Carbon pricing instruments to address socio-environmental externalities and enhance compliance with national mitigation commitments
Carbon pricing instruments together with additional actions and policies are effective mechanisms to support national GHG emission reduction commitments by addressing social and environmental costs and sending clear political and economic signals to the market to stimulate cost-effective decarbonization. Through the Chile Carbon Price project, the country is evaluating options, scenarios and concrete proposals to build a more complete system of carbon price instruments in the future.
According to data provided by the World Bank, between 2012 and 2015 the number of countries that have implemented carbon pricing instruments increased by 90%, while tax structures and emissions trading systems were applied by 40 governments and more than 20 sub-national jurisdictions by the end of 2015, covering 4.3% and 8.8% of total greenhouse gas emissions, respectively.
What is the carbon price?
What is the carbon price?
- Carbon pricing is the way in which countries and markets set a monetary value for CO2 and other GHG emissions.
- The price of carbon contributes, in a more flexible way and with lower costs for society, to the cost-effective reduction of GHG emissions and becomes one of the most powerful incentives that governments can use to achieve climate change mitigation policies. It also promotes the use of alternative energies and technological investment to reduce emissions, promoting new engines for more sustainable and low-carbon economic growth.
Advantages of carbon price instruments
Advantages of carbon price instruments
- They contribute to the reduction of GHG emissions, supporting national efforts to mitigate climate change.
- In line with ‘the polluter pays’ principle, they encourage companies and individuals to reduce their consumption and increase their energy efficiency by encouraging the use of non-conventional renewable energies and investment in emissions-reduction technologies.
- They improve energy security and independence by increasing competitiveness on fuel replacement and reducing dependence on fossil fuels.
- They promote innovation among companies to generate research and development projects in the field of technologies for emissions reduction.
- They contribute to public health due to improved air quality as a result of reduced emissions.
- They facilitate public investment to finance social and climate programs.
This instrument directly sets a price on carbon, defining a rate on greenhouse gas emissions or on the CO2 content of fossil fuels. Unlike other instruments, the tax does not predefine the outcome of emission reductions.
(More information in the FAQ section).
Emission Trading Permit Systems (ets)
Emission trading permit systems (ets)
The emission trading permit system (ETS) is a market-based instrument designed to reduce GHG emissions. Governments or jurisdictions that use them determine a ceiling (cap) on total emissions in one or more sectors of the economy. The companies involved must have permits for each metric ton emitted into the atmosphere. These permits can be traded (trade or commerce), generating supply and demand for emission permits among market players, hence greater flexibility in terms of time and formulas to reduce emissions.
Advantages of an Emission Trading Permit System
- Establishes a strict limit on emissions.
- It provides flexibility for companies to decide how to reduce their emissions.
- It adapts to different economic and political contexts.
- If governments decide to auction off permits, it would generate fiscal revenue that can be reinvested in other climate action programs or to compensate low-income households.
- It favors co-benefits in environmental, economic and social matters. These include improved air quality, resource efficiency, energy security and job creation.
- Allows connections in order to create larger and more efficient markets.
(More information in the FAQ section).
An offset is a measure and/or an action taken to reduce or absorb GHG emissions that makes it possible to reduce emissions in other countries or sectors when the originating countries or sectors are unable to make reductions using carbon credits measured in tons of equivalent carbon dioxide.
The most common offset systems are those from renewable energy projects and the forest sector, which follow a full set of validation and verification procedures to demonstrate that they are reducing emissions. Therefore, they are regularly monitored by independent third parties.
An important example of offset is the UNFCCC’s Clean Development Mechanism (CDM), the main global certification standard for projects that have resulted in or are producing emission reductions. Chile was a major player in Latin America in the use of this mechanism, with 102 projects registered by 2016, 77 of them in non-conventional renewable energy.
Advantages of offsets
- They allow governments and companies to offset their environmental impact in other sectors, support the fulfilment of their emission reduction targets and contribute to national climate change mitigation policies.
- By purchasing carbon credits to offset their emissions, companies provide essential financing for renewable energy, forest protection and reforestation, forestry and biodiversity projects that would otherwise not be economically viable.
- Many of these projects also bring additional sustainable impacts to local communities and the environment, such as job creation, improved health and well-being and protection of biodiversity.
Green taxes in chile
What are green taxes?
Green taxes are a type of environmental management instrument that tax carbon and other harmful gas emissions. It creates an economic incentive to reduce these emissions, as companies try to reduce their tax burden through process improvement, fuel switching or technological innovation.
Green taxes are based on the principle of economic efficiency. Production processes that create many emissions pass on the costs of pollution to the entire society that suffers the effects. Introducing a tax based on the damage generated by externalities not only allows society to be compensated for the costs of emissions, but also provides an incentive for companies to reduce their emissions.
To this end, they explicitly set a price on carbon and other polluting gases or use a metric (i.e., the price per ton of CO2) to internalize the social and environmental costs generated by the pollution produced by different activities, such as energy, industry, mining, transport, agriculture, livestock, forestry, waste, and others.
What green taxes exist in Chile?
Currently, Chile has three new taxes on emissions from mobile and fixed sources, which were included in the Tax Reform approved in Law 20.780 of 2014.
The first applies to the initial sale of light vehicles, according to their urban performance and nitrogen oxide (NOx) emissions. The second applies to fixed sources and taxes the emissions of local pollutants NOx, particulate matter (PM), and sulfur dioxide (SO2) into the atmosphere, which directly affect the communities surrounding the places where they are emitted. The third is a direct tax on the emission of carbon dioxide (CO2), the main global pollutant and is responsible for climate change. It is applied to the same fixed sources as the others.
Why such taxes should be implemented in Chile?
Based on ‘the polluter pays’ principle, these taxes make it possible to regulate the activity of the productive sectors that emit the most as a result of consuming fossil fuels and other GHG emitting activities.
Thus, a price instrument like taxation has a role to play in reducing GHG emissions in the context of meeting national climate change mitigation commitments under the Paris Agreement and national climate policies.
Who is subject to these taxes?
For fixed sources, the law considers those establishments that use boilers or turbines with a rating of 50 MW or more, considering the upper limit of the fuel’s energy value.
The Ministry of the Environment shall annually publish a list of establishments whose installations comply with these conditions and shall keep a register of boilers and turbines to be declared through the Single Window System of the Pollutant Release and Transfer Register (PRTR).
The authority has drawn up an annual publication list with the establishments involved, which produce around 40% of the total CO2 equivalent emissions.
The measure targets emissions from burning of fossil fuels in the processes of these facilities that emit both global and local pollutants. Most of these taxes fall on the electricity generation sector, which still has a high consumption of fossil fuels, but will also tax emissions from establishments belonging to other productive sectors, such as agriculture, fisheries and food.
In the case of mobile sources, the tax is applied to less efficient vehicles and those that generate higher emissions of toxic gases and precursors of particulate matter (PM) formation, a local pollutant that affects human health.
Green taxes will not apply to emissions based on those non-conventional renewable energy sources whose primary source of energy is biomass.
How are green taxes implemented?
Green taxes entered into force on January 1st 2017, while its Regulation was published in the Official Journal on 30 December 2016.
The Superintendency of the Environment (SMA) is responsible for establishing the methodologies and systems for monitoring, reporting and verifying tax-impacted emissions. The value for the carbon tax was set at USD 5 per ton emitted. For local pollutants a formula has been defined for its calculation, which includes factors such as the social cost and the population affected by a fixed source subject to the tax. Subsequently, the consolidated information shall be reported to the Internal Revenue Service (SII).
Lastly, the payment is made in April of each calendar year following the emission generation to the General Treasury of the Republic.
How are pollutant emissions affected by taxes monitored, reported and verified?
The implementation of green taxes is subject to the design and application of a Monitoring, Reporting and Verification System (MRV) that allows for the support and validation of the information associated with the emissions affected by the tax. The MRV system is being designed jointly by the Ministry of the Environment and the Superintendency of the Environment with support from the Carbon Price Project.
The MRV system is expressed in methodologies, protocols and guidelines that establish the what, who, how and when the taxed emissions are monitored, reported and verified. Since its inception, this system has contemplated a potential expansion of the range of carbon price instruments.
Co-benefits of Green taxes
- Create an institutional framework for the implementation of new public policy instruments.
- Contribute to the reduction of GHG emissions and the achievement of national climate change mitigation targets under the Paris Agreement.
- Create the need for market actors to monitor their emissions.
- Recognize the impact of emissions on people’s health and contribute to the reduction of their effects at the local level, especially when considering particulate matter.
- Evidence of the social cost of environmental damage.
- Reducing pollution in saturated districts and supporting compliance with decontamination plans.
- Reduce dependence on fossil fuels imports in Chile, enhancing the country’s energy security.
- Stimulate innovation and technology transfer by encouraging relevant organizations to modernize their facilities to consume efficient, clean energy.
- Encourage companies, public institutions and individuals to reduce their consumption and increase their energy efficiency, stimulating the use of alternative energies and investment in technologies that reduce emissions.
- To promote Non-Conventional Renewable Energies (NCRE).
- To install environmental policy principles in economic activities, encouraging efficient and environmentally responsible production.
- Contribute to the financing of social policies.
Keys to green taxes
- With the entry into force of green taxes, Chile has become a pioneer in the use of price instruments for greenhouse gas mitigation, contributing to national climate change mitigation commitments.
- Green taxes, established in the Tax Reform, are an environmental management tool that allows supporting the reduction of global and local pollution, counteracting environmental externalities and contributing to the advancement of better environmental quality for the development of society.
- Green taxes have several associated co-benefits, such as public health, greater efficiency of pollution controls, incentives for innovation and technology transfer, and others.
- The Monitoring, Reporting and Verification (MRV) system opens an opportunity to identify institutional and regulatory gaps and to better understand emission sources at the national level. It also proposes learning from international experiences and opens a space for cross-sector and citizen dialogue.
Clean Development Mechanism
With regard to Chile’s experience in carbon markets, the use of the Clean Development Mechanism (CDM) introduced by the Kyoto Protocol, together with other “flexible” mechanisms, should be noted. In this context, the development of CDM projects in various UNFCCC sectoral areas, such as afforestation, energy efficiency, fuel switching, NCRE projects, landfill methane capture, methane leak prevention and nitrous oxide reduction projects, has been promoted from the outset.
By early 2016, more than 100 projects had been registered, for a total emission reduction of approximately 11,570,000 tCO2/year. Of this total, more than 70 registered projects are non-conventional renewable energy projects (NCRE), equivalent to the displacement in the interconnected carbon-intensive generation systems to the approximate order of 3.3 GWh by clean and renewable energy (wind, biomass, solar, mini-hydro and run-of-river plants).
As the CDM is currently showing signs of declining international impact, the Chilean private sector involved in the development of CDM projects in the past has expressed concern about the future of their efforts in the area of CERs under the CDM. Many of these project developers in Chile have expressed their disappointment with the CDM’s evolution (e.g. low prices, substantial decline in demand for CERs with the consequent disincentive to continue investing in cleaner technologies, and lack of clarity on the part of the authorities). They are therefore skeptical about possible developments in this and other similar mechanisms in Chile and more generally.
As a way forward, especially now that Chile is facing the implementation of a carbon tax (where they have expressed concern because it does not consider the use of offsets in the original design), the private sector has systematically proposed that the CERs available be included in a combined tax and offset scheme, thus facilitating compliance with this national regulation.
Keys to carbon price instruments
Keys to carbon price instruments
- Chile is exploring new ways to support emission reductions. Carbon price instruments are part of this quest, as they address socio-environmental externalities and contribute to sustainable development and low carbon growth.
- Carbon pricing instruments are effective mechanisms for achieving national GHG emission reduction commitments.
- Carbon price instruments can be classified into three types: (a) carbon taxes, (b) emission trading permits system, and (c) offsets.
- Carbon pricing instruments provide several co-benefits, such as incentives for innovation and technology transfer, promotion of non-conventional renewable energies, energy security, improvement of public health, public investment in social and climate programs, and others.