Commentary: China’s Carbon Market Needs a Tax Fix

China’s carbon market is a central element of the country’s strategy to address climate change and achieve a comprehensive green economic and societal transition. Pilot carbon trading initiatives began in seven major cities in 2011, helping the country to develop experience around allowance allocation, trading systems, and regulations. This foundational work led to the official launch of the national carbon market in July 2021, marking the move into a new stage of carbon reduction efforts after four years of development [para. 1].

The market achieved significant milestones by 2024, with total transaction values reaching 18.04 billion yuan ($2.47 billion). In 2025, the market expanded to include the steel, cement, and aluminum smelting sectors, raising the scope of covered emissions from just over 5 billion tons to around 8 billion tons—covering more than 60% of China’s total carbon dioxide emissions. By the end of June 2025, the cumulative trading volume hit 669 million tons, with transactions totaling 45.93 billion yuan [para. 2].

On August 25, 2025, China’s central government released a new policy to further advance the green transition and enhance carbon market vitality. The policy promotes measures to improve carbon pledging and repurchasing, standardize related financial activities, and gradually allow qualified individuals to trade in the national voluntary greenhouse gas market [para. 3].

However, a significant challenge arose in February 2025 when the State Taxation Administration announced a 6% value-added tax (VAT) on carbon emission allowance trading, classed as an intangible asset. This move threatens to complicate existing policies and suggests that tax management approaches must be improved [para. 4]. The 6% VAT increases compliance costs and undermines market participation. During the pilot phase, carbon allowances were inconsistently taxed, but the new unified standard creates additional issues like retroactive tax obligations, problems for institutional investors in securing input invoices for tax deductions, and complications for companies purchasing allowances via auctions or allocations without proper invoicing. These administrative ambiguities and invoicing challenges significantly increase the burden on participants [para. 5].

Operational problems include difficulties in invoice issuance, especially for block trades and among unfamiliar counterparties, encouraging each participant to consolidate transactions or trade with known partners, thereby reducing liquidity and market breadth [para. 6]. For individual investors, invoicing complications result in a 6% extra cost for trades involving individuals, disadvantaging them and potentially hindering further development of voluntary and local markets [para. 7]. Furthermore, the current tax approach inhibits innovation in carbon-linked financial products, such as futures and repurchase agreements, because treating allowances as intangible assets with complicated compliance costs discourages new entrants and diminishes liquidity [para. 8].

Comparatively, the European Union’s carbon market tax system evolved after problems like VAT fraud during its initial phase. The EU addressed this with a “reverse charge mechanism,” shifting VAT liability from sellers to buyers and vastly curbing fraud, supported by a central registry system. Today, the EU recognizes carbon trading’s financial nature, uses accounting rules to prevent asset overvaluation, and treats spot and derivative transactions differently for taxation [para. 9-11].

To optimize its system, China should classify carbon trading more appropriately—treating compliance use as an intangible asset but financial trading as a financial product with taxation on net gains. Implementing a “reverse invoicing” approach, similar to the EU’s mechanism, piloting detailed, uniform tax guidelines, and applying digital platforms to ease administrative burdens would boost efficiency, reduce compliance costs, and bolster market development [para. 12-16].