Tax policy option to support climate change and sustainability

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Introduction

It’s been just over one year since world leaders from the United Nations Framework Convention on Climate Change adopted the Paris Agreement at the 21st Conference of the Parties (COP 21). This legally binding, universal agreement set a long-term goal of limiting the global temperature increase to well below 2°C above pre-industrial levels and pursuing efforts to contain the increase to 1.5°C. More than 60% of the convention parties ratified the agreement, which took effect on 4 November 2016.

To comply with the Paris Agreement, each country must establish its own emission reduction target. Individual nations have a variety of policy options to meet their goals, including mandates, regulations and incentives. Carbon pricing, supported by some in the business community, has emerged as a cost-effective method to control emissions. Indeed, more than 1,000 global businesses endorse it as the most cost-effective approach.

Carbon pricing overview

As world leaders evaluate the most effective carbon pricing plan for their countries, they have two main options: emission trading systems and carbon taxes. Trading systems, often in the form of a cap-and-trade regime, account for 40% of global gross domestic product and are present in 35 countries, as well as a handful of subnational jurisdictions.

Under a cap-and-trade regime, governments set limits on emissions, and markets determine the price of carbon. Although it is advantageous to set a specific limit on emissions, it can create uncertainty for businesses because the price of carbon varies depending on the market. Under a carbon tax system, by contrast, the price is fixed and there are no emission limits. This option may be more business-friendly because it provides pricing predictability and allows companies to plan for its impact. Many economists favor a tax system, arguing it is more efficient to implement and administer than a cap-and-trade system.

Corporate internal pricing of carbon

Increasingly, corporations are implementing an internal carbon price. Some 1,249 companies currently have — or plan to add — an internal price on carbon emissions,1 a 23% increase from 2015, according to the Carbon Disclosure Project, a global nonprofit organization that measures corporate and government environmental impacts. Of these companies, 517 already use an internal carbon price while 732 plan to implement one by 2018.

Internal pricing systems vary widely among companies. At the most basic level, internal carbon pricing serves as an accounting and risk management tool. But some companies use it to achieve emission reduction goals and adjust budget allocations.

This results in a shadow price on the profit and loss statements of a company’s business units. By adding this burden to future investments and operational costs, companies can anticipate and manage the risk of government legislation on carbon pricing, monetize and record the negative externalities of carbon emissions, and incentivize lower-carbon projects by incorporating the price in return-on-investment calculations.

The spread of internal carbon pricing demonstrates corporate commitment to sustainability and preparation for future carbon prices by government entities.

Current and future carbon taxes

Since COP 21, momentum has built for implementing carbon pricing worldwide and reducing greenhouse gas emissions. Already, 40 national jurisdictions and more than 20 cities, states and regions have imposed a price on carbon, according to an October 2016 World Bank climate change report. Of those, 17 implemented a carbon tax.

The scope and rate of the carbon tax vary by jurisdiction, from less than US$1/tCO2e in Mexico and Poland to more than US$130/tCO2e in Sweden. However, most rates are in the US$10 to US$25 range and generally apply to most fossil fuels.2

The Canadian province of Alberta introduced carbon taxes at the beginning of 2017, following in the footsteps of neighboring British Columbia. The Alberta carbon tax applies to diesel, gasoline, natural gas and propane, with a rate of CAD20/tCO2e in 2017, rising to CAD30 in 2018. The Prime Minister of Canada announced that all provinces must implement carbon pricing by 2018 or face a federal carbon tax. Separately, Chile, South Africa and Colombia finalized carbon tax plans and regulations.

Carbon tax policy considerations

Jurisdictions have a handful of policy options3 to consider when implementing a carbon tax, including:

  • What fuel and energy sources should be taxed and at what rate?
  • At what stage in the fuel supply should the carbon tax be assessed?
  • How would the disproportionate impact on low-income families be offset?

Some taxpayers are concerned about whether the tax should be revenue-neutral, meaning that any revenue from it would be returned to taxpayers through tax rate reductions or credits. Revenue neutrality may be crucial to gaining support from taxpayers and businesses.

Nearly two-thirds of registered US voters support a carbon tax on fossil fuel companies and would use the revenue to reduce other taxes, according to a survey by the Yale Program on Climate Change Communication.4 Some economists have found that revenue-neutral carbon taxes would have a minimal impact on the economy because reducing the other taxes offsets nearly all the negative effects of imposing a new tax on consumers.

For example, the eight-year-old revenue-neutral carbon tax in British Columbia continues to reduce greenhouse gas emissions and does not appear to have hurt the economy. Emissions are down 6.1% in the province since the tax was enacted but are up 3.5% in the rest of Canada. British Columbia also outpaced Canada as a whole in gross domestic product growth over the same period. As a result, British Columbia reduced personal and business taxes by CAD1.2 billion in 2013.

What EY can do

The EY Global Sustainability Network advises clients on the business implications of carbon and other energy taxes, which are increasingly seen as viable options to curb greenhouse gas emissions. EY recently hosted two carbon tax forums in the US, featuring some of the largest US-based corporations. Here are three points for businesses to consider:

  • Operation cost reductions. Costs can be reduced by minimizing energy and environmental taxes, adapting strategies and implementing relief. In 2016, EY helped a US-based client with operations in the UK to secure a reduction of more than £3 million against the UK Climate Change Levy from energy efficiency gains.
  • Enhanced return on investment. Identifying and securing sustainability-related incentives can aid the return on investment, from renewable energy endeavors to energy efficiency retrofits. In the US alone, EY helped capture a substantial amount in sustainability-related tax incentives and grants.
  • Risk reduction and limitation. Verifying that all compliance and reporting requirements are met can help reduce the threat of audits and penalties. Our teams throughout the European Union can confirm that energy taxes are reported timely and correctly.

Conclusion

We all see the harmful effects of climate change and know that it threatens future generations. Could businesses and governments use tax policy to steer social change and help save the environment?
As countries explore policy options to meet their emission goals, they should view carbon taxes as a strong contender. Carbon tax systems, particularly those that are revenue-neutral, may be the most appealing approach for the business community. Such taxes have a minimal negative impact on the economy — as seen in British Columbia — and could ease political tensions among the business community and others as taxpayers benefit from offsets. As world leaders address this pressing problem, expect taxes to play a vital role.

EY - Jeffrey N. Saviano

Jeffrey N. Saviano
New York: +1 212 773 0780
Boston: +1 617 375 3702

EY - Dominick Brook

Dominick Brook
+1 614 232 7376


1 Embedding a carbon price into business strategy, Carbon Disclosure Project, September 2016.

2 State and Trends of Carbon Pricing, World Bank Group, https://openknowledge.worldbank.org/bitstream/handle/10986/25160/9781464810015.pdf?sequence=6&isAllowed=y, accessed on 13 February 2017.

3 “11 essential questions for designing a policy to price carbon,” The Brookings Institution, https://www.brookings.edu/research/11-essential-questions-for-designing-a-policy-to-price-carbon, accessed on 13 February 2017.

4 Politics & Global Warming, November 2016, Yale Program on Climate Change Communication, http://climatecommunication.yale.edu/publications/politics-global-warming-november-2016/2/, accessed on 13 February 2017.