Meeting CO2 Targets with Carbon Pricing through Taxation and

Trading

OLUFEMI AIYEGBUSI, ROSSITSA YALAMOVA

Dhillon School of Business

University of Lethbridge

CANADA

JOSEPH ESSADOH-YEDDU

Institute of Oil and Gas Studies

University of Cape Coast

GHANA

Abstract: - We review various alternative sustainability strategies for combating climate change as goal posts

for meeting CO2 reduction targets towards zero net economy periodically have to be replaced. Research on

policy success in reducing CO2 emissions through taxation and emission pricing/trading in various countries is

analyzed to provide insight for policy makers. Economies with large energy sectors may consider appropriately

designed cap and trade system that will achieve emission intensity reduction. In addition, carbon tax will

incentives energy efficient economic and consumer behavior. Any combination of strategies for mitigating

climate change should be adjusted to specific aspects of local social, economic and environmental factor and

should be periodically attuned to their changes.

Key-words: Environment, Carbon Prices, Sustainability, Climate Change, Energy Sources

Received: June 12, 2021. Revised: January 12, 2022. Accepted: March 6, 2022. Published: April 14, 2022.

1 Introduction

Since the United Nations adoption of the Kyoto

Protocol in 2005 (COP 11, 2005), putting a price on

carbon emissions has emerged as one of the most

promising component of any combination of

strategies for mitigating climate change. Its

rationale is straightforward; if there is a reasonable

cost attached to carbon pollution, then there is an

incentive to avoid emitting more than is necessary

and for that matter ensuring low-carbon

sustainability.

We define the emissions challenge as equivalent to

the anthropogenic climate change creating events

of extreme weather patterns with consequential

destructions leading to human suffering. It is

noteworthy that these events are spread across

continents, i.e. globally regardless of the location of

the emitters. This feature underscores the need for a

global response with shared responsibilities.

The foregoing also underlines the general need for

a change in how we live, in order to preserve the

earth. Practices in manufacturing, agriculture,

resource exploration and exploitation, and

transportation especially need to be relooked at

with the aim of reducing their current negative

environmental externalities. The burning of fossil

fuels for energy has been identified as the heaviest

culprit in greenhouse gas (GHG) emissions.

Energy has been the key sector for global GHG

mitigation, accounting for about 60% of global

carbon dioxide emissions and also accounting for

about 30% of almost all industrial and other wealth

creation activities (IPCC, 2007). As at 2016,

Energy production of all types accounted for 72%

of all emissions. Globally, the primary sources of

GHG emissions have been electricity and heat

(31%), (World Resources Institute, 2017).

Fossil-fuel-fired electricity-generating plants and

oil-prospecting and processing units are particularly

notorious and together, accounted for about 26%

of global GHG emissions between 1990-2000,

increasing to over 30% between 2000-2010 (IPCC

AR5, 2014).

Thus, the growth in GHG emissions has continued

since the released of the IPCC Fourth Assessment

Report (AR4) in spite of more efficient vehicles

(road, rail, water craft, and aircraft) and policies

being adopted. Consequentially, the transport

sector which produced 7.0 GtCO2eq of direct GHG

emissions (including non-CO2 gases) in 2010 and

hence was responsible for approximately 23% of

total energy-related CO2 emissions (6.7 GtCO2),

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DOI: 10.37394/232024.2022.2.12

Olufemi Aiyegbusi,

Rossitsa Yalamova, Joseph Essadoh-Yeddu

E-ISSN: 2944-9006

Volume 2, 2022

an increase from about 13% in 2004 (IPCC AR5,

2014, Chapter 8).

Share of GHG emissions from industry also

increased from 19% in 1990-2000 to between 24-

31% in 2000-2010, depending upon the accounting

structure of the industrial sector ( IPCC, 2007;

2014; Statistica, 2022).

Agriculture and Forestry together usually called

AFOLU

sector share of GHG emissions however

has dropped from 31% in 1990-2000 to just under

25% in 2000-2010, total emissions was about 10–

12 GtCO2eq/yr) (IPCC AR5, 2014, Chapter 11).

The majority of the world’s heavy emitters are

linked with the global energy sector. Consequently,

in developed countries such as Canada and the

United States, the major villains are almost always

electricity-generating companies, and oil and gas

companies. Since all economic sectors run on

energy, substituting other methods of energy

generation should lead us to a cleaner and healthier

world. However, this has proven an inadequate

strategy due to limits to the speed of development

of technologies that efficiently harness alternative

sources.

2 Alternative Sustainability Ways for

Combating Climate Change

Energy-source substitution on a global scale cannot

be an instantaneous occurrence, therefore some

proven options are concurrently being pursued by

relevant stakeholders.

The major option that is being given the most

attention currently is mitigation; which is described

by Fawzi et al. (2020), as entailing the reduction of

emissions by the establishment of projects that

reduce anthropogenic emissions of greenhouse

gases into the atmosphere.

These projects include those that enhance and

reward the efficient industrial use of fossil fuels,

renewable energy projects, and carbon-sink forestry

projects (Stern Review, 2007). The main focus of

mitigation is on carbon emissions which account

for about 76% of GHG emissions Methane,

primarily from agriculture, contributes 16% of

GHG emissions and nitrous oxide, mostly from

industry and agriculture, contributes 6% to global

emissions (Centre for Climate & Energy Solutions,

2022)

The emission-reducing projects are expected to be

paid for ultimately by emitters, who shall be

Agriculture, Forestry, Land Use under IPCC

nomenclature

required to buy up chunks of the carbon called

emissions allowances in order to continue

producing after exceeding their allotted emissions

limit. The added cost of production from purchase

of emissions allowances may itself discourage

excessive emissions and encourage firms to

develop better emissions-efficient processes and

technology- thereby speeding up the process of

achieving more sustainable habits in pursuit of an

inhabitable future.

Other mitigation options being proposed are

carbon-dioxide removal (CDR) such as carbon

sinks, biomass for carbon sequestration, direct

engineered capture of CO2 from the atmosphere,

and ocean fertilization as well as some methods of

solar radiation management (SRM) such as earth-

surface albedo enhancement, marine-cloud

reflectivity enhancement, sulphate-aerosol

injections, and space-deflectors. The major

difference between CDR and SRM approaches is

that CDR approaches attempt to tackle the problem

at its root by removing the excess carbon-dioxide,

while SRM methods focus on correcting radiation

imbalance by shading or shielding the earth (see

Lenton and Vaughan (2009)

Another option other than mitigation is Adaptation

which is defined as “to prepare for and adjust to

both the current effects of climate change and the

predicted impacts in the future” (EU, 2021). This

option is a crisis control strategy which cannot be

entirely separated from the mitigation, but distinct

to the extent that it aims at boosting resilience to

extreme weather conditions such as floods and

cyclones, and enhancing efficiency in the

management of scarce natural resources including

forestry, water bodies.. Its theme is that climate

change might not be entirely preventable and

humanity must be prepared when some extremely

damaging changes start to appear. Given the scale

of climate change and the fact that it will affect

many areas of life, adaptation also needs to take

place on a greater scale. Thus, our economies and

societies need to become more resilient to climate

impacts.

3 Some Major Sustainability Debates

and Issues

3.1 Emissions Reduction Versus Emissions

Intensity Reduction

Cap and Trade systems function by imposing a

limit (cap) on the quantity of allowable carbon

emissions in a system, which causes a scarcity of

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Olufemi Aiyegbusi,

Rossitsa Yalamova, Joseph Essadoh-Yeddu

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Volume 2, 2022

emission-allowances and thus creates a market

phenomenon. That limit could either be an absolute

one, or an Intensity limit. An absolute limit

specifies an amount of GHG emissions that must

not be exceeded within a period of time while an

intensity-limit specifies the amount per unit of

production. Obviously, the Intensity limits

emphasize efficiency while the Absolute limits

emphasize specific targeted quantities. Invariably,

both limits aim at achieving behavioral changes

with respect to emissions; the major difference

being in the level of certainty about the magnitude

of emissions-reduction that would result, and their

implications for economic growth. Absolute limits

have been used before in curbing emissions of

Sulphur-dioxide and Nitrous-oxides in some

developed markets like the United States. The

Kyoto Protocol also specified limits in an absolute

sense. However, according to Ellerman and Wing

(2003), they are much less commonly used than the

Intensity limits which for instance has been used

for the US’s State Implementation Plans, the EU’s

Large Combustion Plant Directives, Canada’s

Carbon Policy and carbon mitigation plans of many

developing countries such as Argentina and India to

mention a few.

Zeng et al. (2016) compare the economic and

political benefits of the EU and Chinese Emission

Trading Systems.

The main debate currently resides on the efficacy

of either limit in reducing carbon emissions. The

chief arguments in favor of an absolute cap are that

it assures certainty in quantity of emissions to be

reduced (thus it is useful for precluding emission

growth), and is simple to communicate to

stakeholders. Its disadvantages are mainly that it

could lead to escalating costs, and consequently,

stifle economic growth pending the development

and accessibility of new carbon-free technology in

the not-so-near future (Nordhaus, 1994). Absolute

caps are also criticised for causing and/or

perpetuating economic disparities particularly to

the disadvantage of less-developed countries, for

which economic growth is more tightly coupled

with emissions growth and which are unequipped

with resources including technology, with which to

meet most reasonable absolute targets (Pizer, 2002;

Mideksa, 2019). Intensity limits on the other hand,

have the distinct advantage that they accommodate

economic growth and instead focus on performance

as a function of efficiency. The key obvious

disadvantage of intensity limits is that given

accelerating economic growth, emissions may

burgeon faster than ever even in the face of

decreasing emissions intensity; this will happen

insofar as the economy grows faster than

emissions.

From the brief expose above, it is rather obvious

that the debate is charged, not by intrinsic qualities

of either approach, but by how climate change is

conceived by different parties. At an extreme, an

intensity approach is naturally acceptable to those

who believe that the amount of “global-cooling” we

can achieve in the short-run through mitigation is

not worth the possible sacrifice in economic

growth, while, at another, an absolute cap is likely

to be more acceptable to those like Hansen et al

(2006), who believe that it is necessary to

aggressively tackle global warming before it

reaches thresholds that force an irreversible climate

change that may potentially result in several

degrees of disasters including the melting of

permafrost, the extreme consequence of which is

the extinction of species including the human race.

While the motivating scenario of the latter

viewpoint is indeed possible, it is shrouded in

uncertainty. Given this uncertainty, the majority of

policy makers the world over seem to have chosen

(possibly under the influence of the press) to pursue

economic growth on the chance that climate change

will not be too harsh. The evidence for this decision

seems to be strongly reflected in the prevalence of

intensity limits relative to absolute ones. Thus,

although absolute caps may be the more effective

method (at least from an emission-reduction

perspective), as Quirion (2005) opines, intensity

limits are more politically acceptable and more

likely to thrive subsequently in future emission

policies. Reviewing the literature, Doda (2016)

finds that «no single mechanism emerges as a

dominant option for capturing the welfare gains

associated with responsive carbon pricing

instruments».

That said, according to the World Resources

Institute (Herzog et al, 2006), how effective either

policy-option is in reducing emissions depends

more on how stringent its application is, how

widely defined its scope is, and how legally binding

its compliance is. Even an intensity limit could be

made very stringent, defined to capture most

significant sources and be made mandatory by law

enough to yield substantial mitigation dividends,

whereas an absolute cap may be made so high,

encompass few significant sources, and left open to

volition such that it hardly has any impact. Such a

high absolute cap is however likely to be more

easily perceived as weak than an equally ineffective

intensity target which often deceptively appears

high and ambitious. Kolstad (2005) has provided an

elaborate discussion on this topic. Wang et al. 2021

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Rossitsa Yalamova, Joseph Essadoh-Yeddu

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derive the welfare comparison between tradable

performance standards and a price-based

alternative.

3.2 Emissions Taxes Versus Emissions

Trading

Emissions trading and emissions taxing are two

alternative market-based approaches to attributing

the cost of pollution to emitters

. As with most

other economic debates, it is unlikely that there is a

strictly superior policy option between emissions

taxes and emissions trading. In a world of absolute

certainty, both options should yield equivalent

results (Green, 2008). However, we live in a world

fraught with uncertainty and either option is only

more likely to be effective in certain circumstances,

while being less effective in others. Dissou and

Karnizova (2016) find the cap has lower volatility

but higher welfare costs for shocks to energy

sectors. In order to appreciate this point, we briefly

explain the theoretical mechanisms of both market-

based instruments, and conclude with comments on

instances where each could be an effective policy

option.

The theoretical underpinning of emissions taxes, as

observed by Ekins and Barker (2002), is generally

agreed on by economists; if the production of a

commodity causes negative externalities not

reflected in the price of that commodity, social

welfare can be improved by imposing a tax.

Emissions taxes are designed to tackle the

emissions problem by fixing a price per unit of

emission, and allowing those on whom the burden

is imposed to determine how much to emit.

However, an emissions tax has to reflect the social

cost of the taxed good to a reasonable degree in

order to increase the price of emission-intensive

production, thereby making emission-intensive

products less competitive relative to low-emission

substitutes. Karmaker et al. (2021) identified that

environmental taxes stimulate technological

innovation in high and middle-income nations

which should lead to cost savings. Thus, it aims at

achieving behavioral change using a direct price-

fixing mechanism that reflects the popular “polluter

pays” principle. Each participant in the system it

covers is levied an amount of tax per unit of

emission released in the course of its production or

A third approach – regulation – is generally unpopular

among policy-makers due to its inherently high cost,

potential damage to industry and economic growth, and

poor efficiency relative to market mechanisms (taxes

and trading schemes).

consumption process. In theory, emission-taxes

equalise marginal abatement costs across all

emitters and can achieve emission reduction at the

least cost to society. By and large emission-taxes

are simple and easy to communicate to

stakeholders. While electorates and industry are

usually tax-averse, a carefully designed emission-

tax, revenues from which might be used to grant

the low-income class some meaningful rebates

from other historically unpopular taxes or fund

some welfare program, is likely to meet with

acceptance. One primary problem that faces the

international adoption of the carbon tax strategy is

the fact that it is virtually unrealistic for countries

that hitherto protected, supported, and even

subsidized their energy sector and other heavy

emitters, to suddenly erase those policies and start

to penalize these same industries upon which their

growth has been predicated.

Shmelev and Speck (2018) employed an

econometric approach to analyse the effectiveness

of energy and carbon taxes in Sweden, leading in

CO2 tax as well as an extensive environmental tax

reform. The results showed that taken in isolation a

CO2 tax was not sufficient to result in a significant

change in CO2 emissions, except for petrol. Niu et

al. (2018) found that environmental tax shocks

could drive the reduction of carbon emissions in

China. Li and Yu (2020) propose a collaborative

coordination scheme to improve energy sharing,

which reduces cost and carbon emissions. They

assert that implementing carbon tax would lead to a

decrease in energy exchange. Dissanayake et al.

(2020) evaluated a carbon tax, a fuel tax and an

ETS for Indonesia and asserted that carbon tax is

simpler and more swiftly implementable than the

ETS. He at al. (2021), examined the relationship

between environmental tax, economic growth,

energy consumption, and carbon dioxide emissions

in China, Finland and Malaysia from 1985 to 2014

and confirmed that the double-dividend effect of

environmental tax exists in all three countries in the

long run.

On the other hand, emissions trading is designed to

fix the quantity of emissions allowed within an

economic system at the level of a predetermined

target, and by the scarcity that ensues, create a

market within which price is formed. Players

within the trading system are then left to determine

the least costly way to meet the effective limit by

buying or selling emission permits (Sijm, 2005).

The expectation is similar to that of a tax; polluting

firms get punished by incurring the added cost of

buying emission-permits, and attempt to explore

low-carbon technologies and processes in order to

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Olufemi Aiyegbusi,

Rossitsa Yalamova, Joseph Essadoh-Yeddu

E-ISSN: 2944-9006

Volume 2, 2022

avoid that cost. Those who switch successfully and

are able to reduce their emissions below a given

benchmark – for example 21% below 1990

emission benchmark levels in the EU ETS Phase III

plan (UK Department of Climate Change, 2008)–

generate permits that they can resell to those who

still require them for compliance purposes. Herein

lies the main appeal of emissions trading systems;

under them, emitters have an incentive, not only to

reduce their pollution in order to avoid compliance

costs but, to reduce emissions beyond the statutory

requirement through innovation, and thereby

generate permits which they can sell. This spells

competitive advantage for such proactive

participants, and a least-cost reduction in emissions

to society, by creating a compliance system in

which those emitters who find it most economical

to reduce their emissions do, while others without

that comparative advantage can simply purchase

from them.

Emissions’ trading however is not without some

serious demerits, some of which are high price-

volatility and high susceptibility to corruption.

Nordhaus (2005) reviews several emissions

markets within which volatility is rife, while data

from the European energy exchange (2015, 2016,)

indicate that EU allowance prices fluctuated by

more than 15% monthly on average between May

2015 and April 2016, and experienced an 80%

crash and equivalent recovery in the subsequent 3

months. Similarly, the US Environmental

Protection Agency (2012) reports annual average

fluctuations in Sulphur-dioxide permit prices of

over 40 percent between 1997 and 2012, with price

increasing from $106 in 1997 to $860 in 2006 and

$2 in 2011. Such volatility if experienced on a

global scale portends huge costs and shall

negatively impact both the business and

consumption of carbon-intensive economies,

potentially crippling them. Taxes on the other hand

are by design not sensitive to the changes in

weather or economic growth that drive volatility.

Trading also leaves more room for cheating than

taxes would for the mere fact that among other

reasons, governments are naturally more

incentivised to perform their monitoring and

enforcement roles under tax regimes where they

collect revenue, than in a trade scenario (Nordhaus,

2005). Moreover, taxes could be easily

administered through pre-existing tax collection

mechanisms while emissions trading would require

the design from scratch of new mechanisms.

Weitzman (1974), and subsequently Hepburn

(2006), attributed the objective determining factor

in choosing between both options to the region of

uncertainties. Weitzman showed in his much-

acclaimed paper “Prices vs. Quantities” that where

there is uncertainty about the cost functions or a

possibility that costs are very sensitive to above-

optimal emissions reduction, a tax is preferable;

whereas where the uncertainty lies in the damage

function (that is how grave the impact of that

externality is) or where the damage function may

be very sensitive to above-optimal level of

emission, a trading system is preferable. Cost

function uncertainties are already being resolved,

and are likely to be mostly resolved in the near

future, however damage function uncertainties are

unlikely to vanish even in the long run. Therefore,

given this criterion, our current climate

predicament seems to support some combination of

both instruments in the short run (after which cost

functions will likely become more certain), while

trading will be preferred as a longer term

instrument.

In essence, the more appropriate question for

debate may not be “Which is better?”, but “How

much of each to use and when?” This raises further

hard questions of how such policy-instruments

could best be combined to avoid conflicts such as

distortion of substitution objectives (Sorrell and

Sijm, 2003), instrument-redundancy and other

practical problems that breed inequity. In any case

whatever instrument choice is made, adequate

commitment must be made to its enforcement,

stringency and coverage in order to reap any

significant benefits.

In administering carbon taxes in the short-run, it is

also practically useful to remember Baumol and

Oates’ (1971) work on environmental externalities,

which cautions that in the absence of

comprehensive information about cost functions,

taxes on goods with associated negative external

effects, should be applied iteratively in order to

meet up with emission-reduction goals, since there

is no hard and fast way to know a priori what level

of taxes would result in the desired changes. Taxes

and trading schemes would both require keen

monitoring and continuous adjustments in order to

achieve meaningful goals. Moreover, Fu 2017

proposes a framework of combinatorial mitigation

actions which is characterized as collaborative

iterative dynamics with multiple players in the EU

electricity sector. Cooperative behavior in a

complex system requires trust and transparent

information for sustainable outcome.

Carbon pricing, which is a means of providing

economic incentives for reducing carbon emissions

is found to be another cost-efficient way in

mitigating climate change. According to the World

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Bank (2020) there are 61 carbon pricing initiatives

in place or scheduled for implementation, covering

around 22% of global GHG emissions. The

adoption and implementation of an efficient carbon

pricing system is however a complex process.

There are technical, institutional, economic, and

political factors that restrict the opportunities for

implementing a uniform and comprehensive

system. Carbon pricing should therefore be seen as

part of a policy package and not a silver bullet. The

design of the systems thus should be adapted to

meet different socio-economic interests and

consequently compromises in design are often

necessary. For instance, subsidies and tax

exemptions are common. Khan and Johansson

(2022) provided an overview of factors identified

as influential in terms of the adoption,

implementation and design of carbon pricing policy

instruments, analysing policy instruments that were

implemented between 2000 and 2015.

4 Conclusions

We have been witnessing political will and

economic efforts to reduce CO2 emissions in order

to avoid climate catastrophe. Political decisions

informed by scientific evidence should allow us to

avoid disastrous consequences. In economic terms,

if there is a reasonable cost attached to polluting,

then there is an incentive to avoid emitting more

than is necessary and sustainable. However, what

price to put on carbon emissions (in essence, what

this ‘reasonable cost’ should be) and how to arrive

at this price such that it is effective enough to align

production and consumption patterns with

environmental goals remain much debated issues.

While some policy-makers and researchers favor a

carbon tax mostly for its simplicity and direct effect

on price; others support mitigation through a cap-

and-trade framework due to its advantages with

respect to the certainty it affords in meeting

emissions-reduction targets, its efficiency in cost

allocation and tolerability in a tax-averse world.

There is definitely an argument for a combination

of these two tools in addition to other mitigation

and adaptation efforts to alleviate the impact of

climate change on livelihood, health and prosperity.

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EARTH SCIENCES AND HUMAN CONSTRUCTIONS

DOI: 10.37394/232024.2022.2.12

Olufemi Aiyegbusi,

Rossitsa Yalamova, Joseph Essadoh-Yeddu

E-ISSN: 2944-9006

Volume 2, 2022

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