Why companies should pay attention to climate change proposals

Climate issues have moved to the forefront of global policy discussions, and businesses cannot afford to sit on the sidelines. Governments around the world are announcing commitments to carbon neutrality, and increasingly, investors and customers are asking businesses to integrate climate plans into their long-term strategies. The pandemic has further accelerated the global push toward net zero greenhouse gas emissions – and in fact, EY teams have committed to being net zero by 2025. The time is ripe for action, and momentum is building for climate policy responses.  

In fact, many businesses are focused on the issue. As part of their environmental, social, and corporate governance (ESG) strategies, they are putting forth climate commitments and targets. CEO groups and well-known large global and investment companies have called for large-scale action – with some favoring market-based solutions, others pushing for reengagement with the Paris Agreement and enhanced disclosure of businesses’ climate plans, and still others committing to carbon pricing regimes. Consumers are watching, and are making purchasing and investment choices based in part on a company’s climate strategy.

Climate policy 101

Climate-related policies touch on a number of economic, environmental and industry issues, including:

• Effects on pollutant emissions and the environment
• Economic and revenue implications
• Effects on specific industries and sectors
• Corporate stewardship and commitment to a low-carbon future
• Cross-border business consequences

Methods to address greenhouse gas emissions fall into three general categories that countries and regions also sometimes use in combination – regulations, cap-and-trade programs and carbon taxes.¹ Fuel efficiency and emissions standards fall under the regulatory category, while cap-and-trade programs such as the EU’s emissions trading system (ETS) require energy-intensive plants to obtain tradable permits for the carbon they emit.

Carbon tax policies typically have at their core some type of pricing on carbon output. Economists generally prefer carbon taxes because of their simplicity and certainty, and because these taxes are thought to reflect a more direct correlation between emissions and their cost.

For businesses, especially those with an international footprint, the use of different approaches by different countries and regions can create complexity and uncertainty. Globally, support is increasing for a market-based mechanism for pricing carbon as governments around the world announce commitments for carbon neutrality. Currently, 46 national and 32 subnational jurisdictions put a price on carbon.²

Most carbon tax proposals begin at $25 or $30 per ton and increase according to a formula or rule based on carbon mitigation and inflation. In the recent US proposals, the highest CO2 tax rate in the year 2030 would range from $30 per ton to $165 per ton. The Netherlands is introducing a carbon levy/tax in 2021 that complements the existing EU Emissions Trading System³. The tax starts at €30 (US$36) per ton and is set to rise to €125 (US$150) by 2030. Most of the carbon pricing programs typically focus on covering major emissions sources within the economy.

As with any type of tax, there are drawbacks inherent in carbon pricing, and one key issue would be its impact on lower- and middle-income taxpayers. Design of the tax matters, and some parameters policymakers need to consider when designing any carbon tax proposal include:

• What to tax: stationary sources such as power generators, mobile sources such as gasoline or both
• The initial tax rate and how it would change over time
• Where to assign the statutory incidence of the tax
• How to account for differences in carbon regimes across the globe. For example, to prevent disadvantaging domestic industry relative to imports not subject to carbon pricing, a US carbon tax would likely feature a border adjustment
• How to spend the revenue generated
• What’s the impact on existing regulatory regimes to reduce emissions that are already in place
   

Global climate policy developments

Three of the largest Asian economies have all committed to carbon-neutral goals. Mainland China, the world’s largest CO₂  emitter,⁴ has an existing regional ETS and has committed to carbon neutrality by 2060. Japan, the region’s third largest economy, is targeting zero emissions of greenhouse gases and has pledged to be carbon-neutral by 2050, as has South Korea, which also has an existing national ETS. South Korea’s Green New Deal proposal includes funding for renewables, replacement of some coal capacity with natural gas, an end to coal financing and possible introduction of a carbon tax.

In Europe, the EU Green Deal strategy aims to decouple economic growth from the use of natural resources and achieve carbon neutrality by 2050, with a price tag of €1 trillion. Key EU Green Deal initiatives include supporting new business models based on circular product design with a common methodology, promoting bio-based plastics or reusable/recyclable packaging, and a new carbon border adjustment mechanism (CBAM) to address the risk of carbon leakage. The EU’s CBAM will apply to all imports into the EU and could provide a point of reference for US policymakers.

The EU Emissions Trading Scheme (EU ETS) – a cap-and-trade system - entered its fourth phase in January 2020, with prices increasing for its participants. It is estimated that the ETS covers 45% of the EU’s greenhouse gas emissions, and 30 countries are participating. Further changes are expected to reflect increased emissions reduction targets by 2030.

US President Joe Biden has moved quickly to emphasize his commitment to climate issues, signing executive orders to pause oil leasing on federal land and committing to a number of sustainability initiatives that complement his campaign pledge to drive US $2 trillion in green initiatives and investments.⁵ He has also pledged to put climate issues “at the center of United States foreign policy and national security,” creating numerous new climate-related positions to help implement his goals. He further committed the Treasury Secretary to develop a strategy for promoting financing programs, economic stimulus packages and debt relief aligned with sustainability through international financial institutions.⁶ From a legislative standpoint, the US Congress has introduced or reintroduced at least nine legislative climate proposals in 2019 and 2020, four of them with bipartisan sponsors.⁷

On President Biden’s first day in office, his administration rejoined the Paris Agreement and confirmed that he would host a leaders’ climate summit on Earth Day, April 22. The Paris Agreement is the first legally binding international agreement on climate change. It aims to limit global warming to well below 2°C, preferably 1.5°C, compared to pre-industrial levels. Under the agreement, countries will report transparently on their efforts and progress on climate change mitigation starting in 2024.   

Revenue implications

Governments are weaving sustainability and climate into their budget plans as they consider economic relief measures in the wake of the pandemic. In July 2020, EU leaders agreed on an economic recovery plan to rebuild member states’ economies and lay a foundation for a more sustainable Europe. The funds for the recovery will be concentrated in a €750 billion financial instrument called Next Generation EU. The EU Green Deal has been placed at the heart of the economic recovery, with 30% of the funds dedicated to green and sustainable investments.

Part of a carbon tax’s appeal is its potential use as a revenue raiser – as an example, a $25/ton carbon tax, adjusted annually by 2% after accounting for inflation, is estimated to raise $1.1 trillion over the 10-year budget window.⁸  This can make carbon taxes enticing to policymakers, especially at a time when countries are running large budget deficits.

In the United States, proposals to date have identified a variety of uses for the revenue produced, from infrastructure investment to payroll tax reductions, Social Security payments and deficit reduction. The Tax Foundation, an independent tax policy non-profit organization, has raised the possibility of using a carbon tax to pay for extending the individual tax title of the Tax Cuts and Jobs Act, which expires after 2025.⁹ Globally, existing carbon pricing initiatives cover 22% of global greenhouse gas emissions and raised US$45 billion in revenues in 2019.¹⁰