Executive Summary

• The United States is projected to fall short of the climate goals it set under the 2015 Paris Agreement, even with the burdensome provisions of the Inflation Reduction Act.
• Carbon pricing programs present a more cost-effective solution than subsidies and could reduce emissions by the required amount while generating revenue.
• Existing carbon pricing systems such as carbon taxes and emissions trading systems have their benefits and drawbacks, and can serve as a model for the United States.

Introduction

The Paris Agreement is an international treaty adopted by 196 parties on December 12, 2015, which intended to address the urgent global issue of climate change. The United States is not on course to meet its climate goals and must adopt more aggressive legislation to achieve its targets.

Ultimately, the Paris Agreement aims to limit the global temperature increase to 1.5 degrees Celsius by 2030 and reach net zero carbon emissions by 2050. According to the United Nations Framework Convention on Climate Change (UNFCCC), “to limit global warming to 1.5°C, greenhouse gas emissions must peak before 2025 at the latest and decline 43% by 2030.” The UNFCCC has affirmed that we are not on track for this goal.

As we near the deadline for the initial 2025 goal, it is unlikely that the United States can meet its target of reducing greenhouse gas (GHG) emissions by 26­–28 percent below baseline 2005 levels by 2025 and 50­–52 percent by 2030. After rejoining the Paris Agreement in 2021, the United States stated in its Nationally Determined Contribution to the UNFCCC that it was “on track” to meet its 2025 goal. According to the U.S. Environmental Protection Agency, GHG emissions in the United States had fallen by 16.7 percent as of 2022, with carbon emissions falling by 17.5 percent. Recent environmental legislation such as the 2022 Inflation Reduction Act (IRA) will likely accelerate reductions, however, even with the IRA, the United States is projected to achieve only a 32­–42 percent reduction by 2030, failing to meet both its short- and medium-term goals.

This does not bode well for the Paris Agreement’s long-term goal of net zero by 2050. If the United States wants any hope of achieving net zero, it will be crucial to implement carbon pricing programs. Carbon pricing programs are among the most effective environmental regulations because they are more flexible and less costly than requiring entities to adhere to specific technology, processes, and pollution levels. Among the most popular carbon-pricing possibilities are carbon taxes, carbon offsets, and an emissions trading system (ETS).

Carbon Taxes

A carbon tax is potentially one of the most cost-effective policies for reducing carbon emissions. Currently, no carbon tax exists in the United States.

Carbon taxes tend to be unpopular for several reasons – while taxes are unpopular in general, carbon taxes also happen to be regressive, and could disproportionately affect low-income families. This is because energy costs comprise a larger share of low-income household spending compared to high-income households. Moreover, any discussion about a carbon tax would necessarily include disputes about utilizing the revenue – for example, additional emissions reduction efforts, payroll tax cuts, or corporate tax cuts – making it difficult to agree on and pass a bill.

The United States could potentially draw inspiration from Canada’s carbon-pricing structure, which took effect in late 2019. Canada’s carbon tax started at $20 per metric ton in 2019 and is increasing by $15 per year, approximately equivalent to a 3-cent per liter of gasoline increase. The tax rebates 90 percent of its revenue to households – in particular, low-income households often receive more from the rebate than they pay in the tax. The effect of the carbon tax is modest, however, with very little change in Canada’s annual carbon emissions. But as the tax ramps up, the effect will likely be much more pronounced. Bringing a similar system to the United States could alleviate concerns over the regressive nature of the tax.

Not only are carbon taxes more profitable than subsidies, but they are also more cost-effective. As shown in the table below, the IRA is estimated to have a 10-year cost of $900 billion, with $781 billion due to tax credits. On the other hand, a modest tax of $10 per metric ton of CO₂ is estimated to raise $106­–$118 billion over 10 years. The “Deutch” bill, introduced in 2019 by Representative Theodore Deutch, proposed a tax of $15 per metric ton increasing by $10 annually, which would raise $1.8­–$2.8 trillion. The $10 tax is on par with the IRA in terms of emissions reduction – both result in a 35 percent reduction from 2005 levels – while the Deutch Bill would result in a 52 percent reduction. This would have been enough to meet the United States’ 2030 climate goals if the bill were implemented in 2020.

As a result, the IRA has a significantly higher abatement cost when compared to a carbon tax – to achieve the same emissions reduction as a $10 tax, it costs $45­–$61 per metric ton of CO₂.

	Inflation Reduction Act	Carbon Tax: $10/tCO2e	Carbon Tax: Deutch Bill
Total 10-Year Cost/Revenue	-$900 billion (-$781 billion from tax credits)	$106­–118 billion	$1800­–2800 billion
% Reduction in Emissions After 10 Years, from 2005 Levels	35%	35%	52%
Abatement Cost per Metric Ton of CO2	$45­–61	$10	$15 initially, increases $10 annually

Carbon Offsets

Carbon offsets refer to the reduction of carbon emissions to compensate for emissions created elsewhere. Entities purchase verified offsets, and their money goes toward projects that reduce carbon emissions, generally by one metric ton per offset. Offsets can be tied to environmental projects such as rainforest preservation, or to entities that reduce their emissions by the amount specified by the offset.

Entities often use offsets to achieve emissions targets – most entities have a level of “necessary” emissions that cannot be eliminated, and carbon offsets can sometimes be used to account for those. Offsets are particularly useful because anyone, including individuals and small businesses, can purchase them.

On the other hand, carbon offsets are not always reliable. There are several potential issues with measuring the effect of offsets. Many projects are based in low-income, developing countries which generally cannot properly regulate and measure the environmental impact of the projects. These countries are furthermore incentivized to inflate the impact of projects to receive more revenue from offsets. Even in countries like the United States, offset projects can be difficult to regulate. Measuring the impact of an offset project requires determining a baseline, or the emissions level that would have existed without the project. Offsets can even encourage entities to create more pollution to manipulate the baseline if the income they could receive from selling offsets is high enough.

For carbon offsets to become an effective method of reducing emissions, there needs to be better-defined and more comprehensive regulation of offsets, both on a domestic and international level. Carbon offsets are most often used with other carbon pricing structures to compensate for necessary and costly-to-eliminate emissions. They should not be relied upon in excess, however, as entities may elect to buy offsets rather than expend effort to reduce their total emissions.

Emissions Trade System

An ETS is a system in which the government distributes emissions allowances, which permit companies to generate the amount of carbon specified by the allowance without penalty. The allowances can be traded between the companies – low-emitting companies can make a profit by selling them, while high-emitting companies can buy them to avoid bearing the cost of reducing emissions. There are two main kinds of ETSs:

• Cap and trade: There is an absolute limit on emissions. Allowances totaling to the cap are distributed freely or by auction.
• Baseline and credit: Baseline emissions for individual entities or sectors are determined. Entities with emissions lower than the baseline are issued credits.

Allowances function similarly to carbon offsets – the main difference is that allowances in an ETS are available only to the government and companies covered by the ETS, whereas offsets are available to anyone.

There are potential issues in both kinds of ETS systems. If the cap or baseline is not properly determined, over- and under-estimates can lead to less reduction than desired or overly difficult emissions targets. It is similarly difficult to decide how to reduce the cap in a way that appropriately addresses emissions while maintaining feasible targets. Currently, there are four ETSs in the U.S. The Regional Greenhouse Gas Initiative (RGGI) applies to the power sector and is the only inter-state program, with several northeastern states participating. Additionally, three states have their own systems: Massachusetts has an additional power-focused ETS to complement the RGGI, while Washington and California each have systems encompassing 70 percent of state emissions. While Washington’s cap-and-invest ETS is relatively new, California’s cap-and-trade program has been ongoing since 2012. Since California’s system is more comprehensive and established than others, it provides a model that the United States could draw on to design a nationwide ETS.

California Cap and Trade

California utilizes a standard cap-and-trade system with allowances distributed partially via auction. An auction provides additional price incentives for entities to reduce emissions – since the number of allowances declines each year, their price naturally increases, and the auction revenue goes back into air pollution reduction programs. The system also allows for the use of carbon offsets up to 8 percent of each entity’s compliance obligation, restricted to five emissions-reduction projects based in the United States.

California has reduced carbon emissions by 20.2 percent below 2005 levels, and as the cap and trade program is a significant part of California’s plan to reduce emissions, a substantial amount of the reduction is likely attributable to the program. On the other hand, the program has been criticized for its lax policy regarding the use of carbon offsets, which are not always reliable. California forest fires have been particularly disruptive for the offset program – trees that were meant to be part of offsets ultimately released more carbon due to the fires. The 20.2 percent reduction may consequently be an overestimate and could lead to California reporting false successes in its climate goals. The requirement of limited U.S.-based offset projects is a good step in ensuring that offsets are trustworthy, but stricter verification processes are needed to ensure the project’s success.

Conclusion

The United States is not on track to reach its short- or long-term goals set out by the Paris Agreement despite costly legislation. Currently, U.S. policy focuses mainly on expensive subsidies, such as providing credits for using electric vehicles or installing solar panels under the IRA. While each system has its unique drawbacks, the United States should focus on the more cost-effective carbon pricing policies and analyze existing state-level and foreign systems to design a federal-level pricing structure.