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Carbon pricing, explained
Let us walk you through it.
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What is a carbon credit?
It’s a tradable asset issued to owners and operators of facilities that are reducing the amount of climate change-causing emissions being released into the atmosphere.
To reduce carbon emissions, the pollution needs to be counterbalanced by activities that trap greenhouse gasses (like planting permanent forests) or wean people off emitting activities (like building solar- and wind-powered electricity generation). Each project or initiative is issued carbon credits equal to the amount of emissions it prevents or captures.
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What is a carbon tax?
It’s a government charge, assessed on carbon emissions. The amount varies depending on location. Generally, the more carbon emissions a location produces, the more tax will be owed.
Companies that don’t meet carbon emissions standards set by their locality pay a carbon tax. The sooner these companies reduce their carbon emissions and transition to renewable energy, the sooner they can avoid the extra cost of the tax.
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Carbon taxes can also be designed to increase over time or be subject to inflation adjustments. So, if a polluter is willing to pay the tax on their emissions today, they might not next year. In Argentina for example, the tax rate for fossil fuel companies started in 2019 at 10% of the full carbon tax rate. The tax rate will increase annually by 10% until it reaches parity with other industries in 2028.
In 2021, Sweden had the highest carbon tax rate in the world, at around $126 per metric ton of CO2.
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What is carbon trading?
This one is a little more complicated. Carbon trading is how holders of carbon credits get paid for them and how polluters avoid paying taxes on their emissions. Entities that have exceeded their emission-reduction goals or have produced negative emissions earn carbon credits.
Carbon emitters buy credits to atone for their climate sins. When emissions are offset, there is no tax to be paid—this is called a “cap-and-trade” program, or Emissions Trading System (ETS).
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Why trade carbon?
Those who reduce their carbon footprints faster than expected or create technology to do so get paid for those efforts by selling carbon credits while those that do the opposite see increased costs. It’s meant to incentivize the collective reduction of emissions in a community, even if some polluters don’t change their operations or pollute more.
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