The International Monetary Fund’s call in October for a carbon tax of $75 per tonne by 2030 has put CO2 pricing back in the spotlight. But it merely reflects what climate campaigners have been saying for a decade or more — that businesses need to be charged for their carbon emissions at a high enough price to deter the burning of fossil fuels and encourage the transition to clean energy.
Yet putting an effective price on carbon will be far from straightforward. There are valid reasons why carbon pricing has so far been too low to have much impact, and these will not be easy to overcome — with riots in the streets and international trade wars a distinct possibility.
There are many alternative options to carbon pricing that governments could utilise, which may be simpler to implement and more effective.
Ineffective carbon pricing to date
On the surface, it is easy to see why a price on carbon — in the form of a tax or a cap-and-trade scheme — is desirable.
Environmentalists like it because it discourages polluters from emitting as much greenhouse gas as they desire. As renowned climate campaigner Bill McKibben once put it: “Carbon should not flow unpriced into the atmosphere any more than you should be allowed to toss your garbage in the street.”
And at the same time, economists like it because it allows the market to decide how to reduce carbon emissions efficiently.
Carbon taxes have been around for almost 30 years — the first to be implemented was by Finland in 1990 — and there are now 29 in existence, in addition to 18 emissions trading schemes (ETS), eight of which are regional Chinese pilot programmes. Another 20 carbon pricing initiatives are scheduled for implementation, according to the World Bank.
Yet, generally speaking, these programmes have done very little to reduce emissions or encourage the growth of renewables — prices have simply been too low to change behaviour.
According to the recent World Bank State and Trends of Carbon Pricing 2019 report, “Less than 5% of global emissions covered under carbon pricing initiatives are priced at a level consistent with achieving the goals of the Paris Agreement, ie, $40-80/tonne of CO2 by 2020 and $50-100 by 2030.
“Moreover, about half of the emissions covered by carbon pricing initiatives are still priced below $10 per tonne of CO2.”
Only six countries have carbon taxes in place that are higher than $40 per tonne — France, Norway, Finland, Switzerland, Liechtenstein and Sweden.
It is also worth pointing out that the world’s top four emitters — China, India, the US and Russia — responsible for more than half of all CO2 emissions, do not have national carbon pricing programmes (although China is due to implement an ETS in 2020).
Negative carbon prices
At a time when the world urgently needs to decarbonise, it is perverse that most governments still have policies in place that subsidise the extraction, production and/or consumption of hydrocarbons. These fossil-fuel subsidies are now rightly being labelled as “negative carbon pricing” by organisations including the World Bank.
According to the International Monetary Fund (IMF), global pre-tax and post-tax fossil-fuel subsidies in 2017 amounted to $296bn and $5.2trn, respectively, when including knock-on financial impacts (or “externalities”), such as global warming and air pollution. By comparison, global renewable energy subsidies amounted to $140bn in 2016, according to International Energy Agency (IEA) calculations.
What we are doing is using taxpayers’ money… to destroy the world.
As UN secretary-general António Guterres memorably stated this year: “What we are doing is using taxpayers’ money… to destroy the world.”
It is utterly pointless to tax carbon emissions when governments are spending taxpayers’ money to help businesses and citizens emit more carbon. For instance, China spent a staggering $44bn on subsiding its citizens’ consumption of fossil fuels in 2018, according to the IEA.
While it is blindingly obvious that countries should eliminate their fossil-fuel subsidies, governments need to be smart as to how they remove them.
When Ecuador lifted its consumer subsidies on fossil fuels earlier this month (as part of a S$4.2bn loan deal with the IMF), diesel prices doubled overnight and petrol prices rose by a quarter, prompting huge riots that forced the government to flee the capital and reinstate the subsidies 12 days later. Similar tax hikes on diesel in France triggered the ongoing gilets jaunes (yellow vests) protests, which have seen hundreds of thousands take to the streets, violent clashes and riot police firing rubber bullets and tear gas at protesters.
By contrast, G20 nation Indonesia managed to phase out its consumer fossil-fuel subsidies — which accounted for almost 3% of its GDP in 2008 — by taking a more considered approach. It reduced its subsidies over several years, while at the same time conducting effective public communication campaigns and instituting financial compensation programmes for poorer citizens that were hardest hit by the rise in fuel prices.
The good news is that transferring just 10-30% of the world’s fossil-fuel subsidies to renewables would pay for the entire global energy transition, according to a recent report by the Canada-based International Institute for Sustainable Development (IISD).
“Almost everywhere, renewables are so close to being competitive that [a 10-30% subsidy swap] tips the balance, and turns them from a technology that is slowly growing to one that is instantly the most viable and can replace really large amounts of generation,” said Richard Bridle, the IISD senior policy advisor. Such a move was “an absolute no-brainer”, he added.
The trouble with carbon pricing
It is one thing to advocate for a carbon tax, and another to successfully implement it.
With very few exceptions (see panel below), carbon pricing to date has largely been a complete failure. Carbon levies have been introduced, but have not been high enough to make a significant impact.
There are two key reasons for low carbon pricing (presuming incompetence is not a factor) — fear that higher electricity and fuel prices will be politically unpopular among the electorate, and fear that higher prices would raise costs for local industries, making them less competitive in global markets.
These two fears are now, finally, being seriously addressed, which could pave the way for more forceful carbon pricing.
Revenue-neutral carbon levies
The fear of the kind of political backlash seen in Ecuador and France can be assuaged to a large degree by ensuring that citizens are rewarded, rather than punished, for reducing their carbon emissions.
This can be achieved by redistributing the income from carbon levies back to the people, rather than governments keeping it for their own use. Such a “revenue-neutral” scheme was first introduced in Switzerland in 2008, while Canadian prime minister Justin Trudeau this year imposed a “fee-and-dividend” scheme on four provinces that refused to set their own carbon levies, as required by the federal Greenhouse Gas Pollution Pricing Act.
In Switzerland, revenues from its carbon tax are redistributed via deductions on health insurance premiums and in pay packets, while in Canada, taxpayers will receive uniform tax rebates that will, in around eight out of ten cases, be higher than the increased costs passed onto consumers by energy companies and polluting industries.
If a fee-and-dividend scheme was implemented across the US, with a carbon price of $50 per tonne and the tax’s revenue used to reduce payroll taxes, it would actually boost the country’s GDP by 0.5%, according to a study by the Baker Institute for Public Policy at Rice University in Houston.
Putting more money into people’s pockets is always a vote winner, so there is growing consensus that fee-and-dividend schemes are the best approach for pricing carbon.
Carbon border taxes
The fear of making businesses less competitive in the global marketplace is another genuine concern — governments can be brought down by job losses, company bankruptcies and an under-performing economy.
But support is growing for a policy that could prevent businesses with high carbon taxes losing out to overseas firms that do not pay such levies, or parent companies moving production to countries without carbon pricing — so-called “carbon leakage”.
For instance, steel maker ArcelorMittal has already reduced production in the EU by 7%, citing the extra costs from the relatively modest carbon price as a key factor in its decision.
Ideally, there should be a uniform carbon price across the world.
“Ideally, there should be a uniform carbon price across the world, reflecting the rationale that a tonne of carbon dioxide-equivalent does the same amount of damage over time wherever it is emitted,” says the Grantham Research Institute on Climate Change and the Environment at the London School of Economics. “Uniform pricing would also remove the risk that polluting businesses flee to so-called ‘pollution havens’ — locations where a lack of environmental regulation enables businesses to continue to pollute unrestrained.”
Achieving a global uniform carbon price seems highly unlikely, given the attitude of some governments to climate change and the general antagonism between the world’s most powerful nations.
One method to prevent carbon leakage and pollution havens is to apply carbon border taxes — tariffs on imports, priced according to how much carbon was used in the production and transportation of the imported goods. This would, in effect, emulate a global carbon price.
Oxford University economist Professor Dieter Helm, who is credited with the idea, says that this would not be a “protectionist” policy, but a way of ensuring a level playing field.
“For example, China is, in effect, subsidising its energy-intensive exports by not incorporating a carbon price,” he recently explained.
There is no point, for instance, in making gas-fired British steel more expensive by applying a high carbon tax on its production, and then allowing coal-fired steel to be shipped in from China, where there is no price on carbon and the 21,000km journey results in tonnes of CO2 emissions.
The incoming European Climate Commissioner, Frans Timmermans (pictured above), who is due to take office this year, said earlier in October that the EU will immediately start work on a tax on polluting foreign firms in order to protect European companies as the EU strives to become carbon neutral.
“We should also be prepared to consider other instruments, for instance a carbon border tax, to level the playing field for European products,” Timmermans told the European Parliament.
“My idea would be to say to our international partners: we are making this transition to a climate neutral economy by 2050. If you make the same measures or comparable measures going in the same direction, we will make this voyage together.”
He said he believed a carbon border tax would be compatible with World Trade Organization (WTO) rules, but said the new European Commission would have to research that.
Helm has been clearer on this point. “The WTO rules explicitly allow for environmental considerations. There is a good case for making this much more explicit, in the interests of fair trade, and in the interests of the environment generally,” he said.
But establishing carbon border taxes would be a perilous exercise.
For a start, there are plenty of precedents showing that countries facing increased import tariffs retaliate with their own tit-for-tat tariff increases — China and the US being a recent example. This could result in international trade wars and increased prices for consumers that could be damaging for the global economy.
Then there is the problem of how such border taxes would work, and how they would be calculated.
“I think the key issue is one of feasibility. It sounds intuitively a very good idea — we’re not decarbonising the planet by shifting the emissions out of the EU,” said Paul Dawson, head of regulatory affairs at RWE Supply & Trading, at the BNEF Summit in London earlier in October. “But in terms of how you would actually apply that tariff, even if politically you wanted to, it’s incredibly difficult just to calculate what the implied emissions are.”
Bjørn Kjetil Mauritzen, head of climate office at Norwegian aluminium producer Norsk Hydro, which has to buy carbon allowances on the EU ETS, added: “When you start looking at the details, it’s complicated. Should [the carbon border tax] be only on primary materials, should it be on secondary materials, should it be all the way [down to the product level], for instance, my iPhone contains 31 grams of aluminium. Or should it be only for direct emissions or indirect as well?
“The idea is good, but it can be very complicated. And we might end up with something that doesn’t rely help either the climate or the industry.”
There might also be countless disputes over how much carbon content is contained in a particular product, with claims and counter-claims clogging the courts for years.
A question of trust
An important factor in the implementation of carbon prices is trust. Emissions cannot be measured at every factory chimney and steel furnace, so verifications and calculations have to be made — processes that can be manipulated and are open to corruption.
You don’t have to look further than the recent Volkswagen scandal to see that even highly regarded Western manufacturers can manipulate their emissions data. So how can we ensure that a steel plant in a remote part of China is not doing the same, especially if it is owned by a state entity that benefits from keeping prices as low as possible?
How can we be sure that companies will pay their fair share of carbon tax?
And can fossil-fuel companies that have financed climate-denial campaigns for decades be trusted to provide accurate in-depth details of all their climate-polluting activities for all their facilities in every jurisdiction?
Can we trust the markets to fairly trade the intangible financial products known as carbon credits — when we know that the dubious actions of financiers caused the credit crunch of 2008 and the subsequent global recession?
And can politicians be trusted to oversee the implementation of carbon levies, or pass on all income from revenue-neutral carbon taxes to consumers?
In countries where corruption is rife, or where democracy is non-existent or under pressure, it is hard to believe that carbon emissions and carbon prices will be accurately represented. And if some countries are perceived to be not playing by the rules, there will be calls among rival countries not to do so either.
A 2018 study by European Commission economist David Klenert and others, including the influential climate economist Nicholas Stern, found a correlation between trust in politicians and carbon pricing.
“Cross-national studies indicate that countries with greater public distrust of politicians and perceived corruption persistently have weaker climate policies and higher greenhouse gas emissions,” said the paper, published in the Nature Climate Change journal. “This is exemplified by Finland, Norway, Sweden and Switzerland, which all exhibit high levels of trust and have carbon prices above $40 per tonne of CO2.
“If trust is low, revenue [from a carbon levy] should thus be recycled using a transparent, trust-boosting strategy to enhance its acceptability.”
The paper also suggests that carbon levies will be more likely to succeed if they have widespread political support.
“Carbon pricing schemes are more likely to survive successive partisan changes in government if they benefit constituencies across the political spectrum.”
A good example is Sweden, where an informal coalition of the five mainstream Swedish political parties came together in 2016 to agree on a long-term climate plan — to hit 100% renewables for electricity by 2040. It is perhaps no coincidence, that Sweden has the highest carbon tax in the world (see panel below).
A bad example is Australia, where a carbon pricing scheme was introduced by a centre-left Labor government in 2011, and was scrapped in 2014 after the climate-sceptic Liberal/National coalition came to power.
The same reversal recently came close to happening in Canada. Ahead of the general election in late October, the Conservative Party had campaigned to scrap the “Trudeau carbon tax” if it won power — but in the end it came a close second behind Trudeau’s Liberals.
Despite all the challenges that carbon pricing will inevitably face, economists increasingly believe that a high carbon price is needed. But more discussion will be needed, nationally and internationally, as to how to best implement them. A workable solution to carbon leakage would be needed, but no-one seems to know what that might look like.
However, Kingsmill Bond, new energy strategist at think-tank Carbon Tracker, has a rosier perspective on carbon taxation, arguing that those countries that price greenhouse gases will end up with economies that are fitter for the low-carbon world of the future.
The world's finally waking up to a recognition that carbon is something that needs to be taxed.
“I think the world's just finally waking up to a recognition that [carbon] is something that needs to be taxed,” he tells Recharge.
“If the world is moving to a renewable energy system, which I think it is, the duration of travel is pretty clear. It becomes a race for countries and companies to be the fittest for this new world. And those which don't therefore implement this tax will find themselves like trying to run a 100km race and weighing 200 kilos — it's going to make them really flabby and will mean that they lose the race. So, increasingly, it becomes in people's interests to price carbon and to get ready for this shift.”
But equally, relying on carbon pricing as a key instrument for solving the climate crisis — as some economists advocate — would be an extremely dangerous strategy. Not least because there are many other alternative carbon-reduction methods available to governments that would arguably be more effective and far less risky.
The UK is regularly cited as a prime example of the potential effectiveness of carbon pricing.
As an EU member (at least for now), it has been part of the bloc’s Emissions Trading System. But the Conservative-Liberal Democrat government of the early 2010s was frustrated by the low price of EU Allowances, which had fallen below €5 per tonne.
Realising that this price would have little impact on emissions reduction, it introduced a “carbon price floor” in 2014 — effectively a top-up on the ETS price, so that electricity generators would have to pay £18 (€21/$23) per tonne of CO2 emitted.
This still modest price was high enough to make many UK coal-fired power plants uneconomic — ultimately leading to the proportion of coal in the country’s energy mix to fall from 30% in 2014 to 5.4% in 2018 and 2.9% in the first quarter of 2019.
Sweden’s carbon tax, which dates back to 1991, has by far the highest price of any CO2 levy in the world — 1,150SKr ($130) per tonne — and is levied on all fossil fuels in proportion to their carbon content, and therefore applies to households as much as businesses.
Perversely, large emitters subject to the EU ETS — power plants, oil refineries, heavy industry, etc — do not have to pay Sweden’s high carbon tax due to EU rules on conformity across the bloc.
Nevertheless, the carbon tax has led to a large reduction in fossil-fuel imports and an increase in renewable energy (mainly wind and biomass) — which has grown from 33% of the energy mix in 1990 to 54.5% in 2017.
Since the carbon tax was introduced, the Swedish economy has grown by 60%, suggesting that the fears of economic damage from higher carbon prices may be overstated.