Carbon pricing is an instrument which puts a price on carbon emissions. A price on carbon helps transfer the burden for the impairment from carbon emissions back to individuals, businesses, and governments, who are responsible for it and who can avoid it. Carbon pricing pushes reduction of carbon emissions through placing a fee on emitting and/or offering an incentive for emitting less.

There are two primary approaches when it comes to carbon pricing:

Carbon Tax

Government sets a fixed price per ton of carbon dioxide emissions or an equivalent greenhouse gas and entities must pay this tax based on the amount of emissions they produce. Since taxes increase with emissions, companies and individuals are encouraged to cut back on emissions to save costs. 

Cap and Trade (Emissions Trading System)

In a cap and trade system or emissions trading, the government sets a limit on the total permissible greenhouse gas emissions within a certain jurisdiction or industry sector. Following distribution or auction, emission allowances are sold to companies and entities. Companies who emit less than their allotted allowances may sell their extra allowances to companies that emit more than their allotted allowances. This gives businesses a market-based incentive to reduce emissions since they can make money by selling extra allowances or have to buy more allowances if they go over their caps.