(John Kemp is a Reuters market analyst. The views expressed are his own.)
By John Kemp
LONDON (Reuters) - No one likes paying taxes, but a significant and rising tax on carbon dioxide emissions is probably the only way to stem the rise in emissions contributing to climate change.
Putting a price on CO2 emissions and letting the market figure out how best to reduce them is the lowest-cost and least-distorting way to cut the amount released into the atmosphere.
There are several alternative routes to establishing a carbon price, all of which are theoretically equivalent, but the simplest, most comprehensive and most straightforward to administer is via the imposition of a tax.
Most countries already impose taxes on the production and/or consumption of coal, oil and gas, so it would be comparatively straightforward to increase such tolls and levy them in proportion to their respective emissions.
The main obstacle to introducing significant carbon taxation is intense political opposition. Levying new taxes is always difficult, especially when they affect large numbers of voters and industrial interests.
Even long-standing sources of revenue such as excise duties, tariffs, income taxes and sales taxes were fiercely opposed at first and most remain contentious even today.
Creating and sustaining a broad political coalition in favor of introducing significant carbon taxes poses a formidable challenge because of the large number of consumers, regions and industries that could lose out unless the tax is designed carefully.
Carbon taxes have won increasingly broad intellectual support from economists and policy advisers across the political spectrum (“Economists’ statement on carbon dividends”, Climate Leadership Council, 2019).
“A carbon tax offers the most cost-effective lever to reduce carbon emissions at the scale and speed that is necessary,” said a statement signed by four former chairs of the Federal Reserve and 15 former chairs of the Council of Economic Advisers who have served under presidents from both major U.S. parties.
A sufficiently robust and gradually rising carbon tax will replace the need for various carbon regulations that are less efficient, the statement says. Substituting a price signal for cumbersome regulations would promote economic growth and provide the regulatory certainty companies need for long-term investment in clean-energy alternatives.
So far, elected policymakers have been reluctant to endorse comprehensive carbon taxes because such levies remain unpopular with voters and in some instances have been rejected at the polls.
Some policymakers and commentators have suggested carbon taxes will remain a theoretical ideal and will never be politically feasible.
But the art of political leadership is largely to assemble and sustain coalitions for particular policies, and coalition-building to support specific taxation and spending distributions is the most fundamental of all political functions.
If emissions are to be reduced significantly in the next few decades, it will almost certainly require a successful political effort to assemble a broad coalition in favor of CO2 taxation.
The International Monetary Fund estimates the tax on CO2 emissions would need to rise to a worldwide average of $75 per tonne by 2030 to meet the climate-change target set by the Paris Agreement of 2015.
The current global average price is just $2 per tonne, nowhere near high enough to limit global warming to less than 2 degrees Celsius (“Fiscal monitor: how to mitigate climate change”, International Monetary Fund, October 2019).
Increasing carbon taxes to meet the target would raise the retail cost of natural gas by an average of 68%, electricity by 43% and gasoline by 14% in the G20 countries, the IMF says.
“Under carbon taxation on a scale needed ... the price of essential items in household budgets, such as electricity and gasoline, would rise considerably but such increases have been experienced in the past,” the IMF notes.
In the past, however, steep rises in energy prices have been blamed on broader economic forces outside the immediate control of policymakers and have usually been only temporary.
Persuading politicians to take responsibility for deliberately inflicting substantial and permanent price increases in the cost of basic items and services, and persuading voters to accept them, is a far tougher challenge.
Carbon taxes would substantially raise the cost of energy to all businesses and consumers for heating, lighting, power and transportation, making them unpopular with voters.
In most countries, the burden would fall most heavily on lower-income households because they spend a higher share of their post-tax income on heating, lighting and motor fuel. (tmsnrt.rs/36GXrdD)
The burden would also fall disproportionately on energy-intensive industries such as aluminum, glass, chemicals, plastics, paper and steel, creating strong anti-tax lobbies.
It would hit rural and suburban communities poorly served by public transport and dependent on private cars (“State and trends of carbon pricing”, World Bank, 2019).
Finally, carbon taxes would hurt coal, gas and oil-producing communities, reducing local incomes and employment, likely causing long-term regional decline and fuelling determined local opposition.
But in addition to their costs, carbon taxes would raise substantial amounts of government revenue, equivalent to around 1-3% of gross domestic product by 2030 in the G20 countries, according to the IMF.
Carbon tax revenues could be used to increase government spending, pay down debt, reduce other taxes, or be returned to households and business through lump-sum payments.
The precise number and distribution of winners and losers from a carbon tax depend critically on how the revenues are recirculated (“Using carbon revenues”, World Bank, August 2019).
Before redistribution, carbon taxes would tend to be regressive in most countries because lower-income households spend a higher share of their income on energy and energy-intensive products.
But the actual impact on post-tax income distribution depends on deliberate policy choices about how the revenues are used.
Returning carbon tax revenues through equal lump-sum payments to households would make the system strongly progressive.
Revenues could also be used to offset the adverse impact on rural residents and workers in energy-intensive industries as well as coal, oil and gas-producing communities, through tax cuts, increased spending and retraining.
Carbon taxes would hit the international competitiveness of oil, gas and coal producers as well as energy-intensive industries unless they are introduced at similar levels globally.
If carbon taxes are not coordinated internationally, governments would probably need to introduce a border tax adjustment, similar to a tariff, on imports from countries with low or no carbon taxes.
Governments may also need to offer carbon tax rebates to exporters to ensure a level playing field with countries that have low or no carbon tax.
One advantage of carbon taxes is that they create a transparent way to measure price coordination and calculate any border tax adjustments.
The European Union has already started to investigate the legal and practical implications of a future border tax adjustment system (“Incoming top EU climate official pledges to tax polluting imports”, Reuters, Oct. 8).
Carbon taxes are not the only way to put a price on CO2 emissions but they are the simplest, most comprehensive, lowest-cost and most effective.
Emissions trading systems also establish an explicit carbon price. In principle, they are equivalent to a tax if all producers and/or consumers are required to buy permits.
In practice, however, most trading systems cover only large individual CO2 sources and most give away some allowances for free, reducing their effectiveness and increasing the costs of emissions reduction.
Taxes, subsidies and regulations imposed on specific products and industries can also create an implicit carbon price, but lacking comprehensiveness they create distortions and increase the overall cost of CO2 reductions.
Some policymakers prefer technology-led solutions to climate change: carbon capture, utilization and storage; energy-efficiency improvements; and investments in energy systems such as hydrogen and nuclear.
But most of these alternative technologies will need a significant carbon tax or otherwise high carbon price to become competitive.
And experience suggests technological improvements that lower the cost of energy will increase total consumption from all sources, including from CO2-emitting ones.
They will not curb the amount of CO2 discharged into the atmosphere unless combined with an explicit price signal.
Editing by Dale Hudson