This article is a part of the series - Raisina Files 2024
As countries increasingly shift towards net-zero economies to mitigate the risks posed by climate change, carbon pricing mechanisms are emerging as a promising instrument in the fiscal policy toolkit as a highly cost effective means to reduce carbon emissions. Of the 195 Parties to the Paris Agreement, 122 have indicated in their updated Nationally Determined Contributions (NDCs) that they are planning or considering the use of carbon pricing to meet their pledges.[1]
Carbon pricing is one of the well-established economic instruments that internalise the cost of carbon in goods and services. Mechanisms to apply carbon pricing can play a vital role in driving emission reductions, stimulating investments in low-carbon technologies, generating government revenues, and promoting sustainable growth, thus paving the way for a lowercarbon future.[2] In an evident shift globally towards more inward-looking industrial policies, carbon pricing can serve as an effective pre-emptive strategy to rapidly decarbonise and build competitive economies geared for the global market. Moreover, strategic fiscal policies leveraging the revenue from carbon pricing can mitigate the initial economic burdens linked to implementing such schemes and enhance its political appeal.
Tailored carbon pricing policies can assist, for example, the G20 countries comprising both highly industrialised and emerging economies. These countries account for a massive 80 percent of the world’s greenhouse gas emissions.[3] The most common approaches to pricing carbon are carbon taxes and emission trading systems (ETS), and the majority of G20 members have established at least one of them. A carbon tax sets a price on GHG emissions, likely using existing taxation systems, but does not directly limit emissions. An ETS, or cap-and-trade, allows emitters to trade emission units to meet targets set by the government and lets the market decide the price of carbon. The latter may require more infrastructure and legislative support.[4]
Within the evolving landscape of international cooperation in carbon markets, each carbon price instrument comes with different considerations that depend on the economy’s circumstances. Boosting its relevance within the G20 and facilitating international collaboration through carbon markets will enable nations to collectively pursue emission reduction goals, fostering global cooperation in this endeavour.
It is not an easy task, especially in emerging economies, because of two primary concerns: insufficient capacity for devising and executing the necessary instruments; and the social ramifications of their adoption, which is the focus of this essay. Much of current literature indicates that the social impacts of existing carbon pricing regimes have been overstated, and that where such impacts do occur, there are design elements that can mitigate and reverse any negative social and income effects of carbon pricing. The article will also assess the landscape of capacity building initiatives on carbon pricing and advocate for enhanced knowledge sharing across the Global South.[5]
Understanding and Mitigating the Social Challenges of Carbon Pricing
Distributional implications for the public and the affected economic sectors are important considerations in evaluating carbon pricing policies.
Social Challenges and Inequality Impacts
1. Impacts on households
One of the main and politically crucial stakeholder groups who will bear the impact of carbon pricing’s distributional dimension are households. In theory, households at the high- and middle-income range tend to have larger carbon footprints and will therefore pay more under carbon pricing schemes in absolute terms. However, relative to their household income and expenditures, upper-income consumers generally pay less than lower-income households. In this way, carbon pricing policies may be regressive—i.e., they could place a greater burden on lower-income individuals and communities. Lower-income households can be particularly affected through increased expenditures and loss of employment, thus exacerbating energy poverty.[6]
2. Impacts across sectors
The political acceptance of carbon pricing policies is often influenced by the sectors covered. Certain industries that are particularly affected due to their heavy reliance on carbon-intensive processes and products, limited capacity to reduce emissions, or competition from low-emission industries may experience economic disruption as a result of carbon pricing policies, resulting in political mobilisation and advocacy from sector stakeholders.[7] Public perception, understanding, acceptance and trust are crucial for the success of carbon pricing policies.[8]
3. Impacts across different geographies
The social repercussions of carbon pricing can vary across countries and regions. While increased costs for energy, transportation, and goods and services will be consistent across economies and geographies,[9] they will create more impediments in emerging economies or less affluent regions. Overall, carbon pricing can impact rural and urban areas differently, with regions characterised by diverse energy mixes potentially experiencing varying degrees of electricity price hikes. Additionally, the economic makeup of regions may influence whether the effects are regressive or progressive: resource-rich regions could potentially benefit, while those heavily reliant on carbon-intensive industries like coal mining or oil extraction may face economic disruptions.[10]
4. Social factors and environmental justice
Environmental justice concerns related to carbon pricing policies revolve around the equitable distribution of the costs and benefits of these policies, especially for vulnerable and marginalised communities. These concerns highlight the potential for carbon pricing to disproportionately affect disadvantaged communities and exacerbate existing environmental and social inequalities. Any transition to a lowcarbon economy must prioritise these communities.[11]
5. Carbon leakage
In a globalised economy, unilateral implementation of carbon pricing tools in one jurisdiction can lead to the risk of carbon leakage, where, to avoid costs, businesses move their operations to regions with less stringent or no carbon pricing policies. This can result in emissions being shifted to other jurisdictions rather than getting reduced, provoking concerns of carbon leakage.[12]
Tools to Address Distributional Issues in Carbon Pricing Development
The following paragraphs explore policy measures that can be employed to mitigate distributional concerns associated with carbon pricing.
1. Revenue recycling
Recycling of revenue from carbon pricing is directly associated with the ‘double dividend’ hypothesis. It refers to the dual benefits that can be achieved through redistributing the revenue generated from a carbon pricing mechanism to reduce pre-existing direct taxes, like payroll or sales taxes, or otherwise accommodate the costs of the necessary industrial or social change arising from the imposition of a carbon tax (e.g. promoting re-skilling of the workforce in vulnerable industries). Thus, not only reducing emissions but also gaining positive economic impacts.[13] Direct cash rebates or lump-sum transfers to support low- and middle-income households and other subsidies and transfers are other effective policy measures to offset the increased cost of carbon pricing.
2. Infrastructure investments including public transportation
Investment in affordable and accessible public transportation systems, cycling lanes, and pedestrian-friendly infrastructure to reduce the transportation costs for individuals with limited mobility options, or even subsidies in public transportation that increase the availability of low-carbon options, can also preserve the carbon price signal.
3. Cleaning electricity sector
Carbon pricing does not hit the electricity expenditures if the electricity supply is relatively clean—meaning that a higher share of clean energy will have an indifferent distributional incidence towards either progressivity or regressivity. Investing in decarbonisation of the electricity sector can thus be an effective tool in reducing impact on both households and power-intensive industries.[14]
4. Sector-specific support
Provide targeted assistance to industries or sectors that are particularly vulnerable to carbon pricing, including those with high energy intensity and trade-exposed sectors.[15]
5. Subsidy reform
Subsidy reform measures are policies aimed at phasing down or redirecting government subsidies that support fossil fuels or other carbon-intensive activities. When designed as a distributional tool alongside carbon pricing policies, subsidy reforms can help address environmental justice concerns and ensure that the burdens and benefits of carbon pricing are distributed fairly.[16]
6. Spending on policy considerations
Revenues can also be recycled in support of ancillary policies. These can include renewable energy or low-carbon initiatives, through risk-proofing of financing in lowcarbon production and climate-tech innovations, and in just transition policies that support workers and communities affected by the transition.
The Imperative for Capacity-Building Support on Carbon Pricing
Opportunities to employ carbon pricing tools to meet sustainable development and climate goals should be matched with the means to design, implement, and review carbon pricing policies. Effective capacity building for carbon pricing can help in both, accelerating the pace and broadening the scale of carbon pricing’s contributions to climate action. The success of carbon pricing policies will rely in part on participating countries’ capacities to embed carbon pricing approaches within existing domestic policy, legal, regulatory, and finance frameworks.
While certain infrastructure capacity requirements may be similar among countries implementing a specific policy,c their capacity building needs will differ. These needs may encompass various issues within each country, including economic analysis and emissions modelling, public and stakeholder engagement, market-based policy design, carbon finance, legal frameworks, and institutional arrangements.
Some work has already been undertaken to understand carbon pricing capacity building needs, and it is therefore important to have a comprehensive understanding of the landscape of current capacity building efforts. Few, if any, comprehensive assessments exist of the efficacy of carbon pricing capacity building efforts. A collective review and assessment of capacity building efforts across various initiatives and systems would assist in identifying lessons learned and in tailoring efforts to local circumstances.
A holistic package of targeted, continuous support aligned with a country’s individualised needs, is more likely to generate results than ad-hoc efforts on isolated topics. An IMF/OECD report outlined various potential factors for G20 Finance Ministers to consider concerning carbon taxation policies.[17] These include enhancing the assessment of countries' primary greenhouse gas mitigation policy measures, exchanging metrics and indicators for evaluating countries' carbon footprints, examining the effects of energy price fluctuations on households, industries, and employment in susceptible sectors and regions, as well as assessing measures aimed at mitigating any adverse effects.[18] The report also suggests analysing the potential repercussions of increasing disparities in carbon prices on carbon leakage, as well as on countries' imports, exports, output, and employment.[19]
Numerous capacity-building initiatives have been launched to aid developing nations in navigating carbon markets. As the efforts started growing in size, it became clear that many countries were not receiving the expected level of technical assistance fit for their local context. Second, there is often a lack of sustainability in capacity-building efforts, particularly within governmental entities. While capacity may be developed initially, there is no guarantee of its retention or continuity over time. The challenge is exacerbated by the limited size of teams dedicated to carbon market development matters within government structures. Third, there is weak coordination at the institutional level between different stakeholders which impedes the implementation of carbon pricing initiatives and policies. Moreover, it is frequently observed that training sessions conducted for high-level officials fail to disseminate essential knowledge and skills to the local stakeholders who bear the responsibility for actual implementation. This lack of cascading information hampers the execution of strategies and initiatives at the grassroots level, highlighting the need for targeted efforts to bridge this gap in knowledge transfer.
Fourth, there is inadequate engagement with the private sector to enhance their capabilities in conjunction with the public sector. The private sector holds a pivotal position in furnishing financial backing for project execution and galvanising support for pioneering research and development initiatives related to carbon pricing. Lastly, capacity-building initiatives in carbon markets often suffer from a lack of coordination among various programmes and organisations, resulting in duplication of efforts, inconsistent quality standards, and inefficient resource allocation. Without proper coordination, these initiatives may struggle to achieve their intended impact, leading to a fragmented approach with limited outcomes.[20]
The Next Wave of Carbon Markets
At the forefront of the evolving landscape of international carbon markets, the Paris Agreement has prompted a resurgence of carbon pricing instruments in the climate policy toolkit. The history of carbon markets in the Global North offers important lessons around the challenges and opportunities associated with carbon pricing policies that can inform their expansion into emerging economies and developing countries.
Governments in the Global South face unique challenges in implementing carbon pricing instruments. Limited resources may pose hurdles, with environmental agencies sometimes operating with smaller staff compared to their counterparts in developed countries. These regions also face data poverty and may lack the data management systems required to establish effective carbon pricing mechanisms. Furthermore, the transition to carbon pricing is complicated in contexts with incipient liberalisation in the electricity and overall energy market, requiring careful navigation of regulatory frameworks. Compounding the challenge is the lack of access to affordable capital for low-carbon solutions, underscoring the need for complementary policies to de-risk investments and facilitate climate finance. Most importantly, there is a strong focus on addressing energy access and energy poverty in many of these regions, which often takes precedence over emissions reductions, potentially derailing the adoption of carbon pricing measures.
Despite the obstacles, emerging economies in the Global South also possess advantages. For instance, there is an emerging generation of young leaders, equipped with training in climate policies and carbon pricing, who can offer fresh perspectives and innovative solutions to address the challenges. Additionally, these economies have the opportunity to avoid the lock-in of new infrastructure, enabling them to align with decarbonisation imperatives from the outset and avoid costly retrofits in the future. There is also a growing focus on the development and adoption of new "leapfrogging" technologies. These advantages position emerging economies to transition directly to cleaner, more efficient energy systems, fostering sustainable development and resilience in the face of global challenges.
Opportunities for South-South Cooperation in Carbon Markets
Amid the challenges and opportunities, there is potential for South-South cooperation in carbon market development:
• Capacity-building across geographies that share a common language, breaking down barriers to information.
• Development of common market architecture across regions, including data exchange standards, registries, and approaches to offsets (such as through mutual recognition or adoption of common standards).
• Establishing common thinking on issues such as the legal context of carbon markets and credits.
• Exploration of linking between markets as a longer-term goal, with the possibility of regional connections within the Global South.
By building on the lessons learned by countries in the Global North over the last two decades, and through mutual understanding of national circumstances, sharing experiences, and co-designing systems, South-South cooperation can unlock collaboration and joint efforts to address climate change.
As the world's largest economies, G20 members have influence over global carbon emissions and economic policies. Discussions on carbon pricing must gain greater prominence within the grouping as countries seek effective strategies to reduce greenhouse gas emissions while promoting sustainable economic growth. Moreover, the G20 recognises the importance of international cooperation in addressing climate change, and carbon pricing provides a platform for collaborative action. Coordinated approaches to carbon pricing can help prevent carbon leakage and ensure a level playing field for industries across different regions.
The Carbon Border Adjustment Mechanism (CBAM) introduced by the European Union (EU) is a case in point: It raises concerns for emerging economies and the broader landscape of international trade, and threatens to exacerbate existing inequalities in the global economy. Compliance with the CBAM requires accurate measurement and verification of carbon emissions throughout the production process, posing logistical and administrative burdens for countries, particularly in emerging markets that are already incapacitated. By promoting dialogue, cooperation and capacity building support on carbon pricing, the G20 can drive momentum towards a low-carbon transition while fostering sustainable and inclusive economic development. As such, discussions on carbon pricing within the G20 are crucial for advancing climate goals and shaping the future of global environmental governance.
Endnotes
[1] Climate Watch, “Explore Nationally Determined Contributions (NDCs),”
[2] “About Carbon Pricing,” United Nations Framework Convention on Climate Change
[3] “G20 Economies are Pricing More Carbon Emissions but Stronger Globally More Coherent Policy Action is Needed to Meet Climate Goals, Says OECD,” Organisation for Economic Co-operation and Development, October 27, 2021
[4] “What is Carbon Pricing?” Carbon Pricing Dashboard, World Bank; Ian W.H. Parry, Simon Black, and Karlygash Zhunussova, “Carbon Taxes or Emissions Trading Systems?: Instrument Choice and Design,” International Monetary Fund, 2022
[5] “What is Carbon Pricing?”
[6] Constanze Haug, Alexander Eden, and Mariza Montes de Oca, Addressing the Distributional Impacts of Carbon Pricing Policies, Berlin, Adelphi, 2018
[7] Johanna Arlinghaus, “Impacts of Carbon Prices on Indicators of Competitiveness: A Review of Empirical Findings,” OECD, 2015
[8] Dabla-Norris et al., “Public Perceptions of Climate Mitigation Policies: Evidence from Cross-Country Surveys,” Staff Discussion Note SDN2023/002, International Monetary Fund, 2023.
[9] Haug, Eden, and Montes de Oca, “Addressing the Distributional Impacts of Carbon Pricing Policies”
[10] Haug, Eden, and Montes de Oca, “Addressing the Distributional Impacts of Carbon Pricing Policies”
[11] Haug, Eden, and Montes de Oca, “Addressing the Distributional Impacts of Carbon Pricing Policies”; M. Li et al., “Co-Benefits of China’s Climate Policy for Air Quality and Human Health in China and Transboundary Regions in 2030,” Environmental Research Letters 14, no. 8 (2019), doi:10.1088/1748-9326/ab26ca; Carbon Pricing Leadership Coalition, “Carbon Pricing, Climate Change, and Air Quality,” 2019, https://climatestrategies.org/ wp-content/uploads/2020/05/Carbon-Pricing-Climate-Change-and-Air-Quality.pdf; Alex Bowen, “Carbon Pricing: How Best to Use the Revenue?” Grantham Research Institute on Climate Change and the Environment & Global Green Growth Institute, 2015, https://www. lse.ac.uk/GranthamInstitute/wp-content/uploads/2015/11/Bowen-policy-brief-2015.pdf; International Monetary Fund, “How Much Carbon Pricing is in Countries’ Own Interests? The Critical Role of Co-Benefits,” 2014, www.imf.org/external/pubs/ft/wp/2014/ wp14174.pdf.
[12] Bowen, “Carbon Pricing: How Best to Use the Revenue?”
[13] Danuse Nerudova and Marian Dobranschi, “Double Dividend Hypothesis: Can it Occur when Tackling Carbon Emissions?” Procedia Economics and Finance (2014): 472–79, DOI: 10.1016/S2212-5671(14)00369-4
[14] Jan C. Steckel et al., “Distributional Impacts of Carbon Pricing in Developing Asia,” Nature Sustainability (2021): 1005–14
[15] Virender Kumar Duggal, “Carbon Pricing Development and Dynamics: Implications for Developing Asia,” Asian Development Bank, 2023
[16] Nils Ohlendorf et al., “Distributional Impacts of Carbon Pricing: A Meta-Analysis,” Environmental and Resource Economics 78 (2020): 1–42
[17] Tax Policy and Climate Change, Italy, IMF and OECD, September 2021
[18] “Tax Policy and Climate Change
[19] “Tax Policy and Climate Change
[20] Hanna-Mari Ahonen et al., “Capacity Building for Article 6 Cooperation: The Way Forward,” April 2022
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Mannat Jaspal is an Associate Fellow with the Geoeconomics Studies Programme at ORF. Mannat is deeply interested in exploring matters on sustainability and development – ...
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