Proposal for an International Carbon Price Floor Among Large Emitters
Author: Ian Parry1
  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

Countries are increasingly committing to midcentury ‘net-zero’ emissions targets under the Paris Agreement, but limiting global warming to 1.5 to 2°C requires cutting emissions by a quarter to a half in this decade. Making sufficient progress to stabilizing the climate therefore requires ratcheting up near-term mitigation action but doing so among 195 parties simultaneously is proving challenging. Reinforcing the Paris Agreement with an international carbon price floor (ICPF) could jump-start emissions reductions through substantive policy action, while circumventing emerging pressure for border carbon adjustments. The ICPF has two elements: (1) a small number of key large-emitting countries, and (2) the minimum carbon price each commits to implement. The arrangement can be pragmatically designed to accommodate equity considerations and emissions-equivalent alternatives to carbon pricing. The paper discusses the rationale for an ICPF, considers design issues, compares it with alternative global regimes, and quantifies its impacts.

Abstract

Countries are increasingly committing to midcentury ‘net-zero’ emissions targets under the Paris Agreement, but limiting global warming to 1.5 to 2°C requires cutting emissions by a quarter to a half in this decade. Making sufficient progress to stabilizing the climate therefore requires ratcheting up near-term mitigation action but doing so among 195 parties simultaneously is proving challenging. Reinforcing the Paris Agreement with an international carbon price floor (ICPF) could jump-start emissions reductions through substantive policy action, while circumventing emerging pressure for border carbon adjustments. The ICPF has two elements: (1) a small number of key large-emitting countries, and (2) the minimum carbon price each commits to implement. The arrangement can be pragmatically designed to accommodate equity considerations and emissions-equivalent alternatives to carbon pricing. The paper discusses the rationale for an ICPF, considers design issues, compares it with alternative global regimes, and quantifies its impacts.

Introduction

Global carbon dioxide (CO2) emissions, along with other greenhouse gases (GHGs), must be cut by around a quarter to a half by 2030 to be on track to stabilize the climate. With currently implemented policies, central case (post-pandemic) projections suggest global CO2 emissions will rise from around 30 billion tons in 2020 to 37 billion by 2030. Illustrative pathways suggest that containing warming to ‘well below’ 2°C and ideally towards 1.5°C above pre-industrial levels requires global CO2 emissions in 2030 to be limited to about 15 to 25 billion tons (Figure 1). Without these reductions, the likelihood of stabilizing the climate will decline rapidly, especially if there is lock-in of long-lived fossil fuel capital (for example, coal plants). Cutting emissions at this pace requires additional measures equivalent to a global carbon tax of around $75 per ton by 2030 (and rising further beyond 2030).

Figure 1.
Figure 1.

Global CO2 Projections and Pathways for Warming Targets

Citation: Staff Climate Notes 2021, 001; 10.5089/9781513583204.066.A001

Source: IMF staff estimates using UNEP (2020) & IEA (2020).Note: $25/50/75 carbon price floor is for China, US, India, EU, Canada, UK – conditional on achieving NDCs. Global $75 carbon tax starts at $15/ton, rising steadily from 2022 to 2030. Pathways assume energy-related national CO2 emissions are reduced in proportion to total greenhouse gas emissions. COVID = coronavirus; NDCs = nationally determined contributions.

Under the Paris Agreement countries are increasingly pledging emissions neutrality targets for midcentury… A total of 195 parties signed the Agreement and most submitted first-round mitigation pledges in their nationally determined contributions (NDCs), many to be met by 2030. Countries are now submitting revised pledges ahead of the Glasgow climate conference (COP26) in November 2021 as part of the first five-yearly iteration of the Agreement’s “ratchet mechanism.” As a result, countries are increasingly committing to long-term ‘net-zero’ emissions targets.1 To date, 59 countries accounting for 54 percent of global emissions have committed to net-zero emissions by midcentury, including Canada, the European Union, Japan, Korea, the United Kingdom, the United States (all 2050), and China (2060).2

…but there is a need to ratchet-up near-term climate ambition.. The Paris Agreement’s universal country participation is critical for its legitimacy. But ratcheting up ambition among 195 parties simultaneously is proving challenging. To date, 85 countries have submitted revised targets, but many do not entail substantial additional emissions reductions by 2030.3 Meanwhile, at a global level, revised commitments – even if fully implemented – remain insufficient to meet the Paris target of limiting warming to “well below 2°C” (Figure 1).

…and, crucially, there is a need to match near-term ambition with credible policy action. While most near-term country targets state the end goals in terms of national emissions levels by 2030, few provide detail on the means to achieve those reductions. Even if countries further tighten their 2030 pledges (by better aligning them with long-term emissions neutrality), there is no automatic mechanism ensuring targets are actually achieved— in fact, scaling up mitigation policy unilaterally can be extremely challenging given concerns about competitiveness and that other countries may not achieve their mitigation commitments.

An international carbon price floor (ICPF).4 offers a realistic prospect of catalyzing the needed global action in the next decade, and its success is in participants’ individual and collective interests. The ICPF has two key components: (1) it would be negotiated between a small number of key large emitting countries, and (2) negotiation would focus on the minimum carbon price that each must put on their CO2 emissions.5 Ratcheting up ambition among a smaller group of countries such as the large emitters would be more straightforward than a global agreement, and regional carbon price floors would also be a possibility. Concerns about other countries low-balling their ambition, failing to implement commitments, and the potential adverse impacts on competitiveness of domestic exporters from unilateral action would all be addressed. Negotiating based on minimum price levels would be transparent, and would focus policymakers on the means to achieve the emissions cuts required in this decade. All participants would be made better off by an effective agreement, as all would benefit from the collective action to address climate change. And an agreement among the major economies would strongly influence other countries to follow suit.

To make progress on the price floor, flexibility provisions are likely needed on pragmatic grounds to address equity concerns and potential obstacles to carbon pricing in some large emitters. Given their lower per capita income, smaller contribution to historical emissions, and generally higher emissions intensity of production, lower price floor requirements for emerging market economies (EMEs) may be appropriate and needed to encourage their participation. Provisions allowing for some inclusion of non-pricing approaches which yield equivalent emissions outcomes to pricing may also be needed to accommodate countries for whom, due to domestic political or other factors, standard carbon pricing instruments are difficult to implement or increase.

An ICPF would also likely circumvent pressure for unilateral border carbon adjustments (BCAs)… In the absence of internationally coordinated carbon pricing, jurisdictions moving ahead with aggressive carbon pricing may well impose BCAs (that is, charges for the embodied carbon in imports) on jurisdictions without adequate carbon pricing. BCAs are far less efficient and effective than price floors in achieving emissions reductions as they apply to only a small portion of a trading partner’s emissions.

…and the prospects for implementing a pragmatic ICPF may be better than those for alternative regimes to supplement the Paris Agreement, namely “pure” carbon pricing or annual country-level emission targets. A pure carbon pricing agreement—for example, one which specifies a single carbon price level implemented exclusively through explicit carbon pricing instruments—has fewer degrees of freedom for addressing international equity issues and precludes participation of countries where explicit carbon pricing is currently difficult to implement. Reaching agreement over country-level emissions targets is difficult because of the zero-sum nature of negotiating each individual target,6 is less aligned with the operating logic of the Paris Agreement,7 and entails more uncertainty over the specific policy actions countries will take.

The ICPF would complement rather than conflict with the existing Paris Agreement. The Agreement allows for “mini-lateral” agreements to augment ambition, since it was well-known by negotiators at the time of drafting that the then-intended nationally determined contributions were not sufficient for achieving the Agreement’s temperature goals. The focus on price floors, rather than price levels, accommodates countries needing to exceed the floor price to meet their Paris mitigation pledges. In effect, the ICPF and the Paris Agreement would reinforce one another, and other countries may follow the lead of the large emitters in setting up similar carbon price floor arrangements, such as regional schemes.

An ICPF could be especially timely, providing the basis for countries to “build back better” in a collaborative and coordinated fashion. The health and economic crisis precipitated by the COVID-19 pandemic has not obviated the urgent need for cutting global GHGs (Figure 1). Governments are scaling up investment plans to boost their economies while managing the risks of burgeoning fiscal deficits. In this context, it is important that fiscal policy reorients private investment towards the development, adoption, and diffusion of low-carbon technologies while maintaining fiscal space. Carbon pricing achieves both objectives, by simultaneously providing the essential price signal needed to foster private investment in clean technologies and mobilizing much-needed revenues, which are especially valuable in the aftermath of the pandemic.

However, to ensure the arrangement is effective and provides incentives for sustained participation among key parties, getting the design details right for an ICPF would be critical. This paper elaborates on the rationale for an ICPF, discusses the main design issues, compares the price floor with other international regimes for scaling up global mitigation, and assesses the global emissions implications of alternative ICPF designs.

Rationale for an ICPF

The main rationales for an ICPF are that it can (1) facilitate negotiation in a transparent manner and (2) scale up ambition and policy action by addressing key obstacles. These are described as follows.

Ease of Negotiating Policy Action

NUMBER OF PARTIES: Agreement over an ICPF may be more likely than a negotiated strengthening of near-term mitigation pledges for the Paris Agreement because far fewer parties are involved. The very large number of signatories to the Paris Agreement makes it very difficult to agree on both (1) a coordinated scaling up of mitigation pledges over the next decade, and (2) incentive mechanisms to encourage countries to comply with their pledges. In contrast, the ICPF would be limited to a small number of large emitters which could still cover the bulk of global emissions. For example (see Figure 2), China, India, and the US account for 57 percent of baseline CO2 emissions in 2030, and the Group of Twenty (G20) makes up 85 percent (including EU countries).8

Figure 2.
Figure 2.

Global Share of Baseline CO2 Emissions by Country and Region, 2030

Citation: Staff Climate Notes 2021, 001; 10.5089/9781513583204.066.A001

Source: IMF staff calculations.Note: Baseline refers to projected emissions without new, or tightening of existing, policies. G20 = Group of Twenty.

NUMBER OF PARAMETERS: The ICPF offers focused negotiation as it targets a shared price floor, which can be adjusted in response to new information, rather than country-specific parameters. Multilateral dialogue over scaling up ambition under the Paris Agreement is further hindered because (1) each party has their own mitigation pledge, and (2) the process for submitting revised pledges is uncoordinated and assessments of the global emissions implications can only occur after the submission process is largely completed. In contrast, a common emission floor price requirement improves the transparency of countries’ mitigation actions and limits the discussions to just one key parameter. Assessments of the emissions impact of different scenarios for ICPF participation and price levels can be done ahead of time (see the following) to inform dialogue over design specifics. Provisions for discretionary adjustment of price floors if collective emissions are not on track to meet objectives can be included. Pragmatic considerations—notably equity issues—likely require some deviation from a pure price floor however (see below).

TYPE OF PARAMETERS: Negotiation for an ICPF is also facilitated by focusing on a transparent and efficient policy action, the price floor. It is widely accepted that carbon pricing is the most efficient mitigation instrument—it cost-effectively provides across-the-board incentives to reduce energy use and shift to cleaner fuels as well as establishing the essential price signal for redirecting new investment to clean technologies. Indeed, there appears to be global momentum for carbon pricing with, for example, over 60 pricing schemes now implemented at regional, national, and subnational level, major pricing initiatives launched in China and Germany in 2021, and rising prices in the EU Emission Trading System (ETS).9—global coordination over pricing is needed, however, given the global average price is still only $3 per ton.10 In contrast, NDCs under the Paris process focus on targets that are heterogeneous, therefore making pledged ambition difficult to compare across countries.11 This also leaves large uncertainties over the specific policy actions countries will take to implement their mitigation pledges, reducing the credibility of the pledges.

Addressing Obstacles to Scaling Up Policy Action

CONCERNS OTHER COUNTRIES WILL LOWBALL OR RENEGE ON THEIR COMMITMENTS: The coordinated approach under an ICPF, with countries agreeing on ambition and acting simultaneously on the needed policies, helps to address concerns that deter stronger unilateral ambition and policy actions. Countries acting unilaterally under the Paris process may be reluctant to pledge greater mitigation ambition, and scale up mitigation policies, as they would bear the costs while the global climate benefits of their actions mostly accrue to other countries. A “minilateral” approach, where a smaller group of countries agree on the global goal and act simultaneously on the pricing to achieve it, helps to address these concerns—even if a country does not see it as being in its own unilateral interest to adopt a carbon price, it can still be far better off due to the collective benefits if all relevant countries adopt the same price.12 In fact, country participants may support robust floor prices as this leads to bigger emissions reductions for all participants and bigger benefits for all—this is the key incentive to join the agreement. The ICPF may also encourage nonparticipants, and participants for whom the minimum price is not binding (because they implement a higher price to meet their NDCs), to strengthen their mitigation actions.

COMPETITIVENESS (CONCERN ABOUT RELATIVE COST OF DOMESTIC/FOREIGN GOODS): An ICPF can neutralize the effect of carbon pricing on the relative cost of domestic and foreign goods and head off the prospect of unilaterally imposed BCAs. As countries move towards higher emissions prices and deeper decarbonization, other measures—for example, free allowance allocations in the EU and Korean emissions trading systems (ETSs)—for addressing competitiveness impacts on energy-intensive, trade-exposed (EITE) industries will become less effective.13 A system of unilaterally imposed BCAs would be highly inefficient in the sense that: (1) BCAs would be restricted to emissions embodied in exports from EITE (or perhaps some broader group of) industries, whose emissions are typically around 2 to 10 percent of domestic CO2.14; and (2) multiple BCA regimes emerging unilaterally may lead to a proliferation of different prices on a country’s exports depending on their trading partners. On the other hand, if a unilateral regime of BCAs does emerge, it may catalyze interest in a more comprehensive and uniform international pricing regime.

INTERNATIONAL EQUITY: International equity concerns can be addressed in a transparent manner under an ICPF. Scaling up action in large EMEs (with high dependence on coal) is critical; however, under the Paris process: (1) these countries have differentiated, but unspecified, responsibilities and (2) financial compensation mechanisms for their mitigation effort are opaque.15 An ICPF could be designed with this international equity principle in mind, for example, through higher price floor requirements for higher-income countries and/or a simple transfer mechanism to lower-income members of the ICPF.

DOMESTIC DIFFICULTY OF CARBON PRICING: International coordination on carbon pricing might reduce domestic opposition (for example, from industry), but realistically some accommodation for countries where pricing remains difficult is likely needed. Carbon pricing is potentially more difficult when countries are acting unilaterally due to competitiveness concerns. But even when major trading partners simultaneously scale up pricing, the acceptability of higher energy prices at home may be constrained by, for example, opposition from household and industry groups. Further flexibility to accommodate non-pricing approaches with emissions-equivalent outcomes may therefore be needed (see below).

Design Issues for an ICPF and Comparisons with Alternative Regimes

There are several major design issues that would need to be considered for an ICPF. These include country participants, emissions coverage, floor price levels, possible differentiated pricing, compensation payments or other inducements to join, allowable instruments for meeting requirements, and compliance monitoring.16 The following discussion takes each in turn, recommending a pragmatic design for the ICPF, and then briefly compares this with a pure pricing regime and annual country-specific emissions targets.

Key Design Issues

PARTICIPANTS: It makes sense to simplify negotiations by limiting the initial setup of the agreement to a core group of large emitting countries. For example, potential participants might include China, the European Union, India, the United States, and other G20 members with ambitious pricing already in place, like Canada and the United Kingdom. Procedures for allowing others to subsequently join the agreement should be established, but without compromising the decision-making capability of the core group.

EMISSIONS COVERAGE: Starting with a narrower emissions focus may facilitate accomplishing the initial steps. At first, the ICPF requirement might apply to fossil fuel CO2 emissions from the power/district heating and industrial sectors because (1) fossil fuel CO2 emissions are consistently monitored,17 (2) they are generally the most responsive emissions to pricing and therefore play the key role in the early stages of clean energy transitions,18 (3) most ETSs are currently limited to these sectors, and (4) fuels in these sectors are largely untaxed (or generally subject to minimal excises in terms of CO2 equivalent taxes).19. Progressively, the ICPF might then be extended to all fossil fuel CO2 emissions (about two-thirds of global GHGs) though an issue becomes how to treat preexisting transportation fuel taxes (see below). Eventually, the arrangement could cover broader emissions sources (for example, from industrial processes, methane leaks from fuel extraction and distribution, and forestry) as capacity for monitoring and pricing these emissions evolves.20

FLOOR PRICE LEVELS: In principle, floor prices should be set to align aggregate emissions from ICPF participants with global temperature objectives (see the following). Participants would meet whichever is the more stringent of the price requirement or their Paris mitigation pledge. In practice, these prices will emerge from dialogue among ICPF participants and may not be fully consistent with temperature objectives— nonetheless, an ICPF that closed much of the current 2030 emissions gap would be a major step forward.

COMMON VERSUS DIFFERENTIATED PRICING: The possibility of differentiated minimum prices for advanced and nonadvanced countries should also be part of the dialogue to help address international equity issues. The price floor is designed to scale up action in key countries that currently have relatively lax pledges while, in principle, a common price may not bind for countries already implementing aggressive pledges (see Annex 1). This suggests that multiple price minima might be specified, according to accepted conventions for the level of country development, to promote a more even distribution of burdens across countries (though the trade-off would be some loss in economic efficiency from a global perspective). Moreover, the emissions intensity of industrial production in large EMEs is generally greater than advanced countries,21 which reinforces the pragmatic case for differentiated pricing to ease transitions for these countries.

COMPENSATION OR OTHER MECHANISMS FOR PROMOTING PARTICIPATION: As part of the ICPF, a transparent fiscal transfer system could be set up to compensate developing member countries. International transfers of some sort—financial or technological assistance, or perhaps a “grand bargain” with enhanced overseas development aid, and transfers of other (nonenvironmental) technologies—might be needed to induce participation of lower-income EMEs. For illustration, one possibility might be an annual fund allocated to these countries in proportion to their share of emissions in total emissions among lower-income ICPF participants in a recent year. A fund of, say, $10 billion a year would be equivalent to about 1 percent of the revenues from a $50 price on G20 carbon emissions.22 In principle, a BCA exempting trade among ICPF participants might be used as an enforcement mechanism. In practice, however, the incentives for participation from this mechanism may be limited (as noted, carbon embodied in traded goods is a modest share of domestic emissions) and its design complicates negotiations over establishing an ICPF.

ALLOWABLE MITIGATION INSTRUMENTS: A carbon price could best be met through a carbon tax (a charge on the carbon content of fossil fuels) but an ETS (where firms acquire allowances to cover their emissions subject to a cap on total allowances) is readily accommodated. In the latter case, emissions prices are uncertain but this can be addressed through: (1) combining an ETS with price stability mechanisms (for example, requiring allowances to be auctioned at a minimum price) or (2) setting the allowance cap so that the expected emissions price is equal to the floor price. A good prototype is Canada where the federal government sets the needed carbon price (rising progressively from CAN$10 per ton of CO2 in 2018 to $50 in 2022 and $170 in 2030) and provinces and territories have the flexibility to meet it through taxes or ETSs.23

The political acceptability of carbon pricing differs across countries, however, and needs to be accommodated. For example, policymakers may be reluctant to significantly increase energy prices if this is politically sensitive, their energy prices are already on the high side relative to those in competitor countries, or it runs counter to expanding greater energy access to poor households. An ICPF could be designed flexibly to accommodate different policy approaches at the national level, as long as these approaches have equivalent emissions impacts as meeting the price floor (perhaps subject to third-party verification). Keeping the ICPF simple and transparent suggests this flexibility provision should ideally be the exception rather than the rule.

MEASURING COMPLIANCE: Prices in existing carbon tax and ETS schemes are readily available.24 and could be the focus in the early stages of the agreement, especially if it is confined to power and industry emissions. It would make sense to compare existing prices to a benchmark with zero pricing for transparency and to avoid penalizing countries that have already implemented aggressive pricing.

As the ICPF is extended to cover other sources of fossil fuel CO2 emissions, measuring effective carbon pricing may become an issue. Agreement may be needed on how to account for preexisting transportation fuel taxes and for the possibility that countries may exempt certain fuels/sectors (for example, due to political sensitivities).25 To ensure comparability of effort, the ICPF might focus on countries’ “effective” carbon prices. These can be calculated by: (1) expressing existing fuel taxes on a CO2-equivalent basis (that is, dividing the fuel tax rate by CO2 emissions per unit of fuel use); (2) weighting CO2-equivalent fuel taxes and explicit carbon pricing schemes by their relative effectiveness at reducing economy-wide CO2 emissions compared with a comprehensive carbon price; and (3) aggregating across these tax and pricing systems.26

There is little basis on economic efficiency grounds for equating effective carbon prices since these vary considerably across countries. For example, pre-existing transport fuel taxes may have been set accounting for domestic environmental problems (for example, local air pollution, congestion), revenue needs, and risks of diverting fuel purchases to neighboring countries—factors which are highly country-specific. Rather than equalizing effective carbon prices, the ICPF might instead focus on a required absolute increase in countries’ effective carbon prices relative to effective prices in a benchmark year. This would allow countries flexibility in meeting the requirement (for example, through extending coverage of emissions pricing, raising preexisting fuel excises) but prevent relabeling of fuel taxes imposed for other reasons as carbon taxes. Benchmark prices might be defined excluding explicit carbon pricing schemes again to avoid penalizing those who have already acted.27 Debate over measuring effective carbon prices should not hold up the establishment of the ICPF, hence the suggestion to initially consider observed emissions prices for power/industry.

Comparison with Other Global Regimes

In terms of facilitating negotiation, a ‘pure’ carbon price floor and the pragmatic approach outlined previously may be similar, but a pure carbon price floor has fewer degrees of freedom for addressing equity and competitiveness concerns and does not accommodate countries where pricing is difficult. Under the pure pricing scheme with advanced economies and EMEs subject to the same price floor, equity issues can only be addressed through transfer mechanisms and there is no scope for offsetting the relatively larger impacts of pricing on the competitiveness of EMEs. Moreover, the approach provides no accommodation for countries facing severe domestic (political or other) obstacles to carbon pricing.

Annual emissions targets have more scope for addressing equity/competitiveness concerns than a pure pricing regime, and they accommodate different policy approaches, but they are more difficult to negotiate than (pure or pragmatic) pricing regimes and they leave less certainty about concrete policy actions. Allocating a global emissions target across large emitting countries is a zero-sum game—individual countries may have an incentive to claim they are a special case and need a more generous emissions target but this will simply pass some of the burden of mitigation from them onto others. Moreover, the focus on emissions targets leaves more uncertainty about concrete policy actions countries will take, potentially implying a greater need for enforcement mechanisms, for which agreement is difficult to reach. Table 1 provides a summary comparison of the pragmatic pricing regime emphasized here with the alternative regimes in terms of their effectiveness at addressing obstacles to scaling up mitigation action under the Paris Agreement.

Table 1.

Comparing Regimes for Scaling up Global Mitigation Policy by 2030

article image
Source: IMF staff calculations.Note: Red = a problem, green addresses, amber largely addresses, and brown partially addresses the problem. BCA= border carbon adjustment. EME= emerging market economy.

Emission Impacts of Alternative Pricing Scenarios

This section illustrates the emissions impacts of alternative scenarios for country participation and price levels in an ICPF, focusing on global fossil fuel CO2 emissions and a snapshot for 2030. Scenarios are compared with a baseline projection with no new, or tightening of existing, mitigation policies. Annex 2 describes the modeling framework underpinning the quantitative analyses (in this section and elsewhere in the paper) and caveats—the basic framework involves projecting sectoral emissions at the country level and using assumptions about the price responsiveness of fuel use to infer the emissions impacts of carbon pricing.

Table 2 indicates emissions reductions if countries meet their Paris pledges and either just six parties to the Paris Agreement (China, India, the US, EU, UK and Canada) also participate in an ICPF or all G20 countries do. Scenarios are considered where advanced/EME countries are subject to price floors of $50 per ton each, or $75, $50, and $25 for advanced, high-income EME (for example, China), and low-income EME (for example, India) countries, respectively.28 Annex 3 illustrates how a $50 carbon price would affect energy prices in G20 countries in 2030; coal prices are affected most dramatically though coal is largely an intermediate product—impacts on natural gas, electricity, and retail gasoline prices are smaller but can still be large in some cases. Outcomes are compared with central case estimates of emissions reductions needed for warming targets.

Table 2.

Global CO2 Outcomes under Alternative ICPF Scenarios

article image
Source: NDCs from June 2, 2021; and IMF staff calculations.Note: G20 – Group of Twenty; GHGs – greenhouse gases; NDC – nationally determined contributions.

Assumes energy-related national CO2 emissions need to reduce in proportion to total GHGs.

Higher/middle/lower price for advanced/high income emerging market/low income emerging market economies.

Existing NDCs remains insufficient for achieving the Paris Agreement’s temperature targets. Just to reach the top of the 1.5–2°C range requires global emissions cuts of at least 21 percent by 2030 compared with “business as usual” (lightest green area in Figure 1). Current NDCs would fall short—even if all G20 countries achieved their pledges emissions reductions would be just 14 percent below baseline levels.

Reinforcing NDCs with an ICPF – either with a single or differentiated price – would cut emissions sufficiently to enter the upper end of the range for 2°C, even when only the six economies participate. Either a pure $50 carbon price floor for all six countries or a differentiated price floor of $25, $50, and $75 depending on development levels would reduce energy-related CO2 emissions 23–24 percent compared with business-as-usual. Extending the ICPF to other G20 countries causes a modest further increase in G20 abatement. In short, participation in the ICPF by six major economies would greatly enhance the Paris Agreement’s effectiveness.

Under a $25/50/75 price floor emissions reductions compared with baseline vary somewhat with development and pricing levels (Figure 3). Among advanced economies, US and Canada have slightly higher emissions reductions (25 and 24 percent) than EU and UK (21 and 14 percent). This reflects the former’s larger carbon intensity of GDP and emissions responsiveness to prices. China and India have larger price responsiveness in general than AEs, but China has larger emissions cuts compared with business-as-usual (27 percent) than India (13 percent), reflecting the differentiated responsibilities that this regime would allow for. Additionally, only India’s emissions rise in absolute terms (by 21 percent, compared to 9 to 30 percent reductions in other countries), reflecting its lower historical contribution and current per capita emissions.

Figure 3.
Figure 3.

Emission Reductions Under Alternative Carbon Prices, 2030

Citation: Staff Climate Notes 2021, 001; 10.5089/9781513583204.066.A001

Source: IMF staff calculations. Carbon prices are in addition to any existing policies.

Conclusion

The Paris Agreement is a landmark achievement in international cooperation. It has focused policymakers on the need for comprehensive emissions cuts in all countries, including through achieving net-zero emissions by midcentury. But the critical challenge today is scaling up ambition and policy action sufficiently to cut emissions by one quarter to one half in this decade. Even if current 2030 pledges were achieved then global emissions reductions would still fall far short of those needed to keep open the possibility of limiting future warming to below 2°C. This paper argues that an additional mechanism, an ICPF, is needed to complement and reinforce the Paris Agreement. Precedents for this type of international cooperation include tax floors for indirect taxes in the European Union and the Organisation for Economic Co-operation and Development/G20 Inclusive Framework on Base Erosion and Profit Shifting under which over 135 countries are collaborating to put an end to tax avoidance strategies.29

The paper suggests the following key ingredients might enhance the prospects for a successful ICPF agreement:

  • Limiting the initial arrangement to a core group of high-emitting countries (though allowing others to join once design specifics and decision-making processes have been established among the core countries);

  • Focusing the agreement on a common price floor for all participants (rather than, for example, a separate emissions target for each participant);

  • Allowing, however, differentiation in price floors according to level of development, and perhaps financial or other transfers, to address international equity;

  • Allowing provisions for countries to meet requirements through non-pricing policies with equivalent emissions impacts as the price floor;

  • Requiring, initially, carbon pricing for the power and industrial sectors, with progressive extension to other fossil fuel CO2 emissions and broader sources of GHGs; and

  • Focusing the agreement on nominal (easily observed) carbon prices initially, but perhaps transitioning to a focus on effective carbon prices (as monitoring procedures are agreed).

The type of price floor arrangement proposed here could also be implemented at the regional level. For example, several countries in the Latin American region have implemented carbon taxes but at modest levels (for example, Argentina, Chile, Colombia, Mexico) and several countries in the Asia and Pacific region have implemented, or are considering, carbon pricing (for example, China, Japan, Korea, Philippines, Singapore, Vietnam). Regional carbon price floor arrangements could facilitate a scaling up of these country-level initiatives and provide valuable experience for developing a global price floor arrangement.

Proposal for an International Carbon Price Floor Among Large Emitters
Author: Ian Parry, Mr. Simon Black, and Mr. James Roaf