Carbon pricing: carbon taxes, cap-and-trade and baseline-and-credit
Intuition
When a company emits greenhouse gases, the damage falls on everyone, but the company does not pay for it. Economists call this an externality. Carbon pricing fixes it by putting a price on each tonne of emissions, so that polluting costs money and cutting emissions saves money.
There are three main ways to do this. A carbon tax sets the price and lets the market decide how much emissions fall. A cap-and-trade system sets the total amount of emissions and lets the market decide the price. A baseline-and-credit system sets a benchmark for each plant and lets plants trade credits depending on whether they beat it or miss it. India's Carbon Credit Trading Scheme is a baseline-and-credit system.
For analysts, the design matters as much as the price. The same carbon price can cost a company very different amounts under different designs.
Mechanics
The three main designs
| Design | What is fixed | What the company pays | Examples |
|---|---|---|---|
| Carbon tax | The price per tonne | Tax on every tonne emitted (or on the carbon in fuels) | Taxes in several European countries, Singapore, Canada's fuel charge (now removed for consumers) |
| Cap-and-trade (emissions trading) | The total number of allowances | Must hold one allowance per tonne emitted; buys extra if short, sells if long | EU Emissions Trading System, UK ETS, California |
| Baseline-and-credit | An emissions benchmark per unit of output, per plant | Buys credits only for the shortfall against the benchmark; earns credits for beating it | India's CCTS, India's earlier PAT scheme (on energy) |
The global picture
According to the World Bank's 2026 report on carbon pricing, 87 carbon pricing instruments were in operation, covering just over 29% of global greenhouse gas emissions. They raised more than $107 billion for governments in 2025. The average carbon price was nearly $21 per tonne, but prices vary widely. The EU's price is among the highest: the first official CBAM certificate price, which tracks EU ETS auction prices, was €75.36 per tonne for the first quarter of 2026.
Other ways carbon gets priced
- Fuel taxes: taxes on petrol, diesel and coal act as implicit carbon prices
- Internal carbon prices: companies set their own shadow price to test investments
- Border adjustments: the EU's CBAM charges importers for the carbon in certain goods
Sources
From the research
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