Re-air and update: Carbon pricing

Madison Goldberg: Hey, welcome to Ask MIT Climate! I’m your host, Madison Goldberg.

So, later this month, we’re bringing you a new episode on how economists try to gauge the cost of climate change in dollars and cents.

Why would you want to figure that out? Well, one reason could be that you’re trying to put a price on climate pollution, as a way of nudging people and companies to emit less of it.

Today, we’re bringing back an episode from 2019 that explores these pricing policies. Our founding host, Laur Hesse Fisher, spoke with professor Christopher Knittel—who, by the way, now directs MIT’s Climate Policy Center along with the roles mentioned in the episode. And stay tuned at the end, when Professor Knittel will return to tell us about some big developments in carbon pricing since this episode aired.

Laur Hesse Fisher: Welcome to the show where you learn about climate change with real scientists. You might have heard about something called a carbon tax or cap and trade, or putting some kind of price on carbon dioxide emissions. Today, we’re going to break down what all that means and why carbon pricing is so commonly talked about.

To do this, I connected with MIT’s Prof. Christopher Knittel.

Christopher Knittel: I'm the George Shultz Professor of Applied Economics in the Sloan School of Management. I also direct the Center for Energy and Environmental Policy Research.

LHF: The first question I have for you is, why even talk about carbon pricing?

CK: Yeah. I think the short answer to that is that it's free to put greenhouse gases in the air even though they cause cost to society. So in order to fix the market, you can charge, whether it's firms or customers, the damage that they're doing when they emit those greenhouse gases in the air and the most direct way you could put a price on the pollutant is by taxing it directly.

LHF: This is the first kind of carbon pricing, called a carbon tax. You can emit as much as you’d like, you just have to pay for it. It makes products and services that emit a lot of CO2 more expensive, incentivizing companies and people to innovate and to choose less-polluting options. If you want the market to emit less CO2, you raise the tax.

One of the big debates is what would happen to the money that’s collected from a carbon tax.

CK: You could have a plan which taxes carbon dioxide, takes the money into the government coffers, and then redistributes that money on a per capita basis in some way. Alternatively, you can tax carbon dioxide, collect the money and use it to subsidize solar panels or so on.

LHF: So the collected tax money could help support some kind of program, like investing in technologies that suck CO2 out of the atmosphere or to help towns prepare for climate change. Or the collected tax money could also be given back to people to help them pay for the increased cost of energy.

That’s a carbon tax… There’s also something called a “cap and trade” system.

CK: A cap and trade system is slightly different, although it also leads to a price on the pollutant. What a cap and trade system does is the government caps the amount of the pollutant that is allowed to be released into the atmosphere. And then the second step is to issue permits that allow whoever's holding that permit to emit say a ton of carbon dioxide in the atmosphere, and also allows that holder of the permit to sell it if they wanted to. And that's the trade part of cap and trade.

LHF: This kind of carbon pricing is kind of like how hunting permits work. A state park sets limits on how much game can be hunted and then issues permits to people who want to hunt them. And if the state park wanted to protect more game, then they could lower the number of permits that are for sale.

Now, with cap and trade, you could actually sell and buy permits on a market. So if your company didn’t emit as much carbon dioxide, you could sell your permit to another company. Or if you wanted to emit more, you could buy one from someone else.

CK: Whoever holds onto or has one of those permits has a valuable asset that they can sell or use themselves.

LHF: Let's get real here. If a carbon price were to be implemented tomorrow, people are going to see gas prices go up. They're going to see their home energy prices go up. They're going to see other things go up. What would our new world look like?

CK: Yeah, the average American emits or buys products that lead to about 20 tons of CO2 in the atmosphere. So a $40 carbon tax would be about $800 burden per person per year.

LHF: That's pretty substantial.

CK: It is. And a lot of my work focuses on understanding how carbon taxes impact low income consumers. So it's not something we can just sweep under the rug, it's real. But I come back to the fact that a carbon tax generates that same amount of money per person per year.

So what a plan would look like is that the average person would be taxed $800 per year, but then the average person would also receive $800 check per year. Now, you might ask yourself, "well then. What does it do? Why how does that have any impact?" And the reason why it has an impact is that if there's something I can do to reduce my greenhouse gas burden, I know I'm going to get get that much money back in the the following year. That is if I somehow am able to go from instead of emitting 20 tons to 10 tons, then I'm going to be able to save $400 per year if the carbon tax is $40.

So I'm going to have an incentive to change the thermostat slightly during the winter or the summer. Anything I can do to reduce my carbon footprint, I'm going to pocket that cash. And that's going to lead to a lot of behavioral changes that don't exist absent that carbon tax.

LHF: Now, a $40 carbon tax is just an example. There are proposals in the US being discussed that are calling for prices ranging from $12.50 a ton to $50 a ton.

Of course, there are a lot of people who don’t want to see more taxes. And companies who don’t want their products and services to become more expensive. I mean, not many of us want to pay for something that used to be free.

A carbon price would, at least initially, create a cost that society would have to agree is worth it. Because a lot of the things we use and do now would cost more, until we change to buying products and services that produce less CO2.

It’s worth noting that the U.S. federal government did something like this in the past.

In the 1980s, the U.S. implemented a program under President George Bush to limit pollutants that were causing asthma, premature deaths, and hurting our waterways and forests. One of these pollutants is sulfur dioxide, which is also called SO2.

CK: When SO2 pricing came about, what that did is it increased the cost of burning high-sulfur coal. Now it turned out that there was this very cheap way to reduce SO2 emissions and that was to switch from high-sulfur coal to low sulfur coal. So in the absence of that SO2 Market, a lot of the policy discussions were going to require power plants to adopt these very expensive technologies to take the SO2 out of the emissions as opposed to switch to the type of coal. And had we gone down that path we would have spent a lot more money under that where you tell power plants what to do rather than let the market incentivize them to find the cheapest way to reduce SO2 emissions.

So you don't require the government to be heavy-handed. Or to even know how firms and consumers are going to reduce pollution. You let the market figure it out. That led to a much cheaper alternative than what anybody ever envisioned.

LHF: In fact, pricing pollution is generally considered by both liberal and conservative economists as the most cost-effective way to reduce that pollution.

CK: Researchers including myself have done a lot of research comparing alternatives to carbon taxes to reduce CO2 emissions, and there's many, whether it's subsidizing electric vehicles, or subsidizing solar panels, or requiring a certain number of electric vehicles to be bought and sold. And that research suggests that those alternative policies are often up to 10 times more expensive, which means leveraging those policies, for a given amount of money society is spending, we're not reducing as much pollution as we could.

LHF: Carbon pricing can be a contentious subject. It would force entities, like energy and manufacturing companies who emit a lot of carbon dioxide, to start paying for that. That’s a big shift in our economy and it could cost a lot of money upfront, but also could be a very effective way for reducing emissions.

Countries around the world and even U.S. states are already experimenting with carbon pricing.

There are a bunch of cap and trade programs out there. The European Union has one, the state of California has one, a collection of Northeastern states also have a regional cap and trade system. And China has one scheduled to start in 2020.

Right to the north of the United States, there’s the province of British Columbia, in Canada. They implemented a carbon tax program that sent checks before the tax started to each resident to help them adjust to the increased costs.

There is a ton more that we didn’t cover in today’s episode, but I hope we’ve given you at least an overview of what carbon pricing is about.

MG: Hi, it’s Madison again, in 2026. So, plenty has happened in the carbon pricing world since this episode first aired.

We’ll start with Canada, where for years, most people paid a carbon price for vehicle and heating fuels, and the money was returned directly to households. This policy really was lowering climate pollution, and at the same time, most Canadians were getting more money back in rebates than they spent on the tax.

But in 2025, with the fuel charge under political attack, the Canadian government scrapped it.

CK: Now they've kept some of the carbon pricing, they've kept the carbon pricing on firms. But the household-facing prices on carbon, on gasoline and so on, have been rescinded.

MG: Supporters of carbon pricing now wonder if the policy just wasn’t communicated well, or if direct taxes will always face resistance, even if most people come out ahead.

CK: What this does show, I think, is that carbon pricing can be very politically unpopular. And you have to design these programs well in order to get buy-in.

MG: Meanwhile, on the other side of the globe, China’s national carbon market has been up and running since 2021. Firms now buy and sell permits for their pollution, although it’s not a pure cap-and-trade scheme. That said, based on how much climate pollution it covers, it’s already the largest carbon market in the world, and the government has indicated that it will grow.

CK: It's a useful step forward. It's better than nothing, for sure, especially for the largest producer of greenhouse gas emissions in the world.

MG: The last big development we’re going to cover is in the European Union, which this year launched something called a carbon border adjustment mechanism, or CBAM.

CK: So that has a lot of supporters of a carbon tax excited. So what Europe is doing is fixing another potential flaw in carbon pricing.

MG: Say you run a company in the E.U. that makes a climate-polluting product, like steel or fertilizer. The E.U. has a cap-and-trade system, so you’re paying for your pollution. Maybe that price has pushed you to clean up your manufacturing. But your customers might look around and notice, wait, it’s cheaper to buy fertilizer from companies outside the E.U. that don’t pay for their pollution.

The new CBAM fixes that.

CK: So what the border adjustment mechanism does is: if I'm in the US and I'm making fertilizer and I export that to Europe, right when it hits the European border, they're going to place a tax on my fertilizer as if I was producing it in Europe.

It levels the playing field between the domestic European firms and firms that are exporting product into Europe.

MG: And the thing is, this could actually nudge other countries to start pricing carbon. The CBAM only falls on countries that don’t have their own carbon price, or set their price lower than Europe. So if companies in your country are selling goods to Europe, you might think, why should they pay all this money to the E.U.? If we set our own carbon price here, we’ll collect that revenue ourselves.

CK: And you're already starting to see big countries like India looking into pricing carbon as a way to counteract the CBAM. I think this border adjustment might do more than any ad campaign or any set of economists that have lobbied for pricing on carbon have done in the past.

MG: So, who knows? Maybe, if we re-air this episode in another seven years, we’ll be talking about how far carbon pricing has spread.

Ask MIT Climate is the climate change podcast of the Massachusetts Institute of Technology. Aaron Krol is our executive producer. David Lishansky is our sound editor and producer, and the music is by Blue Dot Sessions. And I’m your host and associate producer, Madison Goldberg. Thanks to Professor Christopher Knittel for speaking with us (twice), and to you for listening. We’ll be back soon with a new episode!