An Introduction to Carbon Pricing: Carbon Tax, Cap & Trade, ETS and Internal Carbon Price

Abstract

This study provides an introduction to carbon pricing mechanisms through microand macro-based empirical analysis. The first part provides an overview of existing market-based regulations, comparing instruments in terms of emissions coverage, price structures, and revenue generation. The statistics show that the implementation of regulations follows a positive trend worldwide but remains far below the level required to initiate the transition to carbon neutrality. The heterogeneity of carbon prices and coverage underscores the need to increase the stringency of these policies. In the second part, we examine firm-level carbon pricing data from the Carbon Disclosure Project (CDP) database. Most companies have less than 10% or more than 90% of their Scope 1 emissions covered by regulation. Among respondents, 27% are subject to an external carbon price, 26% have an internal carbon price (ICP), and only 13% use both, suggesting that companies generally do not fully internalize carbon costs. Adjusting for survival and universe biases, we find that ICP adoption has been limited in recent years. Many companies committing to future adoption are not taking action, raising concerns about greenwashing. Finally, we conclude this study with an econometric application to test the relationships between internal and external carbon pricing. Using data from the MSCI World index in 2022, we estimate the main motivations for a firm to adopt an internal carbon price and the determinants of its price level. Firms in carbon-intensive sectors (e.g., utilities, energy, industrials) and those subject to external regulation are more likely to adopt an ICP.

Keywords: Climate change, carbon pricing, carbon tax, emissions trading scheme, shadow price