When U.S. Presidential Climate Envoy John Podesta recently called for a “21st century trade policy” that encourages a “race to the top for climate action”,¹ it was clear that he meant business. He asserted carbon pricing would help limit emissions and China’s dominance of key industries, showing the approach’s growth in policy response to climate change.

However, carbon pricing is not without its challenges.

As with any tax, carbon pricing can impact inflation and therefore macroeconomic performance; their adoption at a national level also creates incentives and disincentives for countries to implement carbon pricing from a competitive standpoint.

Considering such challenges, the full economic impact of carbon pricing is understood by analyzing the current mechanisms, identifying upcoming events in the evolution of carbon pricing infrastructure, and exploring the data around the macroeconomic impact of carbon pricing where implemented.

1) Today’s carbon pricing mechanisms include carbon taxes, emissions trading schemes (ETS), and carbon crediting mechanisms (CCM).

Carbon Taxes: 37 Carbon Tax programs have been implemented globally at national and subnational levels, covering 5% of global GHG emissions. Prices range from $0.41/tonne of Carbon Dioxide (tCO2) in Mexico to $155/(tCO2) in Uruguay, and with several Scandinavian and Western European countries having prices over $80/(tCO2). Average tax across the 37 programs is $25.38/(tCO2). Such taxes generate approximately $30 billion in government revenues globally.

Emissions Trading Schemes (ETS): 37 Emissions Trading Schemes have been implemented globally at national and subnational levels, covering 18% of global GHG emissions. Pricing ranges from $1.12/(tCO2) in the Kazakhstan ETS to $96.29/(tCO2) within the EU ETS; average price amongst all 37 ETS is $25/(tCO2) and 10 of the 37 ETS are Canadian Federal or Provincial programs. These ETS generate approximately $67 billion in government revenues globally.

Figure 1: Direct Carbon Taxes and ETS Implemented and Under Consideration/Development Globally, 2023:

Carbon Crediting Mechanisms (CCMs): 29 government-administered carbon crediting mechanisms are currently in place 14 at the National level and 15 at the Subnational/Regional levels; another eight are currently in development. Over 5.3 billion CCMs have been issued globally up to and including 2023, each representing one tonne of emission reduction activities (tCO2e). Figure 2 displays the geographic concentration of issuance by country, dating back as early as 2007. Notable CCMs include the California Air Resource Board Offset Credits and the Beijing Forestry Offset Mechanism. A broad range of activities qualify under CCMs, including landfill methane capture, avoided agricultural methane, and afforestation; all of which broadly ether avoid GHGs from being emitted, or sequester them from the atmosphere.

Figure 2: Cumulative Carbon Credits Issued, up to and including 2023:

2) Evolution of Carbon Market Infrastructure: At a high level, there are two types of Carbon Markets: Compliance and Voluntary.

Compliance markets: result from any national, regional, or international agreement or regulation and include the ETS and CCMs.

Voluntary Carbon Markets (VCM): refer to the buying and selling of carbon credits on a voluntary basis. Article 6 of the 2015 Paris Agreement provides a basis for facilitating international recognition of cooperative carbon pricing approaches, in short, a framework for supply and demand within VCM.

VCM supply originates from issuers (sovereigns and private abatement project developers) via the four primary programs: American Carbon Registry, Climate Action Reserve, Verra, and Gold Standard. VCM demand comes from nations, corporations, or other entities seeking to achieve emissions reductions states through their own NDCs or other targets. Like Compliance markets, VCM credit instruments include projects in diverse categories as carbon capture and storage, renewable energy, and REDD+, a UN framework to encourage developing countries to reduce emissions and promote GHG sequestration through various forest management activities; a breakdown by type and geography of the nearly 9,000 projects issued via these four VCM programs is shown in Figure 3.²

Figure 3: Cumulative Voluntary Carbon Credits issued via the four primary programs 1996-2023 (by Project Type and Geography):

2023 was a challenging year for VCMs. According to a World Bank report, critical media coverage during the year cast doubt on the environmental integrity of some carbon credits. Further, issuances and retirements of VCM carbon credits were down 13% from January through September 2023 versus the same period in 2022.³ In addition, the United Nations COP 28 held in Dubai in December failed to adopt key provisions of Article 6 of the 2015 Paris Agreement that would have expanded voluntary carbon market activity. Article 6.4, specifically, would have provided a new operational structure for the exchange of emissions reduction credits across borders. Opponents argued that guidance and rules around the environmental integrity of carbon removals was insufficient. The Article is likely to be taken up again at COP 29 in Baku in November 2024.⁴

3) The Macroeconomic Impacts of Carbon Pricing: Considering the current scope of both Compliance and Voluntary Carbon Markets, paired with their growth since the 2015 Paris Agreement, it is timely to consider the impact of increased carbon pricing on economic growth.

Differing perspectives on its impact have emerged. A recent IMF Working Paper has found limited impact of the EU ETS and national carbon taxes on inflation within the Euro area, noting that the impact of Russia’s invasion of Ukraine had a larger and more direct impact on inflation.⁵

A separate 2023 study by the International Chamber of Commerce found that carbon pricing will lead to short-term inflation, particularly with energy and critical minerals; however, it will gradually decelerate in the long run unless action on GHG emission reduction is delayed.⁶ Our own analysis of OECD Effective Carbon Rates (Combined Fuel Excise Taxes, Carbon Taxes and ETS) across 71 countries, versus their current inflation rates does not exhibit a strong correlation in Figure 4.

Figure 4: Effective Carbon Rates (2021) and Average Inflation Rates, 2021-23

More Pricing Ahead

Carbon pricing has seen exponential growth in the past decade. Given the deglobalization trend and Podesta’s latest remarks, it looks certain its impact on public policy will grow more central in the coming decade as national governments determine their short- and long-term responses to climate change.

If you have any questions or would like further information, please reach out to Win Thin, Elias Haddad, or Jay Foraker.