Emission Trading Systems vs. Carbon Taxes in Africa

As countries adopt efforts to mitigate climate change, two main market-based pricing mechanisms have emerged as tools for reducing greenhouse gas (GHG) emissions—Emissions Trading Systems (ETS) and carbon taxes. Both aim to reduce emissions but have different features and approaches to this goal.

As countries adopt efforts to mitigate climate change, two main market-based pricing mechanisms have emerged as tools for reducing greenhouse gas (GHG) emissions—Emissions Trading Systems (ETS) and carbon taxes. Both aim to reduce emissions by incentivising the transition to less-emitting activities. However, they have different features and approaches to this goal. This article highlights some of the differences, advantages, and challenges of these two approaches.

Emissions Trading Systems

The ETS is increasingly being adopted across developed countries globally. It is a tradable-permit system for greenhouse gases (GHG) emissions. Also known as the "cap-and-trade”, it puts a limit (cap) on the quantity of GHG a company/entity can emit. The cap is usually determined by the country’s regulator for the industry.

ETS also have a scope to ensure effective reduction of GHG emissions. The scope covers the range of greenhouse gases (GHGs) i.e. CO2, NOX, NH4; sectors i.e. power and manufacturing; value chain segment i.e. generation or distribution; geographical scope i.e. national or subnational; points of regulations i.e. downstream or upstream; and emission sources i.e. natural gas or petroleum resources.

In an ETS, each tonne of GHG emitted by an organisation is covered by one emissions permit (called an allowance). Organisations can trade allowances. The government can distribute allowances to organisations for free or sell them via a government-regulated auction mechanism or hybrid where a part of the allowance is given away for free, and the rest auctioned.

Carbon Tax

A carbon tax is a fee imposed by a government on organisations that utilise fossil fuels (coal, petrol, and natural gas) for their operations. A carbon tax ascribes a price to CO2 emissions by determining a tax rate on the emissions. This tax rate often depends on the carbon content of the fossil fuel type being utilised. The price is usually represented in currency per unit of CO2 emitted (e.g., USD per tCO2e). This sends a price signal incentivising organisations to reduce their CO2 emissions by transitioning to less GHG-emitting sources for their operations.

For carbon taxes to be effective they have to cover a broad tax base and limit the potential for rebates and other compensation measures that could reduce tax income and render them ineffective. To reduce emissions, the price should be high enough and be applied in high-emitting sectors. Policymakers choose which GHGs to cover based on their mitigation potential and relevance to the country’s emissions reduction targets. The sectors where these taxes are applied are also chosen based on the ease of monitoring and regulating them.

Carbon taxes can either be applied upstream (during the supply of carbon-based fuels) or downstream (when there is a purchase or consumption of produced goods/services). Downstream tax regulation is easier to implement as it captures source emissions. An upstream tax allows broad coverage of scattered downstream emissions sources. For instance, a tax on fossil fuel production would cover all downstream uses, either for transport, power generation or lighting.

Choosing a Pricing Mechanism

In many jurisdictions, the ETS is more easily accepted compared to the carbon tax. This is because the market participants are large-scale GHG emitters who are informed of the environmental requirements they have to comply with. Also, the ETS has no direct effect on consumers and end-users, although it could indirectly affect them. In the case of large-scale power plants, this could result in increased electricity costs. As the participants and stakeholders of the ETS are smaller, an ETS can be implemented easily. A carbon tax, on the other hand, could be rejected by taxpayers, political opposition, and even government regulators as it could have a significant effect on the overall economy. Adopting and applying a carbon tax requires significant political coordination, stakeholder consultations, public awareness and communications to address issues that a tax may raise.

Countries adopting either pricing mechanism must have sufficient and reliable tools to quantify and manage emissions. It is important to develop the appropriate monitoring, reporting and verification (MRV) processes and frameworks. This allows for coordination of efforts in subnational, national, regional, and even global GHG emissions accounting.

Carbon pricing enables governments to raise revenue. It is key that governments identify ways to redistribute the revenues from their carbon pricing schemes. Governments can utilise carbon tax income to fund other projects/efforts that reduce emissions. These could include subsidies or concessional financing for clean energy projects and energy efficiency initiatives. These could help accelerate the deployment of clean energy locally.

Carbon pricing mechanisms are important tools for reducing emissions. Countries must decide which would be effective for them based on their socio-political and economic conditions as well as their specific emissions reduction targets. A hybrid approach that merges features of both may offer a balanced and effective solution for addressing climate change.

*Image credit: Gerhard Roux, licensed under CCBY 2.0

 

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