Carbon Pricing and Cap-and-Trade in the European Union

Carbon pricing comes in two forms. First, is a carbon tax, where government determines a price that firms must pay for every ton of carbon that they emit. The second form of carbon pricing is a “cap-and-trade” (or emissions trading) system. The European Union has implemented the European Union Emissions Trading Scheme (EU ETS), a “cap-and-trade” system for all thirty countries in the EU plus Iceland, Liechtenstein, and Norway). Economists Sanjay Patnaik and Kelly Kennedy of the Brookings Institution noted that “carbon pricing is the most direct and most efficient way to achieve the emissions reductions that are necessary to mitigate climate change. The U.S. will have to take drastic action if it is to meet its climate goals.”

Other countries have developed emission trading schemes: Kazakhstan, New Zealand, Mexico, and China; carbon taxes have been introduced in South Africa, Chile, Argentina, and Canada. Altogether, one-fifth of all carbon emissions worldwide are covered by some form of carbon pricing. The US federal government is the obvious exception.

The Obama administration attempted “cap-and-trade” legislation that barely passed in the House but was squelched in the Senate. Not waiting for the federal government to act, several US states have enacted carbon pricing systems. California was the first with a cap-and-trade system in 2013, followed by Washington state in 2021. Eleven northeastern states participate in the Regional Greenhouse Initiative, a cap-and-trade program covering some 18 percent of emissions in those states. The top recommendation of Hawaii’s 2020-2022 Tax Review Commission was the adoption of a carbon tax for the state; if adopted, it would help the state achieve its goal of sequestering more greenhouse gas annually than the amounts emitted, no later than 2045. If Hawaii adopted a carbon tax, it would be the first state in the nation to do so.

Source: Sanjay Patnaik and Kelly Kennedy, “Why the US Should Establish a Carbon Price Either Through Reconciliation or Other Legislation,” Brookings Institution, October 7, 2021, https://www.brookings.edu/articles/why-the-us-should-establish-a-carbon-price-either-through-reconciliation-or-other-legislation/.