Unfortunately, carbon or green taxes are not extensively used worldwide. Less than 20% of current global greenhouse gases are covered by carbon prices, and most prices are well below USD 40-USD 60 per tonne of CO2, the level recommended by the High-Level Commission on Carbon Prices for 2017. The situation is only slowly improving. According to the OECD, the carbon pricing gap, which compares actual carbon prices and real climate costs estimated at EUR 30 per tonne of CO2, was 76.5% in 2018, only slightly lower than the 79.5% gap reported in 2015.[6] The carbon emission price gap is lowest for road transport (21%) and highest for industry (91%).
A different approach is needed
Simulations show that current pollution abatement policies are not sufficient for keeping global warming below 2°C. Moreover, the IPCC study shows that it would be much better if global warming would be limited to only 1.5°C. However, it is uncertain how investment flows can be increased and redirected to low carbon alternatives.
Although early signs of climate change have already appeared, many actors still deny the urgency for immediate action, as for most of them the catastrophic impacts will be felt well beyond the traditional planning horizons. As long as climate change does not seem a very pressing problem, it is very tempting to become free-riders and let the coming generations make most of the effort in cutting back greenhouse gases. The danger is that we get locked in a high carbon scenario, from which it is very costly to leave. Bank of England’s governor Mark Carney called it “the tragedy of the horizons”.[7]
Normally, governments should have a responsibility in overcoming such market failures through developing policies and appropriate regulatory environment. The COP is an effort to combat climate change at a supranational level.
For the corporate sector, the signing of the Paris climate deal was a signal to include the transition to a low carbon society in the business plans. Companies have started using an internal price of carbon for their business operations and investment decisions.
Since Mark Carney’s speech, financial institutions have also become more aware of the risk of climate change for their operations. Institutional investors, such as investors and pension funds, increasingly incorporate environmental, social, and governance (ESG) factors into their investment analysis. It is one of the factors behind the surging demand for green bonds.[8] In France, article 173 of the energy transition law imposes extensive climate change-related reporting for asset owners and asset managers. The objective is to reduce the carbon footprint of the institutional investors. In the UK, the Bank of England has suggested the risk arising from climate change should form part of its annual stress tests for banks in 2019.
Final energy consumption is the total energy consumed by end users, such as households, industry and agriculture. It excludes energy used by the energy sector (ex. processed fuel in power plants).
Nevertheless, in general, progress in designing and implementing the necessary rules and regulations to achieve the Paris goals is very slow as not all governments share the same long-term vision. Some are held back by commercial interests. Fossil fuel supply and thermal power investment are increasingly dominated by state-owned enterprises. Moreover, the electorate might not be convinced of the necessity of taking active measures in particular if these are costly and may affect their lifestyles. The US government is leaving the Paris climate agreement as a substantial part of its voters doubts the veracity of climate change and fear that it could put US industry at a disadvantage.
Finally, reducing global emissions by fixing national objectives has turned out to be very complicated. A global quantitative target is easily translated in a global price target, as to each quantitative objective a shadow price – i.e. the optimal carbon price – is associated.[9]
The difficulty is that a global quantitative target is not easily translated into individual targets for each country. In the negotiations, each country has an incentive to keep the NDC as low as possible. In this approach it is easy to become a free-rider. The result is a set of about 200 individual quantitative targets which do not add up to the global objective.
From an economic view, a price target, or an environmental tax, is preferable to a quantity target. It is accordance to the principle that individuals and firms should pay the full marginal costs of the emission of carbon. Once the global price is set, all countries are free to design policies to achieve the carbon price and to recycle the proceeds of the tax. However, the implementation of a sufficiently high carbon price is rather problematic. One of the problems is that increases in carbon prices, or more generally in fuel prices, might result in redistribution problems and are often resisted. Users cannot change quickly to cheaper alternatives without incurring heavy costs. In addition, carbon tax hikes may disadvantage disproportionally rural populations that do not have access to good public transport. Lastly, for the tax payer, the link between carbon taxes and climate objectives is not always clear. These taxes could be perceived as just another way to finance the budget.
In 2018, a modest increase in French carbon taxes triggered off heavy street protests which forced the government in reversing the measure. Voters in Washington State also recently rejected a carbon tax. In this case, the tax would have been devoted to renewable energy projects and helping negatively affected workers. In order to gain the support from the trade unions, large industrial facilities would have been exempted. The full force of the measure would have fallen on oil refiners. In this context, it is not surprising that the refiners spent heavily to defeat the ballot proposal.
A solution could be the better framing of climate policy. Recently, George Shultz and Ted Halstead have proposed the so-called ‘Carbon Dividends Plan’.[10] The idea is quite simple. A carbon fee will be levied and the proceeds, the so-called dividend, should be returned directly to tax payers through equal lump-sum rebates. They argue that such a programme would be very popular in the US as over two-thirds of American households would be financial winners, as they receive more in dividend payments than they would pay in increased energy prices. As the wealthier households tend to pollute more in absolute terms, they would face the highest costs. According to the authors, the bottom income deciles would experience the greatest net gains.
A yet unsolved problem is the so-called ‘carbon leakage’. Carbon tax hikes, might induce enterprises to move their most polluting activities to countries with less strict environmental legislation. This would have a negative effect on industrial activity while at the same time hardly reducing global emissions. To solve the problem, William D. Nordhaus, the 2018 Nobel laureate in Economic Sciences suggests that countries could form coalitions, the so-called ‘climate clubs’. [11] These groups agree on a carbon price emitted within their borders. This could be done either by a domestic carbon tax or a trade-and-cap system.
The coalition would impose tariffs at their borders on imports from the rest of the world, both to incentivise other countries to join and as a mean to restricting carbon leakage. Exporters to countries which do not apply a carbon tax would receive a rebate. Two options are possible to determine the size of the tariffs. A first approach is to set tariffs in relation to the carbon contents of imports. Such a tariff would remedy a competition distortion caused by the fact that producers outside the coalition would not be affected by the carbon tax. Some precedents suggest that such tariffs would be legal under WTO rules.[12] But there is a practical problem. It is impossible to work out the carbon contents of every import and some approximations are required. For this reason, Professor Dieter Helm suggests to concentrate on a small number of energy-intensive industries, such as steel and chemicals.[13] Nordhaus is in favour of the second approach, a uniform border tax. The advantage is that such a tax is simple to implement. Moreover, by setting the tax rate sufficiently high, countries have a financial incentive to join the coalition. Both options are likely to be legally challenged. It might require a change in international law to make such import taxes legal.
The major flaw of the COP and the Paris climate deal is that the process is rather non-committal. Countries can leave the deal without incurring sanctions, they are for the moment free to formulate their own objectives and there are no sanctions if these objectives are not met. Nordhaus concludes his above mentioned AEA lecture by noting that “without sanctions, there is no stable climate coalition other than the non-cooperative and low abatement coalition.” By contrast, “an international climate treaty that combines target carbon pricing and trade sanctions can induce substantial abatement”.[14]
Growth and energy projections (investment, capacity, consumption) 2020 to 2050
