CLIMATE AND CARBON ALIGNING PRICES AND POLICIESClimate and carbon Aligning prices and policiesClimate and carbon Aligning prices and policies2Key messages 41. Global action on climate change72. A coherent approach to carbon pricing93. Explicit carbon pricing: Carbon taxes and emissions trading systems114. Implicit carbon pricing: Energy taxes and regulatory standards235. Comparing explicit and implicit carbon pricing policies306. Interactions between policy instruments357. Reforming subsidies to fossil fuels368. Overcoming barriers to coherent carbon pricing41References 49ContentsThe global objective of limiting the average global temperature increase to no more than 2C above pre-industrial levels can only be achieved if countries worldwide take on the responsibility to gradually phase out their emissions of CO2in the second half of this century. This transition will depend on the clarity and consistency of the policy signals that governments provide to consumers, producers and investors alike. If governments are serious in their fight against climate change, the core message of this reform must be that the cost of CO2emissions will gradually increase, creating a strong economic incentive to reduce the carbon entanglement and to shift towards a zero carbon trajectory. A central feature of such an approach is placing a price on carbon. Governments must look across the entire portfolio of policy measures that put a price on carbon and assess if they are effective in reducing CO2emissions and are consistent with their climate change objectives. Without a clear policy signal that there is a rising cost of CO2 emissions over time, there will be little incentive for societies to undertake the needed shift away from fossil fuels. Moreover, it is crucial that the pricing mechanisms that are in place are credible, stable and sustainable over time in order to inspire the confidence to invest in the technologies and infrastructure needed to make a fundamental change. It is also important that carbon pricing policies are consistent with policies to address emissions from other greenhouse gases.In moving the carbon pricing agenda forward, governments must address the following key issues:Put an explicit price on carbon. Explicit carbon pricing mechanisms, such as carbon taxes and emissions trading systems, are generally more cost-effective than most alternative policy options in creating the incentive for economies to transition towards zero carbon trajectories. The use of these mechanisms is expanding in developed, emerging and developing economies, but there is considerable scope for further uptake by governments. Overcoming political opposition to putting an explicit price on carbon will often require close attention to the distributional and competitiveness implications on the domestic economy.Identify other cost-effective policy instruments that put an implicit price on carbon. A number of other policies affect a countrys CO2emissions and can effectively place an implicit price on carbon. Often these policies have been introduced to achieve objectivesKey messagesother than climate-related goals (such as combatting air pollution or raising revenue), with the result that the CO2emissions abatement achieved may come at a relatively high cost. It is, therefore, paramount that the cost-effectiveness of these policies be carefully assessed and maximised. This calls for a clear understanding of what an optimal policy package should look like, given each countrys economic and social context, and how far away current policies are from this package. In bridging the gap, governments should undertake an inventory of policies that explicitly and implicitly price carbon, and assess the impact of the policies and their interactions in order to ensure that they are mutually supportive in achieving CO2reductions as well as other social and economic objectives.Review the broader fiscal policy to ensure that it is coherent with stated climate goals. Coherent carbon pricing should also include a review of the countrys fiscal policy to ensure that budgetary transfers and tax expenditures do not, directly or indirectly, encourage the production and use of fossil fuels. In OECD countries, such support is less likely to come in the form of direct subsidies for fossil fuels and often takes the form of reductions in, or exemptions from, energy taxes. Coherent carbon pricing must include a reform of such support mechanisms in all countries to “level the playing field” for low-carbon technologies. Ensure that any regressive impacts of carbon pricing measures are alleviated through complementary measures and a clear communication strategy is developed to explain them. In order to ensure public acceptance of carbon pricing, any carbon reform agenda must be accompanied by a clear communication strategy. This should not only outline the rationale of the reform process, but also make it explicit how revenues will be use