) or importers (consumers) based on their economic and industrial structure.

Regions with lower emission intensity (the US, the EU and the UK, and Southeast Asia) are net carbon importers. The regions that pollute the most to produce goods (China, India, rest of world and Middle East) are those that export most of these goods worldwide. A positive impact on global emissions could be achieved by decarbonizing supply chains in carbon-exporting regions — notably by engaging carbon producers to create a decarbonized supply chain.

  • Open image description#Close image description

    A horizontal bar chart. The blue bars show imported CO2 emissions in Gton of CO2 in each region, while the purple bars show exported CO2 emissions. The red bars show the net difference between exported and imported CO2 emissions.

Adopting consumption-based accounting, which considers CO2 a commodity embedded in goods, is a way to reduce emissions in carbon-exporting regions. Our analysis suggests this approach could facilitate a smoother price transition for domestic products compared to production-based accounting. Using consumption-based accounting would act as a disincentive to importing or consuming products with high CO2 content, resulting in a more equitable distribution of costs between importing and exporting regions. It could also mitigate against carbon leakages.

  • Open image description#Close image description

    The red line shows the percentage effect of the consumption-based CO2 accounting method in EU27+UK and China on domestic prices in different industries. The purple line shows the percentage effect of the consumption-based CO2 accounting method on EU27+UK and China import prices. The green line shows the % effect of the production-based CO2 accounting method in EU27+UK and China on domestic prices in different industries.

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Chapter 3

What will a viable carbon price framework look like?

The world needs to establish a pricing system that will be equitable for all nations.

The global application of consumption-based accounting and pricing will require a phased approach due to the substantial undertaking in establishing an efficient and equitable global carbon pricing framework that accommodates diverse government and societal contexts.11 These challenges are also rooted in historical emissions imbalances, whereby some countries benefited from fossil fuel usage while others grapple with the consequences of climate impacts. Addressing this equity concern implies sizable financial transfers, which potentially hinder political negotiations, particularly in achieving parity under a universal carbon price.

George Atalla, EY Global Government & Public Sector Leader, says, “More than two decades of carbon pricing schemes have demonstrated both their potential and pitfalls. For carbon pricing to be truly transformational and deliver a just transition, governments should adopt a coordinated approach that ensures different national approaches — be they taxes or trading systems — work in concert together and without loopholes.”

The prevailing trend highlights a dynamic landscape of diverse policy frameworks. As the international community discusses the possibility of a global pricing scheme, it presents an opportunity for governments to adopt a blended approach encompassing:

  • Pricing domestic CO2 emissions on a production-based scheme, using a carbon price levied on its productive sectors proportional to direct CO2 emissions. This framework reflects currently adopted carbon pricing policies such as ETS.
  • Applying additional prices on imported products according to a consumption-based scheme to avoid carbon leakage and the shift of production to countries without environmental regulation.

The EU’s proposed Carbon Border Adjustment Mechanism (CBAM) is based on these principles.12 Combining the two approaches tries to mitigate some weaknesses (e.g., carbon leakages) of standard production-based schemes by assigning a markup to carbon embedded in imported goods. This mechanism aims to impose a COpenalty on imported products from regions with less restrictive environmental policies.

For carbon pricing to be truly transformational and deliver a just transition, governments should adopt a coordinated approach.
George Atalla
EY Global Government & Public Sector Leader

Benefits of pricing carbon as a commodity in shaping the energy transition

In particular, our research analyzed the global power sector, responsible for 43% of global emissions, to test the impacts of different carbon prices and implementation modes on CO2 emissions and tax revenues. Scenarios are based on proposed carbon price floors by the International Monetary Fund and price trends from the International Energy Agency (IEA) or projected from regional policies.

We modeled three carbon price floor scenarios: 

  1. The first scenario is called the universal price floor. In this scenario, all regions implement the same carbon tax of €190 per ton of carbon. This is the highest price reached in the IEA’s Announced Pledges Scenario introduced in 2021. 
  2. The second is the global gradual floor. In this scenario, all regions implement a specific carbon price level that gradually increases over time. Here, the 2020 to 2030 regional carbon prices match the carbon taxation levels the International Monetary Fund reported. While the 2030 to 2040 prices align with IEA estimates, 2050 prices are at the same level as the universal price floor of €190 per ton of carbon.
  3. The third scenario is the large emitters floor. In this scenario, price floors are aligned to the stated policies in each region or country. In EU27+UK, USA and Australia, the carbon price starts at €70 per ton of carbon, gradually shifting towards €190 per ton of carbon in 2050. In China, it gradually shifts from €8 per ton of carbon to €30 per ton of carbon in 2050.
  • Open image description#Close image description

    A line chart. The four lines show changes in CO2 emissions as a percentage relative to 2020. The orange line depicts a scenario where no price of carbon is implemented. The purple, blue and green lines show changes in CO2 emissions following the large emitters, global gradual and universal price floors scenarios. Higher international carbon price floors and a wider geographical application of pricing mechanisms will lead to a faster green transition by 2050.

Our research shows that higher global carbon prices and a wider application of pricing mechanisms can accelerate the transition to green energy by 2050. This could result in CO2 emission reductions of 17% to 68% within the power sector, generating government tax revenues ranging from €15.4t to €80.5t. These scenarios are promising and demonstrate the importance of international collaboration and cooperation to shape sustainable and fair policy frameworks.

While our economic study showcases the potential for carbon pricing as a powerful tool for governments, each government needs to craft its tailor-made strategy, adapting it to its specific context. Several key considerations may enhance the efficacy of their efforts.

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Chapter 4

How can governments shape carbon regulation to deliver value?

There are seven important factors to consider.

As governments consider how best to incorporate carbon pricing into their national decarbonization policies and strategies, they must juggle the economic impacts of such schemes, as well as the political and societal. “The big question in terms of carbon pricing — whether it’s in the form of a direct tax or a cap-and-trade system — is what to do with the money you raise?” says Andrew Philips, EY Global Government & Infrastructure Tax Leader.  “That’s really important from a social impact perspective because putting a price on carbon will likely impact all parts of society — but some more than others.”

Carbon pricing can be a contentious topic, and negotiations around implementing carbon reduction policies can become a drawn-out process unless governments have clear objectives.

The big question in terms of carbon pricing is what to do with the money you raise? That’s really important from a social impact perspective.
Andrew Phillips
EY Global Government & Infrastructure Economics, Finance, and Tax Leader; Co-Director, Quantitative Economics & Statistics (QUEST), Ernst & Young LLP

How should governments start shaping effective carbon regulation? Consider these seven key factors:

1. Know what type of pricing is best for your economy and society

A comprehensive carbon price signals every business to price carbon as effectively they would any other business input and to reduce emissions, eliminating the need for thousands of micro-interventions. Governments without carbon pricing must rely on incentives, which pose budgetary challenges.

The first step is choosing your country's best carbon pricing form. If it’s a direct tax, which industries will be taxed first? If it’s an ETS, which industry sectors and gases are covered, and how do you expand coverage over time? And how do you adjust taxation on imported products?

Design issues include the initial tax rate and how will it rise, assigning the statutory burden, CO2 cap, allowance distribution, existing regulations and ⏤ perhaps most important, from a political perspective ⏤ revenue allocation.

2. Offsetting as an alternate route to carbon pricing

The landscape of carbon emissions regulation is poised to embrace diverse tactics. Offsets, characterized by their ability to counterbalance GHG or enhance carbon storage elsewhere, present a pathway for companies to achieve emission reduction targets. This approach can establish a shared cost framework without a formal carbon pricing mechanism. However, it is essential to exercise caution and conduct extensive evaluations within the carbon credits market to ensure accurate carbon accounting.

Governments can foster decarbonization by setting a significant offset price while simultaneously addressing potential carbon leakage. By allowing offsets to be traded across nations, countries with lower emission intensities can engage in carbon abatement initiatives, such as technology projects or carbon storage, in nations with higher emission intensities. This strategic move is particularly beneficial where older industrial facilities and lower restoration costs exist. Thus, implementing offsets requires a thoughtful balance between incentivizing decarbonization and managing potential carbon leakage, shaping a nuanced approach to emissions control.

3. Have a clearly articulated plan to distribute the revenue raised

Governments can use carbon pricing revenue to lower taxes, invest in clean energy and technology infrastructure, provide relief for low-income households most impacted by increased food and energy prices, tackle social issues related (or unrelated) to climate change, or even finance decarbonization investments for individual companies. The decisions will have a significant social impact, making it crucial for governments to choose their strategy wisely.

4. Demonstrate transparency to build credibility and support for the pricing system

Transparency will maintain credibility for a connected regional and national carbon pricing system framework. Governments must accurately measure carbon outputs and the effectiveness of offsetting to minimize carbon leakage, reduce double accounting and combat carbon fraud and greenwashing.

Technology and better data analytics improve transparency. Space technologies, including satellite data, monitor tropical forests involved in carbon offsetting projects, while distributed ledger technology can track carbon emissions and footprints in global supply chains. AI and data analytics can offer insights into carbon risks and mitigation in operations and suppliers. The information’s value will continue to grow and help shape a global carbon price. “Soon, we will see a variety of carbon pricing systems coexisting as separate markets, says Gianluca di Pasquale, EY Global Green Economies & Infrastructure Leader and Future Cities Co-Leader. “To achieve a unified approach, harnessing the potential of blockchain integrated with IoT is crucial. The main challenge is establishing an ecosystem that promotes trust, transparency, and interoperability."

5. Bolster reporting to drive adoption

Improved carbon data and demands for more robust sustainability reporting will increase the credibility and value of carbon pricing. Governments worldwide regulate non-financial reporting, and the EU’s new Corporate Sustainability Reporting Directive requires most companies to report how climate change impacts not just their business but also the planet and society. In the US, the Securities and Exchange Commission (SEC) has proposed rule changes requiring companies to report climate-related risks likely to have a material impact on their business and financial condition.

6. Build a working and governing culture that understands the importance of decarbonization

The shift toward a net zero economy requires a new generation of professionals who prioritize the climate emergency, biodiversity, and the preservation of the planet in their decision-making. This cultural shift demands a new breed of green jobs and a mindset change across the workforce. Moreover, profitable businesses will increasingly mean green businesses, as the hard-nosed economics of climate change and carbon pricing shape the future economy. The gray economy will slowly dwindle as entrenched industries make way for green alternatives.

7.  Leverage carbon pricing for global climate resilience and innovation

Governments can harness the revenue generated from carbon pricing as a significant source for international redistribution by contributing to a pool of funds to support vulnerable nations' climate resilience and facilitate the transition to low-carbon economies. This collaborative approach demonstrates developed nations' commitment to global climate action and establishes a framework for mutual benefit. Even countries with lower carbon intensity can reap the rewards, as they can export their advanced green technologies and solutions, engage in joint projects and ventures with developing countries, enhance supply chain resilience, and foster improved global trade relations. Examples such as technology transfers are crucial for enabling less-developed nations to adopt clean and efficient technologies, accelerating their transition, and facilitating the exchange of expertise, knowledge and solutions.

Pulling it together for a sustainable society

We must bring global perspectives on carbon policy together to meet our ambitious climate targets. Coordinated efforts are required to price carbon as a commodity worldwide to deliver the best results. Negotiations should be consistent and adapted to different countries and regions’ industrial structure and trade balances.

Governments have been too timid regarding climate regulation for too long, afraid that establishing higher emissions standards will alienate key industries, causing companies to relocate to countries and regions with more relaxed policies.

The reality today is that the business world knows the price of carbon will continue to rise and is looking for leadership and certainty from government. Some cross-border leakage will still occur, but the pathways to net zero have already been established. If government leads, business will follow.

The authors of this article would like to give special thanks to Cathy Koch, Kasia Klaczynska Lewis, Andrew Phillips and Marco Cavalli from the EY organization for their insights.

  • Methodology

    To better understand the leadership role government can play, EY collaborated with a team of academic economists and public policy experts at Politecnico di Milano in Italy throughout 2022 to model possible pathways for governments to lead a green transition. This group and advisory board conducted methodical research to create projections of major macroeconomic, financial and real energy impacts through 2050.

    The analysis is based on an input output stock-flow consistent model (IOSFC), a technique that fully accounts for how energy is produced in (with financial and human capital), and how it flows through (as an input into production and consumption), the economy.

    In business parlance, IOSFC modeling techniques generate an economy-wide integrated set of financial, economic and physical energy accounts, describing changes to both the balance sheet (e.g., stocks of assets) and the income statement (e.g., flows of energy, goods and services) in a consistent fashion. The technique produces realistic projections of major macroeconomic, financial and real energy variables, enabling a detailed understanding of the feasibility of different transition pathways subject to social, political and economic constraints such as government debt ratios and the unemployment rate.

    In this instance, the dataset for this model covered three regions, Europe, the USA, Asia, the Middle East and Australia, which together represent 75% of global GDP and 80% of global CO2 emissions.

  • Show article references#Hide article references

    1. Global Energy Review: CO2 Emissions in 2021, IEA, 2022
    2. Nationally Determined Contributions (NDCs), UNFCCC website
    3. Carbon Pricing Dashboard, World Bank website
    4. More Countries Are Pricing Carbon, but Emissions Are Still Too Cheap, IMF, 2022
    5. Pricing Carbon, World Bank website
    6. Carbon Pricing Dashboard, World Bank website
    7. In-depth Q&A: Will China’s emissions trading scheme help tackle climate change? Carbon Brief, 24 June 2021
    8. Putting a price on carbon:  The state of internal carbon pricing by corporates globally, Carbon Disclosure Project, 2021
    9. Lessons from first campus carbon-pricing scheme, Nature website
    10. OECD Secretary-General Report to G20 Finance Ministers and Central Bank Governors on the Establishment of the Inclusive Forum on Carbon Mitigation Approaches, OECD, October 2022
    11. Consumption-based carbon accounting: does it have a future? Wires Climate Change, 2017 
    12. Carbon Border Adjustment Mechanism: Questions and Answers, European Commission website

Summary

One clear pathway that will help global society move beyond the current climate emergency is effective and equitable carbon pricing. At present, the patchwork of carbon pricing schemes is ineffective and reinforces disparities in different economies. A collaborative effort to develop a global carbon price framework, ensuring different national approaches, is needed to account for the cost of fossil fuels in business and help transition into a green energy economy.

About this article

By George Atalla

EY Global Government & Public Sector Leader

Working with governments to address complex issues and build a better working world.

Contributors