Pricing Greenhouse Gas Emissions 2024

Gearing Up to Bring Emissions Down

Report

OECD Series on Carbon Pricing and Energy Taxation

14 November 2024

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2. Pricing carbon: Developments in Effective Carbon Rates (ECRs)

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Abstract

This chapter offers a comprehensive overview of the evolving trends in carbon pricing including emissions trading systems (ETS), carbon taxes, fuel excise taxes and fossil fuel subsidies. The chapter highlights little change in emissions coverage and decreases in price levels captured by Net ECRs. Responses to the recent energy crisis have overshadowed increases in explicit carbon prices, while many jurisdictions are exploring the implementation of new or expansion of existing ETSs. In addition, this chapter addresses some of the practical considerations that countries are facing in implementing carbon pricing policies, including the choice of instruments, addressing cross-border emissions and pricing hard-to-abate industries, as well as the potential role for carbon revenues and public acceptability.

2.1. Trends in carbon pricing and coverage

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2.1.1. Trends in coverage

Limited progress in the coverage of emissions subject to a positive ECR

Approximately 42% of GHG emissions across the 79 countries covered in this report are subject to a positive Net ECR – positive price coverage has not changed significantly from 2021 to 2023 (Figure ‎2.1). About 27% of GHG emissions in 2023 are covered by explicit carbon prices – an ETS, a carbon tax, or both - while the share covered by fuel excise taxes, an implicit form of carbon pricing, is 23%. Coverage by explicit pricing instruments therefore exceeds that of implicit pricing instruments, with a similar difference compared to previous years. Among explicit instruments, coverage through ETSs is much larger than through carbon taxes, reflecting the higher number of countries with this instrument in place. There are 40 countries with an ETS in place, compared to 27 countries with a carbon tax, and the preference for ETSs as an explicit carbon price continues to grow (discussed further in Section ‎2.2).

Figure ‎2.1. Minimal changes in emissions coverage of carbon pricing instruments
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Share of GHG emissions subject to a positive price, in %, by instrument, all 79 countries, 2018-2023

The emissions coverage of ETSs has increased by 0.7 percentage points and the coverage of carbon taxes has increased by 0.3 percentage points, accompanied by an almost identical coverage of emissions from fuel excise taxes from 2021 to 2023. These developments are mostly driven by only very modest expansions or no change of coverage of explicit carbon instruments across the majority of countries with the exception of Australia, Indonesia, Austria and Slovenia1 which introduced new schemes. The largest change overall from 2021 to 2023 is in the expansion of fossil fuel subsidies, which increased by 1 percentage point from 24% in 2021 to reach 25% in 2023, strongly counteracting the coverage by positive price signals from carbon taxes, ETSs and fuel excise taxes.

At first glance, the expansion of carbon pricing seems to have plateaued. However, there has been modest progress in expanding the coverage of emissions within some sectors such as industry, while other sectors are beginning to be included such as waste incineration (Section ‎2.2). The focus among many jurisdictions has been on preparing for broader coverage and higher carbon prices and the consequences from these increases. This preparation involves addressing challenges in the administration and compliance of existing systems, addressing cross-border emissions (Section ‎2.2), as well achieving public acceptability (Section ‎2.3).

Stalled coverage hides underlying developments in carbon pricing

Among the largest changes in the coverage of positive pricing instruments is Australia’s reform of its Safeguard Mechanism in July 2023, transforming it into a rate-based ETS through the introduction of tradeable permits (Parliament of Australia, 2023[5]). Indonesia also launched an ETS in February 2023, initially covering large coal-fired power plants, with plans to implement a hybrid ‘cap-tax-and-trade’ system with a carbon tax in 2025 (Indonesian Ministry of Energy and Mineral Resources, 2023[6]). Earlier in October 2022, delayed by three months due to energy crisis concerns, Austria launched a national ETS to cover sectors that are not included in the EU ETS (Austrian Ministry of Finance, 2022[7]). In addition, in July 2023, Hungary launched a carbon tax covering EU ETS participants that receive a proportionally large amount of free allowances, set at EUR 40/tCO₂ with retroactive effect to January 2023 (Government of Hungary, 2023[8]). Due to data constraints and its retroactive nature, this carbon tax is not modelled in the price and coverage estimates of the database. While the implementation of these countries’ instruments may not result in significant increases in the average global coverage of emissions, these changes indicate progress is still being made in the implementation of new carbon pricing instruments.

Carbon pricing instruments under development

There is a growing number of countries with carbon pricing instruments that are under development, with a noticeable preference for ETSs. Instruments are considered to be “under development” if the government is actively working towards the implementation of an instrument, a mandate may have been established, but regulated entities do not yet face compliance obligations, and this has been formally confirmed by official government sources (The World Bank, 2024[9]).2

These developments include the EU ETS 2, which will cover CO₂ emission from upstream fuel suppliers in sectors not covered by the existing EU ETS (small entities in buildings and road transport sectors), which will take effect in all member countries (European Commission, 2024[10]). Türkiye has submitted an Updated First NDC with explicit references to a Turkish Emission Trading System and is developing a pilot set to launch in late 2024 (Republic of Türkiye, 2023[11]). Ukraine started the development of an ETS, for which it established a measuring, reporting and verification (MRV) system but this was put on hold due to Russia’s war of aggression (Ministry of Environmental Protection and Natural Resources of Ukraine, 2024[12]). At the time of writing, the MRV system is in force but on a voluntary basis for participants. In 2023, Japan introduced the GX ETS, with the first phase based on voluntary participation by companies (Asia Society, 2024[13]). After the initial phase until 2026, the system is expected to transition to a mandatory ETS, combined with a carbon tax on fossil fuel importers from 2028. In 2023, Canada also began developing a federal ETS for the oil and gas sectors, currently undergoing public consultation with final regulations expected to be released in 2025 (Canadian Department Environment and Climate Change Canada, 2023[14]). Brazil (Feitosa, 2022[15]), India (Indian Ministry of Power, 2001[16]) and Colombia (Colombian Ministry of Environment and Sustainable Development, 2024[17]) have all developed national plans or legislation that establish the institutional and regulatory framework to introduce ETSs in the future. At the subnational level, in the United States, there are several states developing ETSs, including Oregon, Pennsylvania, New York and Colorado (ICAP, 2024[18]). In Mexico and Spain, the state of San Luis Potosi and region of Catalonia, respectively, are also developing subnational carbon taxes (ICAP, 2024[18]). The development of carbon pricing mechanisms across various jurisdictions indicate a growing global interest in market-based approaches to emissions reductions.

The share of emissions covered by a positive carbon price could increase by approximately 7 percentage points if the above-mentioned explicit carbon pricing instruments were implemented (Figure ‎2.2). There appears greater interest in ETSs than carbon taxes; the increase in coverage estimated from ETSs under development is 8.8 percentage points, compared to just 0.1 percentage points for carbon taxes. Several countries that are developing new instruments already have explicit carbon pricing in place at various levels of governance, including EU member states, Japan, Canada, Ukraine, Colombia and Spain. Taking account for overlaps between the emissions coverage of new and existing explicit carbon pricing instruments – whereby it is reasonably assumed that systems do not intend to cover the same emissions with two schemes3 – results in a more modest increase in coverage for ETS of 6.7 percentage points. The estimation of coverage relies on published information on the instruments, combined with additional assumptions where details on the planned implementation are lacking. As such, these estimates should be interpreted as an upper bound of the expected change in emissions coverage (Methodology in Chapter 1). This modelling is an additional estimate and is not included in the core CPET database and therefore is not reflected in the coverage estimates of the Net ECR.

Figure ‎2.2. Additional emissions coverage can be unlocked from explicit carbon pricing instruments under development
Copy link to Figure ‎2.2. Additional emissions coverage can be unlocked from explicit carbon pricing instruments under development

Estimated Share of GHG emissions subject to a positive explicit carbon price, in %, by instrument, all 79 countries, 2023 onwards

Carbon pricing instruments under consideration

There are also a number of countries that have carbon pricing instruments that are still “under consideration”, categorised as such if the government has announced its intention to work towards the implementation of the instrument and this has been formally confirmed by official government sources (The World Bank, 2024[9]).4 These instruments are not modelled above or included in the core CPET database due to a lack of certainty and details regarding their planned implementation at the time of data collection for these measures.

Among the countries covered by CPET, for ETSs, Argentina outlined a framework for an ETS for the power sector in an Omnibus Bill that was first submitted in December 2024, but this has been removed again in latest iteration (as of April 2024) (Padin-Dujon, 2024[20]). In May 2023, the Philippines conditionally approved a bill with provisions for an ETS and a technical review is ongoing (Philippines Congress of the Republic, 2023[21]). Malaysia has also communicated intention to launch an ETS but thus far only a voluntary carbon market has been introduced (Bursa Malaysia, 2024[22]). Nigeria also began discussions of an ETS under the framework of its Climate Change Act in 2022 (Manuell, 2022[23]). Chile has introduced the Green Tax Emissions Compensation System, although its classification as an ETS is ambiguous (Enerdata, 2024[24]). At the subnational level, there are also ETS under consideration in Maryland (US) and Manitoba (Canada) (The World Bank, 2024[9]).

Carbon taxes are also still being considered in several countries. Kenya’s Climate Change Act shapes an administrative and institutional infrastructure for a carbon tax, but this is still under consideration (Promethium Carbon, n.d.[25]). Côte d'Ivoire has also expressed interest in developing a carbon tax in the context of the Partnership for Market Readiness and Carbon Pricing Leadership Coalition (2018[26]). Paraguay has communicated intention to introduce a carbon tax on liquid fuels by May 2025 as part of a series of reforms, but no further progress has been observed to date (IMF, 2024[27]). In 2024, the Moroccan government re-affirmed its intention to implement a carbon tax, specifically in response to the implementation of the EU’s Carbon Border Adjustment Mechanism (CBAM) (Padin-Dujon, 2024[28]). New Zealand has also considered a carbon tax but has recently reverted its plans to introduce a methane tax on agricultural emissions in 2025 (Al Jazeera, 2024[29]). Israel previously announced its intention to gradually introduce a carbon tax on fossil fuels from 2023 to 2028, and has since begun implementation in September 2024 (Israeli Parliament, 2024[30]; Surkes, 2021[31]). At the subnational level, several states and provinces are also considering carbon taxes. These include the states of Colima and Jalisco in Mexico, Hawaii in the US and Manitoba in Canada (The World Bank, 2024[9]).

Changes in coverage from carbon pricing instruments across countries

The share of emissions covered in this report that are subject to a positive Net ECR through implemented instruments varies across countries. As in previous years, the highest Net ECRs tend to be concentrated in high-income economies (Figure ‎2.3). Korea has the largest coverage of emissions with a positive Net ECR at 99%, driven by the far-reaching coverage of its ETS, which has been gradually expanded since its introduced in 2015. As of 2023, seven countries covered in this report have no positive carbon pricing policies in place.

From 2021 to 2023, few countries implemented policies or reforms that resulted in a substantial increase in the share of emissions covered by a positive explicit Net ECR with the exceptions of Australia, Slovenia and Austria. Countries can increase coverage through the introduction of new carbon pricing instruments that are reflected in the Net ECR, or through broadening the emissions base of existing instruments (in the form of increasing the coverage base of positive pricing instruments or reducing the base of fossil fuel subsidies).

Figure ‎2.3. Across countries, changes in the coverage of carbon pricing vary in direction and magnitude
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Share of GHG emissions subject to a positive price, in %, by country, 2021-2023

In contrast to the modest increases in coverage, several countries faced a substantial decline in the share of emissions subject to a positive Net ECR. In almost all cases (except Colombia, Sri Lanka, Finland, Switzerland and South Africa), this was driven by an expansion of emissions supported by fossil fuel subsidies, reaching up to a 40 percentage-point increase for certain countries. In large part, the expansion in fossil fuel subsidies reflects countries’ emergency measures taken in response to the energy crisis shock, starting in the second half of 2021 following the post-pandemic economic recovery and spiking with Russia’s war of aggression against Ukraine in 2022. The ramping up of fossil fuel subsidies substantially outweighed the increases in explicit carbon pricing in most cases and led to a decline in the Net ECR.

Coverage of emissions continues to vary across sectors

The coverage of emissions by carbon pricing instruments continues to vary across sectors (Figure ‎2.4). The share of emissions with a positive Net ECR is highest in the Road Transport sector at 90%, followed by the electricity sector at 74% of emissions. In the road transport sector, fuel excise taxes as implicit carbon prices account for a large share of the coverage, whereas in the electricity sector, explicit carbon prices in form of ETSs are driving the high coverage. The sector encompassing other GHGs remains difficult to address through traditional pricing instruments such as ETS, carbon taxes and fuel excise taxes and therefore has the lowest coverage at 4%, although new efforts are being made to address these complex industries (Section ‎2.2).

The latest update shows that 58% of emissions are not subject to a positive price with the largest laggards in the buildings (67%) and industry sectors (72%), as well as the other GHGs (96%). Fossil fuel subsidies also have a critical role in accounting for the differences across sectors. For example, the share of emissions subject to fossil fuel subsidies in the electricity and buildings sectors is almost double of the share in the industry and road transport sectors.

On average, the share of emissions covered by a positive Net ECR declined slightly between 2021 and 2023 with some small changes across sectors. In some sectors, a decline is driven not by a decrease in the coverage of positive pricing instruments, but by an increase in the coverage of fossil fuel subsidies, particularly in buildings (subsidy increase of 10 percentage points since 2021), road transport and agriculture (subsidy increase of 6 and 7 percentage points since 2021, respectively). This primarily reflects countries’ responses to rising fuel prices due to the energy crisis, which were targeted at the most-affected sectors. Notably, there was a modest increase in coverage in the industry sector due to new schemes and some expansions of current instruments.

Figure ‎2.4. Broad dispersion in the coverage of emissions across sectors remains
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Share of GHG emissions subject to a positive price, in %, by sector, all 79 countries, 2021-2023

2.1.2. Trends in net Effective Carbon Rates

Net Effective Carbon Rates have decreased, but ETS and carbon tax rates remained resilient

While progress in the coverage of emissions with a positive Net ECR has slowed down, the components of the Net ECR have moved in both directions. Ultimately, the decline in the average Net ECR across countries is driven by increases in fossil fuel subsidies and decreases in fuel excise taxes – reflecting emergency responses to the energy crisis – rather than changes in carbon pricing policy. Explicit ECRs increased from EUR 4.44/tCO₂e in 2021 to EUR 5.44/tCO₂e in 2023 (Figure ‎2.5). This primarily reflects the increase in the average ETS permit price, which rose to EUR 4.66/tCO₂e in 2023. In comparison, the average carbon tax rate remains much lower, at EUR 0.78/tCO₂e, having changed little since 2021.

As in previous years, implicit carbon prices in the form of fuel excise taxes represent the strongest price signal at EUR 11.73/tCO₂e, despite decreasing by EUR 2.5/tCO₂e from 2021 (EUR 14.23/tCO₂e). Given that only 48 countries have explicit forms of carbon pricing (carbon tax and/or ETS) in place and for many, at low rates, fuel excise taxes represent the strongest carbon price signal in many countries. In particular, low- or middle-income countries are less likely to have explicit carbon pricing instruments and rely more on fuel excise taxes. The change in fuel excise taxes was accompanied by an increase in fossil fuel subsidies, to an average of EUR 3.12/tCO₂e. Together, these changes reflect countries’ responses to rising fuel prices, which are also evident in the decline in coverage of emissions with a positive Net ECR from 2021 to 2023.

Figure ‎2.5. A decline in Net ECR, driven by fuel excise taxes and fossil fuel subsidies
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Net Effective Carbon Rates, by instrument, all 79 countries, 2021- 2023

Recent changes to Net Effective Carbon Rates within countries

Net ECRs have increased notably – by more than EUR 5 – in six of the countries covered (Switzerland, Chile, Ukraine, Norway, Costa Rica and Canada) with some smaller increases in other countries, leading to an overall increase in the global average rates of both carbon taxes and ETSs. This suggests that governments have not backtracked on explicit carbon pricing efforts, but instead the Net ECR has been dominated by changes in fuel excise taxes and fossil fuel subsidies, largely due to the energy crisis. Some governments chose to tackle energy crisis concerns with different instruments, of which only some are included in the CPET dataset, such as fossil fuel subsidies and fuel excise taxes.

Other notable changes are reflective of large changes in exchange rates to the euro and inflation due to lack of indexing, such as those in Türkiye and Argentina, that can affect the ECR comparisons overtime. After the cut-off of 1 April 2023 for this edition of the CPET database, Türkiye announced a large increase in the fuel excise rate to compensate for this and to raise revenue, while Argentina has delayed fuel excise rises due to shortages in fuel and inflation concerns (Reuters, 2023[32]; Heath, 2023[33]).

Figure ‎2.6. Minimal increase in Net ECR across countries
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Changes in Net Effective Carbon Rates, by country, 78 countries, 2018-2023

Although explicit carbon pricing remained largely resilient throughout the energy crisis shock, there were some countries that paused or reversed advancements on their explicit carbon pricing policies. For example, Austria delayed the launch of its national ETS, planned for 1 July 2022, for three months (Parliament of Austria, 2022[34]). Germany temporarily froze the planned annual price increase of its national ETS, keeping the price of 30 EUR for 2022 and 2023 (German Emissions Trading Authority, 2017[35]). Portugal suspended the planned increase in its carbon tax rate from March 2022 until the end of 2022 (Government of the Republic of Portugal, 2022[36]). Slovenia also repealed its carbon tax from August 2022 until May 2023 (Government of the Republic of Slovenia, 2023[37]). Indonesia, which planned to implement a carbon tax for the coal-fired power generation in April 2022, postponed this twice and instead launched in 2023 (Agung Swadana, Vianda and Tumiwa, 2023[38]).

In addition to changes in explicit carbon rates, there were also countries that increased subsidies to fossil fuels. Some emerging and developing economies, such as Ecuador, Sri Lanka, Morocco and Colombia, have long-standing subsidies, while others introduced new schemes amidst the shock of the energy crisis. These include France and the United Kingdom (UK) that spent upwards of EUR 40/tCO₂e on fossil fuel subsidies, followed by Lithuania (EUR 25.5/tCO₂e), Japan (EUR 19.8/tCO₂e) and Greece (EUR 18.3/tCO₂e). It should be noted that many changes have occurred that are not reflected in the CPET data due to ongoing revisions in support measures, whereby some measured have been discontinued and others introduced. For methodological reasons, the current fossil fuel subsidy data reflects 2022 measures.

Figure ‎2.7. Fossil fuel subsidies substantially decrease Net ECRs for some countries
Copy link to Figure ‎2.7. Fossil fuel subsidies substantially decrease Net ECRs for some countries

Net Effective Carbon Rates, by component and country, 78 countries, 2021 and 2023

Net Effective Carbon Rates continue to greatly vary between sectors

The level of carbon pricing continues to vary substantially between sectors, with road transport continuing to have a Net ECR at least four times higher than other sectors (Figure ‎2.8). However, countries’ responses to the energy crisis have brought about a significant reduction in the Net ECR of buildings, road transport and agriculture, while marginally higher explicit carbon prices increased the Net ECR of industry and electricity. This reflects the difference in instrument use across sectors, where emissions from the road transport sector and buildings are covered in large part by carbon taxes and fuel excise taxes and industry and electricity are covered by ETSs.

Figure ‎2.8. The energy crisis triggered substantial reductions in the Net ECR of buildings and road transport between 2021 and 2023
Copy link to Figure ‎2.8. The energy crisis triggered substantial reductions in the Net ECR of buildings and road transport between 2021 and 2023

Average Net Effective Carbon Rates, by sector, all 79 countries, 2021 and 2023

In the wake of the energy crisis in 2022, governments significantly reduced rates of excise taxes on motor and heating fuels (e.g. gasoline, diesel or natural gas) and not all rebates were phased out by 2023. This strongly decreased the Net ECR in the buildings sector and to a lesser extent in road transport and agriculture (Figure ‎2.8). While road transport continues to face the highest Net ECR across all sectors – EUR 78/tCO₂e in 2023 – the rate is 24% lower than in 2021. Similarly, the Net ECR of agriculture dropped by 52% to EUR 16/tCO₂e in 2023. In both cases, more than 50% of the decrease results from lower fuel excise taxes. In addition to fuel excise rate reductions, many governments strongly subsidised households to mitigate negative social effects of soaring energy bills. This has substantially driven down the net carbon pricing level in (mainly residential) buildings. While the Net ECR of buildings was higher than the one of industry and electricity in 2021, fossil fuel subsidies decreased it by more than 155% to a negative Net ECR of EUR -5.8/tCO₂e, the lowest Net ECR across all sectors. While fuel excise taxes dominated buildings’ Net ECR in 2021, fossil fuel subsidies became the indicator’s largest component, accounting for 58% of the rate predominately from a few countries – new measures in France, UK, Germany. Spain and Japan as well as expanded measures in Kazakhstan and Indonesia. The Net ECR of off-road transport decreased by 34% between 2021 and 2023 primarily driven by an increase in fossil fuel subsidies as well as the lowering of excise tax rates.

In contrast, the Net ECR of industry, electricity and other GHG emissions marginally increased between 2021 and 2023. Emissions in these sectors are more commonly priced by explicit carbon taxes and ETSs, where prices increased in the past years and free allocations have been phased down. Nonetheless, the Net ECR of industry and electricity remain at EUR 7.0/tCO₂e and EUR 8.9/tCO₂e, respectively. Other GHG emissions are also only priced at EUR 1.4/tCO₂e in 2023. Consequently, these sectors face significantly lower rates than road transport, despite each emitting more than double the amount of emissions.

2.2. Considerations in the practical implementation of carbon pricing

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Recent trends in carbon pricing policies reveal a complex landscape. While the expansion of emissions coverage and price level increases have decelerated – and in some cases regressed – this apparent slowdown masks significant underlying developments that could facilitate the ramping up of climate action. To achieve the medium-term emissions reductions targets, a sharp increase in climate policy stringency, including carbon pricing, is essential.

There are a number of considerations government must take into account for the implementation of carbon pricing policies. These range from the choice and design of instruments, addressing cross-border carbon pricing in the face of international spillovers, and designing policies that are able to cover emissions in additional sectors such as waste incineration. These challenges help explain the current trends in carbon pricing policy and point to further efforts required going forward.

2.2.1. The choice and design of explicit carbon pricing instruments

Several factors can influence the preference for carbon taxes or ETSs, including administrative capacity, political feasibility, preference for certainty in price or quantity of emissions reductions and compatibility with economic growth. Overall, carbon taxes have significant practical, environmental and economic advantages, due to their ease of administration, price certainty and revenue-generating potential (OECD, 2023[1]). However, among countries that are planning or considering introducing new carbon pricing instruments, there appears to be a strong preference for ETSs. Eight countries are developing ETSs and another five have ETSs under consideration (Figure ‎2.9). In contrast, carbon taxes remain only under consideration in seven countries with none under development.

The trend towards ETSs could be a result of several factors regarding the design options for these systems. One factor may be that ETSs target emissions reductions directly (depending on design choice) by setting a cap on emissions, for instance. In addition, most existing ETS include free allocation of allowances, which can be used as a tool to mitigate carbon leakage or competitiveness concerns around emission-intensive and trade exposed industries and ease public acceptability (OECD, 2023[1]). This contrasts with most carbon taxes, except some that provide thresholds for applicability or exemptions for certain entities, as is the case in South Africa. Another factor can be the more recent interest in rate-based ETSs, which limit the emissions intensity of the system rather than the absolute volume of emissions (mass-based). Among the ETSs recently implemented in 2023, Australia and Indonesia both introduced rate-based systems. ETSs (and carbon taxed applied on direct emissions and not fuel use) also require monitoring, reporting and verification systems that are more amenable to linking with other ETSs and strengthen the integrity of carbon credits used as offsets.

Figure ‎2.9. A number of countries are developing or considering new carbon pricing instruments
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Count of countries with explicit carbon pricing instruments, by status

ETS have been shown to vary greatly in design (Fischer, Mao and Shawhan, 2018[39]). The two main types of systems are mass-based, whereby total emissions of an industry or installation are capped, and rate-based systems, whereby the emissions intensity is capped. In both systems, the cap can be declining over time. Mass-based systems include cap-and-trade systems. The largest mass-based system, by emissions coverage, is the EU ETS, while the largest rate-based system is operating in the People’s Republic of China (hereafter ‘China’). Among other countries, Australia and Canada have also introduced rate-based systems. At the time of writing, there is a mix between plans for mass-based and rate-based systems, among the countries that have ETSs under development and that have provided details on these design features.

There are numerous other elements that can vary between mass-based and rate-based ETSs. The additional considerations are the coverage of sectors, reduction factor of emissions cap, method of allocating free allowances, market stabilisation mechanisms and more, which result in a diverse array of ETS design. These differences, along with other elements such as the cost-effectiveness, ease of administration, scope and price predictability are key factors in choosing the best-suited carbon pricing instrument with respect to a country’s domestic context.

2.2.2. Growing attention on cross-border carbon pricing instruments and international cooperation

Beyond design choices for domestic carbon pricing instruments, increased attention is being drawn towards tools for addressing cross-border emissions embodied in international trade. These emissions embodied in trade can be between economies with different levels of climate policy stringencies and carbon intensities of goods. Thus, the role of international cooperation and instruments such as border carbon adjustment mechanisms (BCAs) are being considered to help achieve global emissions reductions targets. Net ECRs across countries remain diverse, and although their dispersion appeared to be growing larger in the previous edition of this report (OECD, 2022[40]), this edition does not see the same pattern with only a handful of mixed countries significantly increasing Net ECRs (by greater than EUR 5) since the last edition (Switzerland, Chile, Ukraine, Norway, Costa Rica and Canada). In addition, there appears to be no trend in the reduction of Net ECRs with many economies decreasing Net ECRs across the spectrum of high and low rates.

Following the diversity of carbon pricing across countries, some jurisdictions are seeking a more targeted approach to addressing carbon leakage. The EU’s Carbon Border Adjustment Mechanism (CBAM) entered into force in its transitional phase in October 2023. The compulsory regime that is set to start in 2026 will require importers to pay a fee on emissions associated with imported products based on the carbon price of domestic production. In its current phase, importers of covered products (aluminium, cement, electricity, fertilisers, hydrogen and iron and steel) must report the direct (scope 1) emissions and part of indirect (scope 2) emissions from purchased electricity, as well as some emissions embodied in relevant precursor products for complex goods, but at the time of writing did not have payment obligations (European Commission, 2023[41]). Starting in 2026, importers will be required to purchase emissions certificates for imports based on the differential between the EU ETS emissions allowances and the effective carbon price already paid during production elsewhere, accounting for free allowances and other forms of financial support (European Commission, 2023[41]).

In December 2023, the UK announced its intention to implement a CBAM by 2027 (Burnett et al., 2024[42]). Still in design, current plans present similar coverage to the EU CBAM, including scope 1 and scope 2 emissions, as well as select precursor product emissions embodied in imported products from the aluminium, cement, ceramics, fertiliser, glass, hydrogen, iron and steel sectors. The fee charged to importers will be an effective rate (similar to the ECR indicator) based on the price of emission allowances in the UK ETS adjusted for free allowances (therefore lower than the explicit UK ETS price), and the differential to other countries’ domestic explicit carbon price (UK Treasury, 2024[43]). Further consultations are planned for 2024 to determine design and implementation plans.

There have been several proposals for BCAs in the United States, despite the country not having a federal-level explicit carbon price. The proposals and their various design features differ. The more recent proposal (re)introduced in December 2023,5 the Clean Competition Act, would levy a charge on both domestic producers and importers of goods on the share of the good’s emissions that exceed a sector-specific US baseline emissions intensity (Joint Economic Committee, 2024[44]). The Clean Competition Act was drafted to cover fossil fuels, refined petroleum products, petrochemicals, fertiliser, hydrogen, adipic acid, cement, iron and steel, aluminium, glass, pulp and paper, and ethanol starting from 2025, with expansion to other goods after 2027 (Sheldon Whitehouse, 2024[45]).

Box ‎2.1. The Carbon Rate Gap: a proof of concept using ECRs

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A proof-of-concept analysis produces a new indicator, the Consumption Carbon Rate, using the OECD Embodied Emissions Estimates in International Trade (Yamano and Guilhoto, 2020[46]) and Effective Carbon Rates (OECD, 2021[47]) databases for 2018 to compute effective carbon rates paid on emissions embodied in trade, and hence on final demand. This is an effective carbon rate in final demand, following consumption-based emissions accounting. The proof-of-concept uses an input-output model to trace Effective Carbon Rates along the production chain, revealing the Carbon Rate Gap - the difference between the average rate on emissions produced domestically and emissions embodied in final demand or consumption.

The report provides first results that demonstrate that countries with higher production-based effective carbon rates tend to import goods for consumption from countries that have applied a relatively lower carbon rate on emissions. This results in more similar consumption carbon rates across countries, which could shift if border adjustment mechanisms are put in place or carbon pricing stringency converges. The proof-of-concept points to further analyses that can be used to inform climate policy decisions where issues of carbon leakage and other trade-related costs of carbon pricing have an important role. In particular, the methodology could be used to conduct counterfactual analysis, for instance, to model the effects of border carbon adjustment mechanisms on effective carbon rates, through the lens of complex global production chains that would add an additional indicator for the effects of these policy changes.

Figure ‎2.10. Carbon Rate Gap
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Production-based Carbon rates less Consumption-based Carbon Rates, by country, 2018

There have also been new initiatives that aim at fostering global cooperation on climate change mitigation policies. In February 2023, the OECD launched the Inclusive Forum on Carbon Mitigation Approaches (IFCMA) (OECD, 2024[49]), designed to help optimise the global impact of emissions reduction efforts around the world through better data and information sharing, evidence-based mutual learning and inclusive multilateral dialogue. It brings together senior officials and technical experts from governments, as well as representatives from other international organisations, and is composed of 59 members (including all OECD members, the EU and 20 Project Associates). In December 2023, the Climate Club (2024[50]) was launched, a high-level forum for cooperation on the acceleration of climate action in industrial decarbonisation, consisting of 39 countries under the interim secretariat of the OECD and IEA. These initiatives mark growing effort towards global cooperation on climate change mitigation.

2.2.3. Practical challenges for sectors: The case of waste incineration

In addition to considerations regarding the choice of domestic carbon pricing instruments and new tools to address cross-border emissions, there are also practical challenges to implementing carbon pricing across some industries, such as waste incineration. Eventually, all carbon emissions must be drastically reduced through either pricing or other climate policy mechanisms. This section outlines the trends and practical implementation problems for the case of waste incineration, as an example of growing efforts to expand carbon pricing instruments to new sectors.

Waste incineration is a source of both energy and emissions. On average, the disposal of waste through incineration accounted for 29% in OECD countries and 19% globally in 2019 as a waste management category of plastics, making it the second most important waste management practice after landfilling (OECD, 2022[51]). Waste incineration coupled to a power plant (waste incineration with energy recovery) allows for the generation of heat and electricity. Countries covered in the CPET database generated more than 15 500 TJ from non-renewable municipal and industrial waste in 2021 (IEA, 2022[52]).

Taxes on waste incineration are generally used to recover the costs of waste treatment and disposal but can also act as a tool to internalise environmental costs and encourage behavioural changes. By increasing the cost of environmentally harmful treatment methods, it creates incentives to use alternative treatment methods such as recovery and recycling (OECD, 2019[53]). Among OECD countries, higher solid waste taxes are strongly correlated with reduced waste volumes and increased recycling levels (Matheson, 2019[54]). These taxes are generally charged on incineration facility operators by the weight of waste incinerated, measured in tonnes. Only a limited number of advanced economies have implemented taxes on waste incineration. While such environmental taxes are generally more likely to be adopted by governments with a robust environmental policy framework and a structured and monitored waste sector, they also require a country to operate waste incineration facilities, in contrast to alternatives such as open burning. Among EU Member States, nine levy a tax on waste incineration. Ordered by the highest minimum tax rate, these are Denmark, the Netherlands, Latvia, Belgium, France, Spain, Austria, Portugal, and Italy (European Environment Agency, 2023[55]). In addition, Norway introduced in 2022 a tax on incinerated, non-renewable waste.

As an emitting activity, waste incineration has recently moved into focus for climate policy. Advanced economies have started extending coverage of their ETSs to waste incineration or are redesigning their taxes on waste incineration. Integrating waste incineration as a new sector into an ETS or covering it with a carbon tax requires some methodological considerations.

Methodological considerations for taxing carbon emissions of incinerated waste

The redesign of waste incineration taxes and the activity’s inclusion in ETSs impact the scope of both the Effective Carbon Rate and Effective Energy Rate. A waste incineration tax, levied on the carbon content of waste, is an excise duty levied on CO₂ emissions rather than on waste uniformly. Measured this way, this policy instrument uses emissions factors to approximate a proportionality between the weight of a specific type of waste and its energy and carbon content, effectively mimicking the design of a direct carbon tax. The impact of waste incineration activities covered by a carbon price on the ECRs and EERs implies two main considerations, its contribution to energy use and the precision of applied emissions factors.

The common method for estimating CO₂ emissions from incineration of waste is based on an estimate of the carbon content in the waste combusted, multiplied by the oxidation factor, and converting the product to CO₂ emissions. Volume 5 of the 2006 IPCC Guidelines provides methodological guidance for the estimation of GHG emissions from the waste sector (IPCC, 2006[56]). However, waste is a highly heterogenous commodity. Types of waste incinerated include municipal solid waste, industrial waste, hazardous waste, clinical waste and sewage sludge (IPCC, 2006[56]). The amounts of waste produced, their composition and their origin vary among countries as they relate to the structure of the economy and the level of investment in innovation and cleaner technologies. In many countries, information remains insufficient to monitor total waste streams, their recovery and the use of secondary raw materials in the economy (OECD, 2020[57]). This makes the estimation of precise energy content and GHG emissions factors for incinerated waste a highly complex and difficult task. This is in contrast to petroleum products where energy and carbon content of products are easier to determine and vary less across countries. Although not all countries align these fuel taxes with carbon content, emissions factors can be estimated by using default values. Increasing in precision as well as data requirements, these can be i) general, ii) country-specific and iii) incineration-facility-specific. To respect the proportionality principle between weight of waste and emissions, the highest possible level of granularity is required.

Two additional methodological considerations are needed when assessing how changes in policy instruments impact the scope of the ECR and EER. Adopting a carbon price on emissions from waste incineration, either through changes in design of taxes or the activity’s inclusion increases the coverage of both indicators – but not by the exact same share. Following the IEA’s World Energy Balances, the CPET database distinguishes waste-related emissions and energy use in four categories: renewable versus non-renewable as well as municipal versus industrial waste. However, the IEA’s World Energy Balances only include energy generated from incinerated waste, that is, they only cover waste incineration with energy recovery across all four waste categories. In contrast, data on emissions also include non-energy related greenhouse gases. The CPET methodology stipulates that only non-renewable municipal or industrial waste is a fossil fuel that generates emissions. Consequently, coverage of ECRs only increases through taxes or ETSs covering emissions from incinerated non-renewable waste, while the coverage of EERs would be increased by both, the incineration of renewable and non-renewable waste but only where it is coupled to a power plant (with energy recovery).

Governments are expanding coverage of waste incineration

In the past years, multiple advanced economies have started extending coverage of their ETSs to waste incineration. This entails a change of the tax base from weight (measured in tonnes of waste) to carbon emissions (measured in tonnes of CO₂). Further, two OECD countries assessed in the CPET database have introduced or transitioned to emissions-based waste incineration taxes, Norway and Denmark.

In 2022, Norway introduced an excise duty on CO₂ emissions from waste incineration. The objective of the excise duty is to internalise the cost of CO₂ emissions associated with the activity. In 2023, the tax rate amounted to EUR 22.1 (NOK 238)/tCO₂. Since beginning 2024, the tax sets differentiated rates between EU ETS and non-EU ETS covered facilities, which stand at EUR 82 (NOK 882)/tCO₂ and EUR 16.4 (NOK 176)/tCO₂, respectively. The tax is calculated by multiplying the amount of waste delivered to an incineration facility measured in tonnes by a standard emissions factor of about EUR 0.051 (NOK 0.5498)/tCO₂ per tonne of waste. To incentivise sorting and recycling of fossil materials, incineration facility may apply for the use of a facility specific emission factor, if they can prove to the Norwegian Environment Agency that the fossil material content of the incinerated waste is lower than the assumed standard share of 55%. Incineration facilities that treat hazardous waste or capture and store generated emissions are exempted from this incineration tax (Norwegian Tax Agency, 2024[58]).

In 2009, Denmark converted its weight-based tax on waste incineration to one based on energy and CO₂ content to provide a stronger incentive to recycle the most energy-intensive waste. The tax is a combined input-output tax, charged via two elements: an incineration tax, levied based on the energy content in the input waste, which amounted to EUR 7.03/GJ (DKK 52.5/GJ) in 2022. This component consists of a tax on heat generated from waste incineration (EUR 2.77/GJ (DKK 20.7/GJ)), which is indexed annually with the net price index and an additional incineration tax (EUR 4.26/GJ (DKK 31.8/GJ)), which is not indexed. Further, a CO₂ tax is levied on incinerated, non-biodegradable waste which is indexed annually with the net price index (European Environment Agency, 2023[59]). This tax rate amounted to EUR 26.19/tCO₂ in 2024 and is scheduled to increase to EUR 95.23/tCO₂ (DKK 711.6/tCO₂) in 2025 (Danish Parliament, 2024[60]). Waste from biomass and processing of meat waste are exempted and an exemption for hazardous waste was abolished in 2010 (OECD, 2019[61]).

Waste incineration also became a core component in plans to expand the coverage of existing ETSs. If waste incinerators are included in an ETS, such facilities will have to buy emission allowances for each tonne of CO₂ emitted when processing non-renewable municipal or industrial waste. This additional cost of incineration can act as an incentive for waste prevention and recycling, which will then become relatively more competitive than incineration. At the end of 2022, the European Parliament approved the inclusion of municipal waste incinerators within the scope of the EU ETS as of 2026. EU member states must report and verify emissions from such facilities from 2024 onwards. It is estimated that the inclusion of municipal, non-renewable waste incineration in the EU ETS could decrease CO₂ emissions by 4.3 MtCO₂ by 2030 (Warringa, 2021[62]).

Germany amended its national ETS at the end of 2022 to include waste-derived fuels from 2024 onwards (German Federal Office of Justice, 2022[63]). According to a study commissioned by the German government this expansion in coverage would affect about 100 waste incineration plants, which incinerated 26.3 Mt of waste in 2019 to generate electricity and heat (German Federal Ministry for Economic Affairs and Climate Action, 2022[64]). By including this sector, Germany intended to close gaps in the emissions coverage and thereby create a level playing field with other power plants, which are already subject to a carbon price under the EU ETS (German Federal Ministry for Economic Affairs and Climate Action, 2022[65]). Likewise, Austria launched a national ETS in October 2022, which has similarities to the design of the German ETS. This system also covered emissions from waste incineration since its launch (ICAP, 2022[66]). Depending on the scope of the EU ETS after 2026, the EU system could supersede the German system in future (ICAP, 2022[67]). Austria already decided to replace their national ETS (Simon, 2024[68]). Furthermore, the UK seeks to gradually include emissions and energy generation from municipal waste incineration in its national ETS from 2026 onwards, but plans face opposition by local authorities which would bear the new, high tax burden after 2028 (Stefanini, 2024[69]; Stefanini, 2024[70]). Outside Europe, Australia’s Safeguard Mechanism underwent major reforms in July 2023 that effectively transformed it into an ETS and waste in form of landfills is covered by the scheme (Australian Department of Climate Change, Energy, the Environment and Water, 2024[71]).

2.3. Promoting public acceptability and the role of carbon revenues

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The next period of climate goals will soon require governments to significantly increase the stringency of policies targeting emissions, including but not limited to carbon pricing. However, an increase in the price level or coverage of carbon pricing may lead to additional burdens on households and firms and therefore requires a careful balance of achieving climate targets while addressing public acceptability concerns. There is evidence to suggest that both the choice of instrument and the use of revenue can help to mitigate the regressive impact of carbon pricing increases on households (see e.g. (Immervoll, Elgouacem and Raj, 2024[72]). Carbon pricing revenues could be used to create a ‘double dividend’ (see below), protecting vulnerable groups while achieving emissions reductions (Section 3.4 in Chapter 3) and transitioning tax bases from combustibles to electricity (Section 3.5 in Chapter 3). The political economy of carbon pricing – including trust in government, interactions with other climate-relevant policies, level of policy-relevant education among citizens, among other factors (Zhang, Abbas and Iqbal, 2021[73]) – varies greatly across countries. Therefore, countries are taking tailored approaches to design carbon pricing policies, as well as revenue use policies, that suit the needs of their economies.

2.3.1. Carbon pricing reform could unlock substantial government revenues

For some governments seeking to implement carbon pricing policies, achieving political feasibility and securing public support remains a critical challenge. Several studies and country experiences have demonstrated that the use of carbon revenues could help improve the reception of carbon pricing policies (Dechezleprêtre et al., 2022[74]). This may explain one reason why it is common for economies to earmark revenues from ETSs and carbon taxes for a range of expenditure areas (Cardenas Monar, 2024[75]). However, a range of factors can ultimately determine the political feasibility and public acceptability of carbon pricing, with economies choosing to earmark revenues for different reasons, such as budgeting for new policies and/or gaining public support. In economies where tax revenue use and the financing of other areas of public concern are prevalent issues to the public, earmarking can be one of several approaches that can be used to improve public support for carbon pricing policies.

Overall, the level of net carbon revenues (including revenues from positive pricing instruments, less expenditures on fossil fuel subsidies and free allocation of ETS permits) remains low, on average across countries just 0.6% of GDP (Figure ‎2.11). To compare, in OECD countries, public spending as a percentage of GDP was on average 5.3% on education, 7.6% on health and 16.9% on social protection in 2021 (OECD, 2023[76]). There is a large dispersion in net revenues from carbon pricing across countries. These differences can be explained by the higher levels of positive carbon pricing observed particularly in high-income countries, which generate larger revenues, as well as instances of very large fossil fuel subsidies expenditures, mostly concentrated in lower-income countries, which conversely lower net revenues. On the high end, net revenues reach up to 3.1% of GDP in Bulgaria. On the low end, several countries have negative net revenues caused by relatively high expenditures on fossil fuel subsidies that outweigh revenues collected from positive carbon pricing instruments. For example, Burkina Faso, Ecuador and Kazakhstan have net revenues of less than -2.5% of GDP.

Further strengthening carbon pricing –through increasing the price of ETSs, fuel excise taxes and carbon taxes, or reducing fossil fuel subsidies – could raise substantial revenues for governments while further cutting emissions. The exact revenue potential from a carbon pricing reform depends on prices, subsidies and several behavioural and macroeconomic factors that determine how the tax bases of instruments change over time. Nevertheless, an indication of how carbon pricing revenues can change, at least in the short to medium term, is useful.

Following the methodology described in Chapter 1, there is substantial revenue that could be unlocked from a carbon pricing reform that includes the phasing out of free allocation of ETS permits, phasing out of fossil fuel subsidies and implementation of a minimum ECR, ranging from EUR 60/tCO₂e to EUR 120/tCO₂e (Figure ‎2.11). The less ambitious reform of countries phasing out free allocations, phasing out fossil fuel subsidies and increasing their ECR to at least EUR 60/tCO₂e, would raise net carbon revenues to 1.7% of GDP on average. In the more ambitious scenario with a minimum ECR of EUR 120/tCO₂e, net carbon revenues would increase to 2.3% of GDP on average. This represents an almost quadrupling of the role of net carbon revenues in countries’ GDP from today. For comparison, the median share of tax revenues (in aggregate across all areas of taxation) as a percentage of GDP was 35% of GDP across OECD countries in 2021 (OECD, 2023[77]).

Figure ‎2.11. Substantial revenue could be unlocked from carbon pricing reform needed to reach climate targets
Copy link to Figure ‎2.11. Substantial revenue could be unlocked from carbon pricing reform needed to reach climate targets

Current net revenues, and total estimated revenue from carbon pricing reform (phasing out free allocation, phasing out fossil fuel subsidies, minimum Effective Carbon Rate), in % of GDP, by country

The revenue potential from carbon pricing reform is particularly high among a few countries, including South Africa, Kazakhstan, Malaysia, Kyrgyzstan, China and India, where net carbon revenues can reach 5-8% of GDP. In most other countries, the net revenue potential is much lower. Differences in revenue potential across countries to a large extent stem from pre-existing differences in countries’ Net ECRs and for those with ETS, also the share of free allocation of permits, which tends to be higher in the earlier stages of introduction and phased down over time. Moreover, countries’ emission intensity of GDP is a determinant of the carbon revenues as a share of GDP.

For some countries, achieving such a high carbon price may not be realistic, for many reasons. These include, but are not limited to, differing domestic policy priorities, focus on other climate change mitigation instruments, and lack of administrative and compliance capacities. It is likely that countries will continue to move at different paces, according to their domestic targets and capacities. Considering a lower benchmark, implementing a carbon pricing reform with a minimum ECR of EUR 30/tCO₂e would still raise revenues to 1.4% of GDP on average across all countries. For several countries, especially those that currently have negative revenues, this benchmark (including the phasing out of fossil fuel subsidies and free allocation) represents a substantial change in carbon revenues. In Ecuador, Malaysia, Burkina Faso and Kazakhstan, the share of carbon revenues in GDP could (as an upper bound) increase by 3-6 percentage points.

The additional revenue from a carbon pricing reform can be broken down to illustrate the components driving countries’ revenue potential – including the share of revenue gained from phasing out free permit allocation, phasing out fossil fuel subsidies and raising the ECR to EUR 60/tCO₂e (Figure ‎2.12). The vast majority of revenue potential comes from raising Effective Carbon Rates (on average across all countries, 0.9 from 1.1 percentage points), with a much smaller role for phasing out fossil fuel subsidies and free allocations in comparison. This is in part due to few countries having ETS (and therefore free allocations), and on a country-specific level, revenue potential from phasing out free allocations plays a more significant role in some cases. For example, in Switzerland, Denmark, Norway, Sweden, Finland and Estonia, phasing out free allocations represents about 75% of the total revenue potential from the described carbon pricing reform. While different countries can pursue different strategies, depending on their national positive and negative pricing instruments, the overwhelming potential for unlocking additional carbon revenues is through raising effective rates.

Figure ‎2.12. Raising Effective Carbon Rates is key driver of additional revenue potential from carbon pricing reforms
Copy link to Figure ‎2.12. Raising Effective Carbon Rates is key driver of additional revenue potential from carbon pricing reforms

Components of revenue potential from carbon pricing reform, in % of GDP, by country, 2023

2.3.2. Revenue use can serve as a policy tool to improve public acceptability

The revenue generated from carbon pricing instruments can be substantial with even higher potential if countries align their price levels closer to those needed to achieve their commitments under the Paris Agreement. While raising revenue is sometimes an aim and other times an outcome of taxes aimed at reducing emissions, decisions about the use of these revenues can influence the economic and political feasibility of these instruments (Barrez and Bachus, 2023[78]). The most efficient allocation of tax revenue is to a government’s general budget in the absence of political economy constraints. When revenues are instead designated to a specific spending purpose – whether in a strong form such as legal earmarking, or weak form such as political promises – there is risk of creating economic distortions. This is in part because the connection between governments’ sources of revenue and spending needs can be weak and can change over time, making it difficult to plan an optimal allocation (Marten and van Dender, 2019[79]).

While in general it is economically efficient to allocate revenues to the general budget, this does not rule out that there may be benefits to earmarking (in both the strong and weak form, hereafter), in addition to enabling tax reform when it might otherwise have been difficult or even impossible. There are various reasons for low public support for carbon pricing. The most prevalent relate to doubts about effectiveness, personal and collective fairness concerns about potential negative outcomes from carbon pricing policies (Maestre-Andrés, Drews and van den Bergh, 2019[80]; Carattini, Carvalho and Fankhauser, 2018[81]; Dechezleprêtre et al., 2022[74]), as well as public distrust in the effectiveness of government spending (Klenert et al., 2018[82]; Dechezleprêtre et al., 2022[74]).

Earmarking is one of several tools (among e.g. educational campaigns, stakeholder consultations and more) that governments can use to mitigate potential negative public acceptability consequences and improve public support for carbon pricing policies. Existing studies demonstrate that individuals have a strong preference for earmarking revenues from carbon taxes for environmental spending, such as further emissions reduction efforts (Carattini, Carvalho and Fankhauser, 2018[81]; Baranzini and Carattini, 2017[83]; Maestre-Andrés, Drews and van den Bergh, 2019[80]). This may be due to doubts about the environmental effectiveness of the tax, therefore warranting additional environmental spending (Baranzini and Carattini, 2017[83]), as well as a psychological preference for thematic matching between the source and spending of the revenues (Mus, Mercierid and Chevallierid, 2023[84]). In addition, a survey conducted by the OECD (Dechezleprêtre et al., 2022[74]) suggests that effective communication to explain the functioning and distributional outcomes of policies can increase stated political support for carbon pricing.

Indeed, revenues from explicit pricing, and in particular ETSs, are most often used for climate change or related environmental purposes (Fleurence, Fetet and Postic, 2023[85]). Often, revenues are used to finance investments in additional sectors that are not covered by the carbon pricing policies and serve as complementary to the carbon price. These measures can include for instance, investments in low-carbon technologies, expansion of green transport infrastructure, biodiversity protection and more (in the EU, for instance, Member States are mandated to spend at least 50% of ETS auction revenues for climate- and energy-related purposes (European Commission, 2024[86]). However, climate-related spending is not the only, or necessarily most optimal, area for expenditure (Table ‎2.1). The most effective form of earmarking will be unique to each country and dependent on a number of factors, including but not limited to public concerns, the existing tax system, existing sustainable development related policies, and the vulnerability of businesses and households to higher carbon prices.

Existing studies demonstrate that revenue use tends to also differ by instrument type (Marten and van Dender, 2019[79]). While revenues from excise taxes – which make up the dominant share – tend to remain in the general budget, revenues from ETSs and carbon taxes are more commonly earmarked (both in the strong and weak form). In addition, constraints on excise taxes revenue, when used, tend to be applied to fuels used for specific purposes (e.g., automotive fuels), whereas constraints on revenues from ETSs and carbon taxes more often cover all revenue.

Type	Description	Example
Tax reform	The broader tax system is reformed to lower the rate of tax levied on personal or business income with the aim of boosting economic growth through reducing tax distortions caused by disincentives to labour market participation, consumption and investment. This is also used to offset the potential negative effects of lower real wages in response to higher prices, stemming from the increase in carbon pricing.	British Columbia’s carbon tax was introduced in 2008 alongside additional tax reforms, including cuts to personal and corporate income taxes. The tax reforms were designed to create a revenue-neutral carbon tax, meaning costs imposed on households and businesses from higher carbon prices would be offset by a reduction in other taxes (Government of British Columbia, 2024[87])
Compensation to households and firms	Compensation measures are given to alleviate negative impacts from higher carbon pricing in the form of higher electricity and fuel prices, as well as a loss of employment in emission-intensive industries. These measures can be in the form of direct cash transfers, subsidies or other relief measures such as support for occupational retraining. They may be distributed universally or to particular regions, sectors or income groups that face a disproportionate burden.	Austria’s Klimabonus is an annual cash transfer made to all main residents of Austria as direct compensation for, and funded by, its carbon tax that was introduced in 2022. In 2023, the base amount (subject to an additional regional allowance) equaled EUR 110 (Government of Austria, n.d.[88])
Prevention of competitiveness and carbon leakage effects	This addresses international competitiveness concerns in particular for emissions-intensive and trade-exposed firms that have difficulties to reduce the carbon intensity of their production in the short- or long-term and may be at risk of carbon leakage. These measures can be in the form of free allocation of allowances in ETS, partial tax exemptions or feebates to reduce the cost of compliance with carbon pricing policies for firms	South Africa’s carbon tax, introduced in 2019, contains a number of tax-free allowances to account for competitiveness concerns, particularly for emissions-intensive and trade-exposed sectors. For example, trade-exposed sectors receive a tax allowance up to maximum 10%, based on a measure of their trade exposure (South African Revenue Service, n.d.[89])
Other development objectives	Revenues can be contributed to funds for sustainable development policies, including for example spending on health, education, infrastructure projects such as public transport, and more. This is often done as part of a policy package targeting interlinkages between environmental, social and economic development	The California Climate Investments is a set of programmes across a range of sustainable development areas, funded by the state’s ETS revenues. In the first half of 2023, 84% of revenues benefitted ‘priority populations’ (disadvantaged and low-income communities) through projects such as low-carbon transit, air quality monitoring, and solar power for schools and community centres (California Climate Investments, n.d.[90])

Note: Examples are not exhaustive.

Source: Authors & (World Bank, 2019[91]).

As mentioned, raising the stringency of carbon pricing carries an economic burden, and earmarking could have an influence on the public support of carbon pricing policies. Different uses of revenues have their individual considerations regarding their administrative burden, impact on economic efficiency and political feasibility of the revenue use itself, among other factors (Black, Zhunussova and Parry, 2022[92]). Decisions about how and where to allocate carbon revenues require careful consideration of these factors, countries’ economic and political landscapes, as well as the potential advantages and disadvantages of earmarking more broadly. In addition, there are several other policy tools that governments may choose to use in addition to, or instead of, earmarking to raise public support.

Earmarking can be used to mitigate potential negative effects of carbon pricing policies, that as any other taxes, may improve environmental outcomes but reduce overall economic benefits. It can also be used to connect climate targets to other important (potentially different) areas of public concern. In addition, earmarking can provide greater transparency about policy instruments for taxpayers. However, there are also some potential disadvantages. For instance, if earmarking results in insufficient or excess tax revenue for a particular cause, this can result in under- or over-investment in that area, distorting the optimal spending outcomes and reducing the overall efficiency of the tax system. Governments that choose to earmark revenues will also have reduced flexibility with expenditures to respond to changing priorities or unforeseen circumstances. In addition, in general, allocating revenues to the general budget may be administratively simpler and more flexible than earmarking. Some countries may even have legal constraints to earmarking. Finally, the public visibility of earmarked expenditures may influence intended outcomes, specifically for the case of facilitating public support for policies through earmarking.

Ultimately, countries will choose differing approaches to carbon pricing, as well as the use of carbon revenues as a related policy instrument. A flexible approach whereby countries are able to design their policy instruments, such as earmarking, based on their individual policy priorities and policy landscape can help maintain the momentum needed to achieve approaching climate targets both in terms of political feasibility and public acceptance.

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Notes

Copy link to Notes

← 1. Slovenia’s increase is the result of the reintroduction of a carbon tax, rather than a new instrument entirely.

← 2. At the time of drafting the report.

← 3. It should be noted there are some exceptions to this as Hungary and the Netherlands have proposed schemes that effectively cover the same emissions as the EU ETS but at a higher rate – this however would not change the coverage of emissions for this exercise and therefore a reasonable assumption

← 4. At the time of drafting the report.

← 5. At the time of drafting the report.

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