Carbon Markets & Carbon Tax
🟠 Topic 78: Carbon Markets & Carbon Tax
📌 Introduction
Carbon pricing mechanisms like Carbon Markets and Carbon Tax are essential economic tools to combat climate change by putting a price on carbon emissions. These tools create financial incentives for businesses and individuals to reduce greenhouse gas (GHG) emissions, shift towards cleaner technologies, and promote sustainable practices. As countries aim for Net Zero emissions, carbon pricing is becoming central to climate policy frameworks globally, including in India.
🔹 What are Carbon Markets?
📖 Definition
A Carbon Market is a trading system where companies buy and sell carbon credits or allowances to comply with emission limits set by governments or international agreements.
✔️ Carbon markets put a cap on emissions and allow trading of excess allowances.
✔️ Companies that reduce emissions below their allowance can sell credits to others exceeding limits.
Types of Carbon Markets
| Type | Description | Example |
|---|---|---|
| Compliance Market | Mandatory cap-and-trade for regulated industries | EU Emissions Trading System (ETS) |
| Voluntary Market | Companies buy credits voluntarily to offset emissions | Voluntary Carbon Standard (VCS) |
Key Components
| Component | Explanation |
|---|---|
| Emission Cap | Total emissions allowed for all participants |
| Allowances | Permits allocated to companies |
| Carbon Credits | Tradable units representing 1 tonne of CO₂ reduction |
| Offset Projects | Projects that capture/reduce emissions (afforestation, renewable energy) |
Case Study – EU Emissions Trading System (EU ETS)
- Largest carbon market.
- Covers power plants, factories, airlines.
- Emission allowances gradually reduced to meet climate targets.
- Carbon prices increased significantly, driving clean technology adoption.
🔹 Carbon Tax – Concept & Working
📖 Definition
A Carbon Tax is a direct tax on the carbon content of fossil fuels, aimed at internalising the environmental cost of carbon emissions into market prices.
✔️ Higher carbon tax = Stronger incentive to shift to clean energy.
✔️ Revenue collected can fund green projects or climate adaptation.
How It Works
| Step | Process |
|---|---|
| 1️⃣ | Government sets tax rate per tonne of CO₂ emitted |
| 2️⃣ | Companies pay tax based on fossil fuel consumption |
| 3️⃣ | Higher carbon tax raises fossil fuel prices |
| 4️⃣ | Companies invest in clean technologies to reduce tax liability |
Example
If carbon tax = ₹1,000 per tonne of CO₂, a coal power plant emitting 100,000 tonnes pays ₹10 crore.
🔹 Comparison – Carbon Markets vs Carbon Tax
| Parameter | Carbon Markets | Carbon Tax |
|---|---|---|
| Flexibility | Companies choose to reduce or buy credits | Direct tax on emissions |
| Price Certainty | Price fluctuates with demand | Fixed tax rate |
| Emission Certainty | Total emissions capped | No cap, just price signal |
| Compliance Cost | Depends on market price | Fixed, predictable |
| Administrative Complexity | High (monitoring, trading) | Simpler collection mechanism |
Example – Carbon Pricing in Sweden
- Introduced carbon tax in 1991.
- One of the highest rates globally (~$137 per tonne CO₂).
- Result: Shift to renewable energy, reduced emissions without harming GDP growth.
🔹 Benefits of Carbon Pricing
1️⃣ Environmental Benefits
✔️ Encourages GHG reduction across sectors.
✔️ Provides financial incentives for low-carbon technologies.
2️⃣ Economic Efficiency
✔️ Uses market forces to find cheapest emission reductions.
✔️ Avoids rigid sectoral emission quotas.
3️⃣ Revenue Generation
✔️ Carbon tax revenue can fund: ✔️ Renewable energy subsidies. ✔️ Climate adaptation programs. ✔️ Income support for vulnerable groups.
4️⃣ Innovation Incentives
✔️ Encourages investment in: ✔️ Clean energy technologies.
✔️ Energy efficiency.
✔️ Carbon capture and storage (CCS).
🔹 Challenges in Implementing Carbon Markets & Carbon Tax
1️⃣ Competitiveness Concerns
- Higher carbon prices increase production costs, impacting global competitiveness.
- Carbon Border Adjustment Mechanism (CBAM) by EU aims to equalise carbon costs for imports.
2️⃣ Monitoring & Verification
- Accurate emission measurement critical for credibility.
- Risk of fraud and manipulation in carbon offset projects.
3️⃣ Impact on Consumers
- Carbon pricing increases energy prices, affecting: ✔️ Household budgets.
✔️ Inflation.
4️⃣ Coverage & Exemptions
- Sectors like agriculture often exempted.
- Coverage gaps reduce effectiveness.
5️⃣ Political Opposition
- Carbon taxes often face: ✔️ Resistance from fossil fuel lobbies. ✔️ Public backlash over higher prices (e.g., France’s Yellow Vests movement).
🔹 India’s Approach to Carbon Pricing
1️⃣ Perform, Achieve, Trade (PAT) Scheme
- Energy efficiency trading program.
- Large energy consumers given specific energy reduction targets.
- Excess savings can be traded as Energy Saving Certificates (ESCerts).
2️⃣ Renewable Energy Certificates (REC)
- Power producers can trade Renewable Energy Certificates to meet renewable purchase obligations (RPOs).
3️⃣ Proposed Carbon Market
- National Carbon Market Framework under development.
- Will cover: ✔️ Energy, transport, industrial sectors. ✔️ Allow trading of carbon credits.
- Builds on PAT and REC experiences.
4️⃣ Existing Carbon Pricing (Indirect)
- Cess on coal production (earlier ₹400/tonne).
- Taxes on petrol, diesel (though not labelled as carbon tax, they act as such).
Case Study – Gujarat Emissions Trading Scheme (ETS)
- India’s first cap-and-trade program for particulate pollution.
- Successfully reduced emissions by 20-30% in pilot phase.
- Provides template for national carbon market.
🔹 Global Trends in Carbon Pricing
| Country | Mechanism | Price (USD/tonne CO₂) |
|---|---|---|
| Sweden | Carbon Tax | ~$137 |
| EU | ETS | ~$90 |
| China | Carbon Market (Pilot) | ~$8 |
| Canada | Carbon Tax | ~$50 |
🔹 Way Forward for India
✔️ Develop a national carbon market linked with: ✔️ Renewable energy goals.
✔️ Industrial decarbonisation. ✔️ Gradual introduction of carbon tax on polluting sectors. ✔️ Use carbon pricing revenue for: ✔️ Green transition support for MSMEs. ✔️ Welfare programs for vulnerable populations. ✔️ Ensure transparent monitoring and credible offset mechanisms.
📚 Practice MCQ
1️⃣ Which of the following best describes a carbon tax?
✅ Options:
(a) A tax on total industrial output
(b) A tax on the carbon content of fossil fuels
(c) A direct subsidy for renewable energy
(d) A penalty for industrial accidents
2️⃣ Which state in India launched the first emissions trading scheme for air pollution?
✅ Options:
(a) Maharashtra
(b) Gujarat
(c) Tamil Nadu
(d) Rajasthan
3️⃣ In a cap-and-trade carbon market, the government:
✅ Options:
(a) Collects a flat tax from polluting firms
(b) Sets a cap on emissions and allows trading of allowances
(c) Provides subsidies to green companies
(d) Nationalises polluting industries
