Putting a price on carbon and other greenhouse gas (GHG) emissions directly incentivises action by making polluting activities more expensive. It provides a mechanism for governments at all levels to capture the external costs of emissions, from climate impacts to healthcare bills. It also generates funding that can enable the implementation of other climate policies.
In this article, we explain the main approaches available to cities: emissions trading systems, carbon taxes and other forms of charging, and standards and regulations. As carbon pricing is commonly-used shorthand for the pricing of GHG emissions more generally, we use these terms interchangeably here.
Pricing policies should be informed by the city’s climate targets, an understanding of the greatest emissions sources, regulatory powers and local economic context, and the priority climate actions to take1 – ideally, these would be determined through a climate action planning process.
Why put a price on carbon?
By putting a price on carbon and other GHG emissions, cities can:
This approach sets a cap on emissions, usually for a sector or segment within it – such as large buildings or industrial polluters. Those affected are given an emissions allowance, often through an auction, and can choose how to reduce their emissions. Allowances can be bought by actors who need to further reduce their emissions to remain compliant, and sold by those who are ahead of their targets – creating a market.
Emissions trading systems allow the city to set allowances according to climate targets, limiting the environmental impact of a sector. The price of emissions will fluctuate within the market according to those targets and other factors. Emissions trading systems can also be structured to deliver a predictable emissions reduction pathway through a steadily declining cap, becoming stricter over time and leading to a higher price for emitting GHGs.4
Emissions trading systems are already in operation in several countries and states/regions globally, as well as handful of cities, including Tokyo (described below). While not widespread, these systems offer promise for cities elsewhere.
To begin, determine the scope of the system – the sector(s) and segment(s) to target – and what should be regulated within them. Work with technical experts, including legal experts, to design these schemes. Focus first on the biggest emitters and/or where the city has greatest control, such as heavy industry and large buildings. The scope can be expanded later within the sectors and to new parts of the economy.
The points below introduce recommended steps for creating a successful ‘cap-and-trade’ system. For an in-depth guide, read the International Carbon Action Partnership (ICAP) and World Bank’s Emissions Trading in Practice: A Handbook on Design and Implementation.
Beijing has been operating a wide-reaching emissions trading system since 2013
Beijing launched an emissions trading system pilot in 2013, covering nearly half of the city’s total emissions, including from electricity providers, industrial enterprises, the services sector and public transport (added in 2016). It allocates allowances based on historical emissions and sector-level benchmarking and uses a price floor and price ceiling to keep the carbon price relatively stable. The system is enforced by imposing heavy fines and other penalties, such as reduced access to subsidy programmes. The success of Beijing and other pilots by Chinese cities and regions helped to make the case for a national carbon market, which now runs in parallel.5 ICAP’s briefing explains more.
Tokyo’s cap-and-trade programme
In 2010, Tokyo introduced the world’s first urban cap-and-trade programme, focusing on large buildings and factories. Tokyo’s buildings were responsible for over 70% of the city’s emissions.6 The scheme mandates emissions reductions year on year, with buildings required to meet targets via energy efficiency measures or by purchasing credits. Credits can be purchased from and traded by high-performing buildings and can be carried forward if targets are overshot. Owners are responsible for emissions accounting, verified by a third party, and those failing to meet targets are subject to financial penalties. By 2017, the total emissions from facilities covered by the scheme had fallen by 27% from the baseline.7 The programme also gives ‘top-level’ certification to leading facilities, providing reputational incentives.
Neighbouring Saitama Prefecture launched a similar system a year after Tokyo. Under the Target-Setting Emissions Trading Program, entities covered are subject to mandatory target-setting but incur no penalties for not achieving them. Still, the programme has succeeded in spurring emissions reductions by facilities in Saitama.8
Advocate for emissions trading and charging systems on a national or regional scale
While city-level systems can achieve significant results locally and demonstrate the potential for emissions trading, carbon markets are likely to be most effective on a regional or national scale. Systems at this scale enjoy greater liquidity as there are more players in the market, and they are better positioned to cover more entities and sectors – including those over which cities may not have regulatory power.
Emissions trading systems already adopted or in motion at higher levels of government include those operating in California and the European Union, as well as Article 6 of the Paris Agreement, which aims to establish a global price on carbon. Linking with other cities can be beneficial, too: the systems run by Tokyo and Saitama are directly linked, meaning credits can be used interchangeably in each system.9
Emissions charging systems are will also be more impactful if established at national or regional level. Examples include Canada’s Greenhouse Gas Pollution Pricing Act, a carbon tax that sets a national price on CO2 emissions by establishing a minimum fuel charge for individuals, which will increase year on year, as well as an output-based pricing system for large industrial facilities.10 After the Act was passed in 2018, several provinces challenged it in the courts, before the Canadian Supreme Court ruled it constitutional in 2021.
Cities can most effectively push for action on a national or regional level by lending their voice to international campaigns. In Europe, cities have joined campaign groups such as the Coalition for Higher Ambition and the European Committee of the Regions with a view to increasing the reach and ambition of emissions trading and to make the European Union’s Emissions Trading System and Carbon Border Adjustment Mechanism work better for cities. Read How to advance your city’s climate action through city diplomacy for more ideas and tips.
Greenhouse gas taxes and other forms of charging for emissions place a price on polluting activities, like using a fossil-fuel-based vehicle in a city centre or emitting carbon in a production process. This approach brings cost certainty, as the city sets the prices, but does not establish a limit on emissions.
Like an emissions trading system, the scope and technical criteria for emissions charging schemes should be informed by an understanding of the city’s main emissions sources and include mechanisms for proper measurement and enforcement.
It is critical that these policies are not regressive. They must not place an unfair and unmanageable financial burden on low-income and other vulnerable groups for whom high-emission activities, such as heating and transport, often constitute a higher portion of earnings.11 Alongside prioritising low-income groups in the design of climate policy, consider rebates as a way to address this. Canada’s national carbon tax is accompanied by a significant benefit paid to individuals and families to offset the cost.12 It is important that rebates are not set too low, as Australia’s experience shows. The country introduced a similar carbon price in 2011, but repealed it 2014, in part because rebates to households were too low to counterbalance the rise in living costs. The Australian system refunded 50% of the tax revenue to households, compared with 90% in Canada.13
The main urban sectors targeted by emissions charging schemes to date are:
London’s Ultra Low Emission Zone (ULEZ)
London is a leading city in pricing vehicle use, building on the 2003 Congestion Charge with a Low Emission Zone and the ULEZ. The revenue is ringfenced to support public transport and active travel. These taxes require drivers to pay for the pollution and congestion they cause, encourage the use of public transport, walking and cycling, and build the market for electric vehicles. How road pricing is transforming London explains more.
Boulder’s Climate Action Plan (CAP) tax initiative
Introduced in 2006 following a public vote, the CAP tax initiative places a levy on residents and businesses for their consumption of fossil-fuel based electricity. The first of its kind in the United States, the tax is collected on energy bills by Boulder’s utility and the average annual US$1.8 million in revenue is used to fund the city’s energy efficiency and renewable energy programmes, which prioritise low-income residents. Customers who opt to use the utility’s Windsource local green power programme are exempt from the tax. Boulder residents voted in 2015 to extend the tax to March 2023.15
This can be the better approach where emissions trading or charging systems aren’t politically feasible. Find an introduction to impactful actions in key sectors here. Three examples are:
Impacted sectors and communities must be consulted in the design of pricing policies
This is critical to ensure they work effectively and avoid unintended consequences. For example, when New York City’s buildings emissions standard was feared to be setting too high a price for owners and renters of affordable housing developments, the city worked with these groups to agree on a slower transition pathway.
With thanks to Stefano De Clara, Head of Secretariat at International Carbon Action Partnership, for sharing his insights as we shaped this article.
