Carbon tax
Carbon tax is a tax levied on firms that emit carbon dioxide (CO2) through their operations.
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There are four key mechanisms that aim to encourage reduction of carbon emissions. In this section, we will describe them and provide examples while focusing on the carbon credit mechanism.
Carbon tax
Carbon tax is a tax levied on firms that emit carbon dioxide (CO2) through their operations.
Carbon offset
Carbon offset is an action or an activity that compensates for the emission of carbon dioxide or other GHG in the atmosphere. The actions or activities associated with carbon offsets are quantifiable amounts so that they can be used in the carbon market to be bought, sold, and traded as a carbon credit.
Carbon fines
Carbon fines are penalties for polluting more than the cap that is set by governments and/or international institutions.
Carbon Credits
Carbon Credits refer to any tradable certificate or permit representing the right to emit one tonne of carbon dioxide or the equivalent amount of a different GHG.
Introducing the concept of carbon credits
Through a capped limit on the amount of carbon dioxide a country can emit, governments require businesses to obtain carbon credits, which are essentially regulatory permits to emit an allotted amount of greenhouse gasses per year (usually one ton of CO2 per credit). Over time, this limit is reduced, and when companies have unneeded credits, they can sell those credits to other companies at a profit. This is the basis of the “cap and trade” system, which provides companies with an added incentive to find ways to reduce emissions so that they can earn revenue from the sale of their extra carbon credits. This accomplishes three goals: reducing a country’s negative impact on the global climate, establishing a price on carbon dioxide, and furthering progress toward a sustainability-focused market in the future.
Carbon credits markets - Compliance and Voluntary
Currently, there are generally two different types of carbon markets - mandatory and voluntary. Mandatory carbon markets are used by companies to offset emissions levels to be compliant with regulated emission targets. So far, about 64 carbon compliance markets are now in operation around the world, the World Bank reported in May 2021. Examples of such markets are the EU Emissions Trading System (EU ETS) and the Regional Greenhouse Gas Initiative (RGGI) in the U.S. The EU ETS is one of the largest trading schemes, and has been successful in its goal of decreasing emissions. Since 2005, emissions have been cut by 42.8% in the main sectors covered, power and heat generation and energy-intensive industrial installations. On the other hand, voluntary carbon markets, as the name implies, are where carbon credits are purchased without the intent to be used to stay compliant. These types of markets are becoming increasingly active as the awareness of global warming is also increasing and private entities desire to be part of the goal set by the Paris Agreement. Although the size of the voluntary offset markets has only just reached 1 billion USD by the end of 2021, compared to a massive 27.8 billion market size of the compliance markets in 2020, it is growing significantly faster. The voluntary market saw a near-60% increase in value in the first 8 months of 2021 compared to the previous year, and now represents 70% of all carbon credits generated in 2019 versus only 15% of those generated in 2015. In terms of trade volume, the voluntary carbon market reached a historical 298.4 million mt CO2e in 2021. Nonetheless, the voluntary markets cover less than 0.5% of the total global GHG emissions, whereas the compliance markets cover around 5.5% of total global GHG emissions.
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