Carbon Pricing 101

Carbon pricing works by charging polluters for their emissions. There are two main ways to put a price on carbon — a carbon tax directly on emissions, or a cap-and-trade program, which caps total emissions and allows polluters to buy and trade permits to pollute. The details of carbon tax systems and cap-and-trade programs are a little different, but ultimately they work toward the same goal: reducing emissions.

Cap-and-trade programs reduce greenhouse gases over time by lowering the cap of allowable emissions. With a carbon tax, the higher the price, the greater the emissions reductions. A $50/ton tax on carbon in the U.S. would help drive emissions reductions of about 40 percent, or around 2,620 million metric tons of CO2 equivalent by 2030, below 2005 levels. That’s the equivalent of taking more than 550 million cars off the road — almost double the number of cars registered in the U.S.

Carbon pricing is an essential tool in the fight against global warming, but it shouldn’t be the only tool we use. It needs to be paired with a full suite of climate solutions, including investments in clean energy and clean transportation. Fortunately, carbon pricing can help with that too.

Putting a price on carbon means polluters have to pay for their emissions. As a result, carbon pricing has the potential to raise significant money to invest in climate solutions that will cut emissions even further. The money can be invested in wind turbines and solar panels, energy efficiency measures, electric vehicle tax incentives and charging infrastructure, and more.

In 2018, for example, California’s cap-and-trade program generated $3.3 billion that the state invested in clean transportation, sustainable communities, natural resource management, waste diversion, clean energy and energy efficiency.

Carbon pricing has great potential as a central part of the U.S. policy toolkit to fight global warming. The federal government and U.S. states should pursue carbon pricing programs, along with other policies to cut emissions, as the best way to get to net zero emissions by 2050.

U.S. policymakers should adopt carbon pricing policies with the following elements:

1. Implementing carbon tax and/or cap-and-trade programs as part of a broad set of policies to address global warming.

• Strategies to address global warming also should include use of existing regulatory powers (e.g., the Clean Air Act), reduction/elimination of fossil fuel subsidies, expansion of incentives/subsidies for renewables, research and development (R&D) investments, investments in green infrastructure and others.

2. Setting carbon tax rates and caps to target emissions reductions.

• Carbon pricing programs should use emission reductions timelines, rather than revenue targets or estimates of the social cost of carbon, to set tax levels or caps. This could include accepting caps at levels above emission reduction targets, but that generate revenue that is used to cut emissions further through investments.

3. Investing carbon pricing revenues in renewable energy, energy efficiency, green infrastructure and broad public benefits.

• Carbon pricing programs should direct revenues across sectors as part of overall efforts to decarbonize the economy and to increase public awareness of the importance of carbon pricing in addressing GHG emissions.
• All other uses of carbon pricing revenues should benefit the public. 

4. Ensuring the integrity of programs and preventing loopholes.

• Carbon pricing programs should include backstops that ratchet up prices or otherwise accelerate emission reductions if emissions targets are not met.
• Programs should ideally be comprehensive, covering the entire economy.
• Programs should include measures to prevent “carbon leakage,” e.g., via a border carbon adjustment/border tax adjustment.
• In the case of cap-and-trade, policymakers should adopt tight limits on offsets and ensure that any cost-containment provisions built into the program do not interfere with progress toward needed emission reductions.