Carbon Offsets and the Market for Guilt Reduction

The world’s scientific community is united in the belief of man-made global warming and climate change.  Far less unity exists around what to do about it, especially since combating global warming and climate change is a complex and expensive undertaking.  Global warming and climate change, considered to be largely caused by pollution, is a negative externality that affects third parties not subject to the economic transactions that caused the harms.  Typically, negative externalities require government regulation, as the producers and consumers do not have enough economic incentive to limit the creation of the harms on their own - the private costs inflicted on the producers and consumers are too low to limit the harm creation.

Carbon Emissions and Climate Change

Scientists have discovered that carbon emissions are the primary driver of man-made climate change, with a majority of this carbon dioxide being pumped into the atmosphere coming from the burning of fossil fuels.  Carbon dioxide is a greenhouse gas that creates a greenhouse effect where heat is trapped within earth’s atmosphere, causing global warming.  The massive increase in carbon dioxide in our atmosphere began in the late 1800s with industrialization in western Europe and North America, followed during the 20th century in the remaining continents.  

Who’s at Fault?  The Carbon Footprint

Even when policymakers agree that carbon emissions and global warming are a real problem, threatening to cause extreme weather patterns and rising sea levels, there is much disagreement on who should bear the costs of limiting carbon dioxide output.  This leads to anti-pollution advocates analyzing the carbon footprints of various producers and consumers.  The top producers of greenhouse gases are in the transportation and electricity generation fields, mostly using fossil fuels as an energy source.

Carbon Offsets and Carbon Credits

Government attempts to directly limit firms’ greenhouse gas emissions have weaknesses, especially in terms of incentivizing innovation.  Firms may abide by the caps mandated by regulators, but have no incentive to improve their efficiency beyond that point.  As a result, the government must constantly adjust its regulations and spend taxpayer dollars to pursue innovations to reduce pollution.  The hard work of pollution abatement is done entirely by government, which may be expensive and inefficient.

One way to incentivize firms to improve their own efficiency and reduce pollution is by selling carbon offsets.  Firms are allotted a certain amount of allowable pollution by regulators, but can then sell any unused allotment to others.  Some firms are already more efficient than others, giving them the ability to create a market for externality rights.  Firms that are less efficient, such as older firms with older capital equipment that pollutes more, can choose to either invest in new equipment immediately or purchase carbon credits to continue using pollutant-heavy equipment.  This flexibility is popular with companies.

Popularity of Using Carbon Offsets

Firms can use carbon offsets and carbon credits to advertise themselves as “carbon neutral,” allegedly meaning that they do not contribute to global warming.  With many consumers being environmentally conscious today, firms can increase demand for their products by claiming to be pro-environment.  Recent years have seen a significant increase in the number of advertisements and commercials touting producers’ concern for the environment.  As of 2024, approximately two-thirds of large global firms reported purchasing carbon offsets.  

Only in some jurisdictions is pollution abatement mandatory, so some firms purchase carbon offsets voluntarily, either to improve their reputation (savvy marketing) or to genuinely help the environment.  Individual consumers, such as celebrities who frequently use private planes, also purchase carbon offsets to advertise a carbon neutral lifestyle.  The pollution-heavy lifestyles of the rich and famous have become increasingly controversial in recent decades, especially since most of these individuals can travel to pollution-free locations and avoid encountering their own smog.

Marginal Benefits vs Marginal Cost of Carbon Offsets

Some carbon offsets are allotments of pollution that a firm is allowed but is not using, while others are generated by environmental projects that abate pollution, such as reforestation.  The first type of carbon offsets incentivize efficiency, as firms that do not meet their cap of allotted pollution can now sell the remainder as offsets.  Thus, firms that can reduce their own pollution can make a profit from less-efficient competitors.  The second type of carbon offsets directly benefit the environment through projects that improve the land, waterways, and atmosphere.  However, do the benefits exceed the costs?

The costs of allowing carbon offsets, as opposed to direct government regulation, can be substantial if little decrease in carbon emissions results.  Critics of allowing carbon offsets argue that they often artificially inflate the amount of carbon reduction, such as through double counting (counting one unit of pollution abatement multiple times, such as both for the firm and for the firm’s host country) or counting an existing environmental project as a carbon reduction project.  This has led to arguments of greenwashing regarding the use of carbon offsets, with firms allegedly purchasing carbon offsets instead of making any real attempts to reduce their pollution.

Climate Policy Challenges from Carbon Offsets

One concern with using carbon offsets is that they allow companies to avoid making real improvements in their efficiency.  This will increase over time if there is an increase in the supply of carbon offsets offered by environmental projects of dubious quality.  Critics worry that new carbon offset projects will overstate their environmental impact and allow high-polluting firms to purchase carbon offsets that actually offset little or no carbon emission.  This expansion of the carbon offset market will result in little pollution reduction as firms can buy ample carbon credits for cheap.  Every major company will then be carbon neutral without real effort.

A longer-term harm from cheap carbon offsets, especially those that are of low quality, is decreased effort in researching scientific breakthroughs in combating global warming and man-made climate change.  If everything appears to be carbon neutral on paper, government support for environmental research will likely decline, resulting in no improvements to the overall situation.  An expanded carbon offset market could falsely signal that the problem of global warming is being fixed, while the opposite is true.