Estimating the CO2 emission and revenue effects of carbon pricing

Abstract

This paper estimates the long-run elasticity of emissions and carbon-related government revenues to carbon pricing. It is based on the OECD Effective Carbon Rates database, the most comprehensive cross-country longitudinal database on direct and indirect carbon pricing. Econometric estimates suggest that a EUR 10 increase in carbon pricing decreases CO2 emissions from fossil fuels by 3.7% on average in the long term. In such a scenario, carbon-related government revenues would triple at global level, though over time they are expected to dwindle as additional increases in carbon pricing result in further reductions in emissions. Broadening carbon pricing to currently unpriced emissions contributes to two thirds of the effects on emissions and revenues. At the country level, emissions and government revenues responses differ depending on countries’ sectoral structure and fuel sources. Dynamic simulations based on these estimates reveal that even large effective carbon rates (about EUR 1000 per tonne by late 2030s) will not suffice to meet net-zero emission targets. A sensitivity analysis shows that this result is robust to a large range of elasticity estimates. Reaching net zero then calls for complementary policies aiming at broadening and raising carbon prices, and drastically increasing the substitution of clean energy sources for fossil fuels through innovation and reallocation.

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