Hybrid Approaches: Using Both Instruments
The choice between carbon tax and ETS is not always binary. Many jurisdictions use hybrid approaches that combine elements of both, applying different instruments to different sectors or layering them together. This lesson explores how hybrid systems work and when they make sense.
What Is a Hybrid Approach?
Hybrid approaches combine carbon taxes and emissions trading in various configurations:
Sectoral hybrids: Different instruments for different sectors
Layered hybrids: Both instruments apply to the same sources
Sequential hybrids: Starting with one, transitioning to the other
ETS with price mechanisms: Trading with floor and ceiling prices
Hybrids can capture the advantages of both instruments while managing their disadvantages. But they also add complexity and require coordination.
Sectoral Hybrids
Different sectors may be best suited to different instruments:
ETS for large point sources:
- Power plants
- Heavy industry
- Major facilities
Carbon tax for diffuse sources:
- Transport fuels
- Heating fuels
- Small emitters
Sweden's sectoral hybrid:
| Sector | Instrument | Rate/Price |
|---|---|---|
| Industry (in EU ETS) | EU ETS | ~€80/ton |
| Industry (outside EU ETS) | Carbon tax | ~€130/ton |
| Transport | Carbon tax | ~€130/ton |
| Heating | Carbon tax | ~€130/ton |
Sweden combines participation in the EU ETS (for covered sectors) with its own high carbon tax (for other sectors). This ensures comprehensive coverage while participating in the European market for large emitters.
Why Sectoral Hybrids Make Sense
Administrative efficiency
ETS requires direct emissions monitoring, which is only feasible for large facilities. A carbon tax can cover millions of small sources through upstream fuel taxation.
Appropriate instruments for different contexts
Large emitters benefit from trading flexibility. Small emitters need simple, predictable costs.
Different competitiveness concerns
Trade-exposed industries may need ETS free allocation. Domestic sectors can bear carbon taxes more easily.
Layered Hybrids
In some cases, both instruments apply to the same emissions:
Carbon tax as ETS floor
A carbon tax applies in addition to ETS compliance costs, effectively creating a minimum carbon price.
Carbon tax for non-ETS gases
The ETS covers CO2; the tax covers methane from the same facilities.
Multiple coverage
Some emissions face both instruments, adding their costs together.
Mexico has one of the world's more complex hybrid systems:
Carbon tax (2014):
- Applies to fossil fuel sales
- Rate: ~$3/ton CO2
- Covers broad fuel base
Pilot ETS (2020):
- Covers large emitters (power and industry)
- Currently no trading of allowances (shadow trading only)
- Planned to transition to full trading
How they interact:
Large emitters covered by the ETS also pay the carbon tax on their fuel purchases. The effective carbon price is the sum of both.
Why this design?
- The tax provides immediate revenue and coverage
- The ETS builds capacity for quantity-based approach
- Together, they cover more emissions than either alone
- The tax provides a price floor even if ETS prices are low
Sequential Hybrids
Some jurisdictions transition from one instrument to the other over time:
Tax to ETS:
- Start with a simple carbon tax
- Build ETS capacity while tax operates
- Transition to ETS when ready
- May keep tax for non-ETS sectors
ETS to tax (rare):
- Some have proposed replacing ETS with tax
- Usually driven by frustration with low ETS prices
- More common as a complement than replacement
Colombia's planned transition:
Colombia started with a carbon tax in 2017. Plans include:
- Phase 1: Carbon tax for fuel combustion (~$5/ton)
- Phase 2: Develop ETS infrastructure
- Phase 3: Pilot ETS alongside tax
- Phase 4: Transition tax-covered sectors to ETS
This allows Colombia to have carbon pricing immediately while building toward a more sophisticated system.
ETS with Price Mechanisms
Adding price floors and ceilings to an ETS creates a hybrid between trading and taxation:
At the floor:
- The system behaves like a carbon tax
- Price is fixed, quantity adjusts
At the ceiling:
- Same: fixed price, adjusting quantity
Between floor and ceiling:
- True trading
- Price varies with supply and demand
An ETS with price bounds is like a thermostat. Within the comfort zone (between floor and ceiling), the temperature (price) adjusts naturally. Only at the extremes does the system intervene to keep things within acceptable bounds.
Coordination Challenges
Hybrid systems create coordination needs:
Avoiding double counting
If both instruments apply, you must be clear about what "counts" for compliance. An emitter should not have to surrender allowances AND pay tax for the same ton.
Consistent signals
If the ETS price is €50 and the carbon tax is €10, different sectors face different incentives. This may or may not be intentional.
Administrative complexity
Two systems require two sets of rules, administration, and compliance processes.
Policy coherence
Changes to one instrument may affect the other. Coordination is needed for reforms.
When Hybrids Make Sense
Context suggests different instruments for different sectors:
Large point sources: ETS Diffuse sources: Tax This is the most common hybrid rationale.
Transitioning between instruments:
Want ETS but cannot implement immediately? Start with tax.
Backstop pricing:
Want ETS but concerned about price collapse? Add tax floor.
Comprehensive coverage:
Want to price all emissions but cannot monitor all sources directly? Combine upstream tax with downstream ETS.
Design Principles for Hybrids
1. Clear boundaries
Define exactly which emissions face which instrument. Overlaps should be intentional and understood.
2. Consistent ambition
Carbon prices should be roughly comparable across instruments. Large gaps create distortions.
3. Coordinated governance
Different agencies may administer different instruments. Coordination mechanisms are essential.
4. Transparent communication
Stakeholders should understand the complete carbon pricing landscape, not just individual instruments.
5. Plan for evolution
Hybrids often evolve over time. Build in review and adjustment mechanisms.
Hybrid approaches are common in practice because real-world policy must balance multiple objectives. They add complexity but can achieve better coverage and political sustainability than single instruments.
Looking Ahead
The next lesson examines a specific case study: Singapore's decision-making process for choosing its carbon pricing instrument. This illustrates how assessment frameworks translate into real policy choices.