ADDRESSING CLIMATE CHANGE THROUGH CARBON TAXES — Pros and Cons
In this column, I write about an environmental, economic, and policy issue—in this case, climate change and carbon taxes. The basic idea is written in such a way that a layperson or actor can understand it. Given that it was intended to be as brief as possible, all information could not be included. Nevertheless, references are provided. You are welcome to read, like, and comment on this page.
Introduction
Humans' desire for a better standard of living is constantly growing, and this quest has resulted in increased production and consumption. As we develop, our economic activities continue to affect and cause changes in the earth’s climate. If we need a reminder of climate change, the recent floods that displaced over a million people in Nigeria (World Economic Forum, 2022), the wildfires in California that caused nearly $150 billion in damage (Wang et al., 2020), and the 2018 heatwave and drought in Europe that resulted in overall cereal production being 8% lower than the previous five years (Brás et al., 2021) are vivid extreme weather events caused by climate change that is driven by human carbon emissions. Following this, an increasing number of leaders agree that in order to mitigate the issue of climate change (transition to a decarbonized economy), we must bring these increasing carbon emissions under control. The public economists’ historical statement regarding carbon dividends, which was printed in the Wall Street Journal, is one prominent example (Wall Street Journal, 2019). Furthermore, it is widely agreed that carbon taxes are a quick and effective way to put real economic pressure on people to switch from carbon-based fuels (Zhang et al., 2016; Hagmann et al., 2019). However, there are issues and controversies with this economic strategy.
Carbon tax
A carbon tax, according to the World Bank, is an economic instrument that directly sets a price on carbon by defining a tax rate on greenhouse gases (GHGs), commonly the carbon content of fossil fuels and CO2 equivalents of other GHGs. Their primary goal is to bring to light the hidden social cost of carbon emissions, i.e., the marginal impact of GHG emissions. This is the damage done by emitting an additional ton of CO2 or the damage avoided by reducing emissions by a ton. Unlike traditional command-and-control policies, which require polluters to set one or more output or input quantities at specific levels, prohibiting them from exceeding them, carbon taxes establish a price that emitters must pay for each ton of GHG emissions (Greenbaum, 2010). In economic theory, pollution is a negative externality and a type of market failure; to address this, economists propose taxing the good that is the source of the externality in order to reasonably reflect the social cost of producing the good to society (Hagmann et al., 2019). As a result, it encourages businesses and industries to develop more environmentally friendly production processes (Hagmann et al., 2019).
Economic perspective:
From an economic standpoint, the projected resultant effect when higher prices are set on carbon-based fuels is that households and businesses will be pushed to reduce the level of pollution and look for alternatives. Therefore, the implementation of a carbon tax would encourage investments in renewable energies, leading to further technological innovation and limiting carbon emissions (Bohm et al., 1985). There is however another economic instrument that does so and arguably creates efficiency between firms — this is the cap and trade system. By efficiency, we refer to the marginal cost of abatement, that is, the marginal loss in company profits from avoiding the last unit of pollution or the marginal cost of reaching a specified pollution target. While a carbon tax sets the price of CO2 and CO2 equivalents and allows the market to determine the amount of reduced emissions but doesn’t consider the differences in abatement costs of emitters (a con), a cap and trade system sets the emission target and issues a quantity of emission allowances distributed to companies, either for free or through an auction (Bohm et al., 1985). Emitters must then hold allowances for emitting each ton of GHG and can also abate their emissions at a lower price and sell their excess allowances to those with higher abatement costs. In the long run, cap-and-trade gives companies stronger incentives to save money by cutting down emissions. A cap-and-trade system, however, requires a certain amount of bureaucracy to select which companies get covered, and that leaves out millions of small ones (Cheung, 2022). A pro of carbon tax over the cap and tradable permits is that the fee is applied at the source and thus is more effective.
How carbon taxes work: Case of plastics
As previously stated, a carbon tax directly sets the price of GHG emissions and applies it to various fuels based on their intensity (carbon content and/or CO2 equivalents). Let us consider the case of plastics. Carbon taxes on plastics have been used to incentivize recycled plastic in packaging in order to improve circularity in the sector and reduce emissions. According to reports such as the Global Plastic Outlook, plastics have significant carbon footprints, accounting for 3.4% of global GHG emissions throughout their life cycle (OECD, 2022). To internalize the social cost of carbon and revitalize the recycled plastics market, countries such as the United Kingdom impose a £200/tonne tax on plastic packaging made or imported with less than 30% recycled plastic per weight. By adding this value to the secondary material chain, it is possible to divert plastics that would otherwise end up in landfill or incineration.
To illustrate, consider the following scenarios:
- Business A produces 200 tons of plastic packaging in the United Kingdom from 100% virgin material. Business A is taxable at £200 per tonne, and they will pay that for all 200 tons because none of it falls under the 30% recycled content threshold. The total liability cost would be £40,000 (£200 x 200 tons).
- Then say Business B is importing 200 tons of plastic packaging, but 100 tons of that packaging is coming from a supplier who can demonstrate that they have properly incorporated 30% recycled content into the material. What this means for Business B is that they only have to pay the tax on the remaining 100 tons for which they cannot provide evidence. Their liability is thus cut in half, totaling £20,000 (£200 x 100 tons).
Why carbon taxes are hard to implement
Regardless of the prospects of carbon taxes, there are several reasons why some governments may choose not to implement them, one of which is the impact on welfare. The party responsible for picking up the tax liability suffers direct consequences. In our previous example, the direct impact was felt by the importers and manufacturers of plastic packaging. In terms of indirect impact, individuals will not pay the taxes directly, but the cost will be borne by the supply chain. As a result, if we buy an item from a UK manufacturer, for example, and that manufacturer paid the carbon tax on those goods, the cost will almost certainly increase by the amount paid as tax. This has a regressive impact, hurting poorer people more than richer people and causing them to lose welfare. For example, an increase in formal energy sources like fuel can push poorer people to use more firewood or coal, which is something we do not want (World Bank, 2022). Secondly, there is an acceptance viewpoint. Carbon price changes have a history of igniting protests, and these protests have the potential to halt these reforms. Thirdly, carbon taxes are based on the economic premise that there are viable alternatives. If these alternatives are unavailable, they become ineffective. Another reason the government might be hesitant is that new taxes can be politically difficult to implement because they would harm entrenched business interests.
Conclusion
As we have discussed, economists assert that carbon taxes are the most cost-effective way to combat climate change (Zhang et al., 2016; Wall Street Journal, 2019; Hagmann et al., 2019). However, a number of studies have found that, in the absence of increased social benefits, a carbon tax would hit poor households harder than rich households (Callan et al., 2009; Berry, 2019). Despite the debate over cap and trade versus carbon tax, they are both sides of the same coin because they both aim to reduce global warming and the negative effects of GHG emissions. Ultimately, a stable climate is more likely to be achieved through the application of multiple economic strategies, depending on the country context. In my opinion, carbon taxation should be viewed as a single element that should be interwoven with alternative non-tax policies to ensure the social and political stability of reforms over the medium and long term.
I hope you enjoyed reading; best wishes!
References
Berry, A. (2019, January). The distributional effects of a carbon tax and its impact on fuel poverty: A microsimulation study in the French context Energy Policy, 124, 81–94. https://doi.org/10.1016/j.enpol.2018.09.021
Bohm, P.; Russell, C. S. (1985). Handbook of Natural Resource and Energy Economics Chapter 10: Comparative analysis of alternative policy instruments, Volume 1, Pages 395–490 Retrieved November 17, 2020 from https://doi.org/10.1016/S1573-4439(85)80013-0
Brás, T. A., Seixas, J., Carvalhais, N., and Jägermeyr, J. (2021). Severity of drought and heatwave crop losses tripled over the last five decades in Europe. Environmental Research Letters, 16(6), 065012. https://doi.org/10.1088/1748-9326/abf004
Callan, T., Lyons, S., Scott, S., Tol, R. S., and Verde, S. (2009). The distributional implications of a carbon tax in Ireland energy policy, 37(2), 407–412. https://doi.org/10.1016/j.enpol.2008.08.034
Cheung, J. (2022). Cap-and Trade Vs Carbon Tax | Earth.Org. Earth.Org. Retrieved December 3, 2022, from https://earth.org/cap-and-trade-vs-carbon-tax/
Greenbaum, A. (2010). Environmental Law and Policy in the Canadian Context Concord, Ontario: Captus Press. pp. 240–241. ISBN 978–1–55322–171–5.
Hagmann, D., Ho, E. H., & Loewenstein, G. (2019, May 13). nudging out support for a carbon tax. Nature Climate Change, 9(6), 484–489. https://doi.org/10.1038/s41558-019-0474-0
OECD (2022). The Global Plastics Outlook: Economic Drivers, Environmental Impacts, and Policy Options Executive Summary: Global Plastics Outlook: Economic Drivers, Environmental Impacts, and Policy Options | OECD iLibrary Retrieved November 21, 2022, from https://www.oecd-ilibrary.org/
Wall Street Journal (2019). Opinion | Economists’ Statement on Carbon Dividends WSJ. Retrieved November 13, 2022, from https://www.wsj.com/articles/economists-statement-on-carbon-dividends-11547682910
Wang, D., Guan, D., Zhu, S., Kinnon, M. M., Geng, G., Zhang, Q., Zheng, H., Lei, T., Shao, S., Gong, P., & Davis, S. J. (2020, December 7). Economic footprint of California wildfires in 2018 Nature Sustainability, 4(3), 252–260. https://doi.org/10.1038/s41893-020-00646-7
World Bank (2022). What a carbon tax can do and why it cannot do it all. World Bank blogs. Retrieved November 22, 2022, from https://blogs.worldbank.org/energy/what-carbon-tax-can-do-and-why-it-cannot-do-it-all
World Economic Forum (2022). Nigeria’s worst floods in a decade have displaced over a million people. Climate Change. Retrieved November 9, 2022, from https://www.weforum.org/
Zhang, K., Wang, Q., Liang, Q. M., & Chen, H. (2016, May). A bibliometric analysis of research on carbon tax from 1989 to 2014. Renewable and Sustainable Energy Reviews, 58, 297–310. https://doi.org/10.1016/j.rser.2015.12.089
