58 ENV/WKP(2022)3
5.
Carbon pricing design related to challenges and increased rationale COVID-19 has brought new challenges to carbon pricing, but also increased the rationale for countries to implement new or strengthen existing carbon pricing schemes. Agreeing to put a carbon price (at high enough levels to provide a proper price incentive) in place has been already challenging for most countries before the pandemic. This section presents insights on how carbon pricing can be designed to overcome the challenges, enhancing political acceptability. It also sheds light on how carbon pricing could advance other important agendas, including reducing inequality. Finally, the section also discusses a number of innovative instruments that may be less challenging to implement.
5.1. Carbon pricing design options to reduce challenges Governments have several options available to mitigate the challenges of implementing carbon pricing, including signalling that carbon prices will increase in the future, (temporary) exemptions or targeted support, the recycling of revenue and the choice of the instrument. Yet, there is no silver bullet; each design option of carbon pricing has its advantages and disadvantages.
Signalling that carbon prices will increase in the future, but keeping prices constant in the short-term Signalling that carbon prices will increase in the future (e.g. starting in 2024) without necessarily increasing carbon prices in the short-term would not exacerbate the situation of vulnerable groups. As carbon prices would not increase in the short-term, vulnerable households and firms would not face a short-term increase of energy prices. Signalling that carbon prices will increase in the future, however, would send a price signal for investment and expenditure decisions in the long-term as it shapes expectations about the future carbon price (Martin and Van Reenen, 2020[246]). In practical terms, the implementation of prospective rising price trajectories for carbon or fuel excise taxes is straightforward. For ETS, however, a more ambitious emissions cap trajectory in the future is likely to translate into higher permit prices in the shortterm if market participants can bank allowances. This is because regulated entities could buy allowances today in anticipation of a more stringent future cap, leading to an increase of current permit prices. This was the case in the EU ETS, where permit prices surged during the pandemic from EUR 15/tCO2 in March 2020 to EUR 60/tCO2 in August 2021 (EEX, 2021[247]). Carbon price announcements, however, are associated with some regulatory uncertainty which is detrimental to investments in long-lived low-carbon infrastructure (OECD, 2020[248]). Among other reasons, regulatory uncertainty can originate from the fact that announcements may be revoked, adjusted, or may not pass parliament. Enshrining a carbon price trajectory (e.g. a carbon tax trajectory or minimum carbon price trajectory for ETS) into law would reduce regulatory uncertainty for investors. Yet, despite a law, uncertainty amongst investors may still exist in countries where support for carbon pricing diverges across political party lines which may result in the overturning of the law with a new incoming government (OECD, 2020[248]). This was, for example, the case in the Canadian Province of Ontario, where the incoming
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