12 minute read 13 Jun 2019
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How future growth depends on tackling climate change

12 minute read 13 Jun 2019

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Carbon taxes provide a way forward if businesses work with governments to address this global challenge.

One might call it the Robin Hood approach to climate change. Earlier this year, some of America’s best-known political leaders, economists and business chiefs got together and called for a new tax.

A tax on carbon emissions of US$40 a metric ton — gradually climbing further over time — is the best available way to combat climate change and provide insurance against its risks, former US Secretary of State James Baker and his colleagues wrote in a report from the Climate Leadership Council.

Renewable energy is a great way to reduce your carbon footprint, but what I really encourage is investments in energy efficiency.
Dominick Brook
US Leader of Global Sustainability Tax Services at EY

They suggested that the proceeds be redistributed to ordinary Americans at a rate of US$2,000 a year per family of four in the form of checks, direct deposits or pension account contributions.

“The risk is sufficiently strong that we need an insurance policy and this is a damn good insurance policy,” Baker told The Washington Post earlier this year.

Coming around

It was an unusual proposal from a group whose public face was Baker, remembered for negotiating lower tax rates as part of the Tax Reform Act of 1986 while serving as US President Ronald Reagan’s Treasury Secretary.

The US has long struggled to find consensus on the need to fight global warming. Indeed, US President Donald Trump in June announced his country’s plans to exit the landmark Paris climate accord, saying it placed “draconian burdens” on US companies.

The case for carbon pricing is getting more traction elsewhere in the world.

Driven by an early Scandinavian upsurge in environmental awareness, Finland introduced the world’s first carbon tax in January 1990. Sweden, Norway and Denmark followed suit, as part of a concerted drive to reduce carbon emissions.

By 2016, according to the World Bank Group’s State and Trends of Carbon Pricing report, some 40 national jurisdictions and more than 20 cities, states and regions were pricing carbon, accounting for 13% of greenhouse gas (GHG) emissions around the world.

Now, says the World Bank report, 101 countries are considering or drawing up carbon pricing proposals covering 58% of GHG emissions, including three of the world’s largest GHG emitters: China, India and Brazil. Carbon has a cost and pretty soon, it seems, most of the world will be paying at least part of it.

“We are at a tipping point now for carbon pricing,” says Mikael Skou Andersen, professor of environmental policy analysis at Aarhus University in Denmark.

The trigger was the Paris Agreement in December 2015, in which 195 nations agreed on actions designed to limit global warming to well below two degrees centigrade above temperatures prior to the Industrial Revolution. (Despite the US’s official exit from the agreement, a number of US states and cities remain committed to the accord.)

The surprise is that it has taken so long. In May 1989, The Economist magazine predicted that within half a century many industrial countries would raise a fifth of their revenues from pollution taxes and charges.

Governments and the business world ignore climate change at their own peril. In a 700-page study in 2006, former World Bank chief economist Nicholas Stern called climate change a massive “market failure” that could wipe 5-20% off global gross domestic product (GDP) each year, undermining prosperity. Stern’s analysis considered potentially devastating economic effects to humans and the environment, such as the impact of rising sea levels and falling crop yields.

In other words, global economic growth would become global decline.

Biding time

Fossil fuels are unduly cheap, economists say, because those who burn them do not pay for their adverse effects.

Advocates argue that carbon pricing encourages fuel burners to release less carbon, and can help finance a switch to less harmful technologies and compensate those affected by the consequences of climate change.

Professor Roberton C. Williams III of the University of Maryland says there is widespread consensus today that “the most cost-effective way to control pollution is some sort of pricing.”

But getting policies implemented is tough. “It’s like roommates debating who is going to take the trash out,” says Williams. “Everyone wants someone else to do it.”

Countries, regions and states have tried three principal routes to containing GHG emissions: regulations, carbon taxes and cap-and-trade schemes, whereby energy-intensive plants, including power generators, must have tradable permits for the carbon they emit. Some use all three.

Market-based cap-and-trade schemes should theoretically focus on efforts to reduce carbon where they can do most good. But they haven’t always worked well.

Take the European Union’s Emissions Trading System (ETS), the world’s largest trading system for GHG emission allowances. Critics say the carbon trading price is too low to encourage companies to cut their emissions and invest in new green technologies.

For businesses (especially those with an international footprint), different measures, in different countries, with different time frames, create complexity and uncertainty.

“Companies are often not keen on cap-and-trade schemes because the market mechanism of these schemes leads to uncertainty in the price of carbon,” says Dominick Brook, US Leader of Global Sustainability Tax Services at EY.

The cure

Carbon taxes, by contrast, are simple, effective and quick to introduce. And because tax authorities collect them from a relatively small number of large companies (which simply raise their prices to their customers) they are cheap to collect and difficult to avoid.

In North America, it is often states, rather than national legislatures, that have pioneered carbon pricing. The Canadian province of British Columbia, for example, introduced a revenue-neutral carbon tax in 2008. Revenue from the carbon tax is redistributed through reductions in other taxes, including personal income and corporate income tax rates.

Though energy companies had to pay more tax, and were able to pass this on to their customers, citizens were aware that overall they were no worse off, says Jeff Saviano, EY Americas Tax Innovation Leader. Canada now plans a minimum nationwide carbon price floor of C$10/metric ton in 2018, rising to C$50/metric ton in 2022.

Carbon taxes are attractive for governments facing deficits: Ireland, for example, introduced a carbon tax in 2010, in the wake of the financial crisis. Emerging economies such as South Africa hope GHG taxes can do good while compensating for a narrow tax base and weak revenue streams.

“Many finance ministries are behind this,” says Ian Parry, Principal Environmental Fiscal Policy Expert at the International Monetary Fund (IMF) in Washington. “A lot of countries are very excited about potential revenues from carbon pricing.”

Indeed, carbon taxes can offer intriguing choices to policymakers, says Professor Janet Milne, Director of the Environmental Tax Policy Institute at Vermont Law School.

A US study of a possible carbon tax in Vermont, The Economic, Fiscal, Emissions, and Demographic Implications from a Carbon Price Policy in Vermont, estimated that a price of US$50/metric ton of CO2 would generate up to nearly US$300 million a year of revenue, compared with a current state budget of about US$6 billion.

But combating climate change effectively requires multiple policy tools, she says.

“We are all learning from experience about the best ways to combine different instruments.” And Parry cautions that “we are currently an awful long way from where countries need to be to be consistent with their Paris pledges.”

Sustainability, carbon and environmental tax life cycle

Complex choices

Adele Morris, Senior Fellow and Policy Director for Brookings’ Climate and Energy Economics Project, acknowledges policy choices are complex and require careful study, because the knock-on effects on companies and economies can be great.

“Different fossil fuels have different levels of carbon intensity per unit of energy they provide,” says Morris.

Adding a carbon price changes their prices relative to each other, and to non-fossil alternatives. “So that instantly incentivizes a shift in production choices and technology choices.”

For companies, the detail of each carbon tax scheme can have far-reaching implications.

One of the reasons carbon prices around the world vary hugely in price per ton is that they also vary widely in scope. Sweden’s headline tax of US$131/metric ton of CO2 applies to household fuels, says Parry, but not to large energy intensive plants, which are subject to the EU cap-and-trade scheme in which recent prices have been below US$10 per ton.

Carbon pricing in China or India, which rely heavily on coal, would have a larger proportionate effect on reducing carbon emissions than in the US or Europe, according to Parry.

IMF studies suggest that some countries, like China, India and Indonesia, would easily meet their mitigation pledges for the Paris Agreement with carbon prices of US$70 per ton by 2030, while others like Australia, Canada and some EU countries will need much higher prices.

More and more companies, including US-based multinationals, are already adopting internal pricing for carbon.

This helps avoid projects that would become loss-making if carbon pricing that impacts their operations is introduced in the future.

Some “are allocating those dollars into a central fund and are then using those dollars to introduce greater use of green technology and taking other steps to mitigate climate change,” Saviano says.

For now, it is difficult for businesses faced with diverse and unpredictable climate mitigation policies across governments to evaluate potential investment projects in different countries, especially those that are energy intensive and involve long-lived assets. They are looking for greater transparency.

“Companies want a seat at the table,” says Saviano. In the US and elsewhere, they seek predictability and a view of what the future holds, he explained.

Being efficient

Brook, who advises companies on sustainability, points out that there’s a simple strategy open to many companies: minimize carbon usage.

“Renewable energy is a great way to reduce your carbon footprint, but what I really encourage is investments in energy efficiency,” he says. This enables companies not only to reduce their carbon emissions, but also boosts their bottom line by reducing energy costs.

Increasingly, there are signs that large-scale carbon mitigation technologies are also at a tipping point. Wind and solar energy are now sometimes cheaper than fossil fuels according to the World Economic Forum, while energy storage devices are improving fast. As prices fall, sales of renewable power and electric vehicles are soaring, albeit from a modest base.

That doesn’t make the introduction of carbon taxes any less likely. But it does flag the possibility of an investment boom that will enable companies and consumers to mitigate some of their effects.

As the IMF’s Parry concludes: “Higher energy costs can negatively impact the economy. But if the revenues from carbon pricing are used to cut taxation burdens on business or labor, or fund socially productive investment, for example in infrastructure, there is a large offsetting benefit to the economy.”

How long can politicians resist?

A smooth start

Adele Morris, Senior Fellow and Policy Director for Brookings’ Climate and Energy Economics Project, suggests five ways to minimize unwanted shocks to corporate or national competitiveness from the introduction of carbon taxes.

Key action points

  • Stay up-to-date with carbon pricing proposals in the jurisdictions where you – and your rivals – operate.
  • Introduce carbon pricing across your business at a credible threshold so that investment projects are carbon-pricing proof.
  • Invest in reducing carbon emissions in every aspect or your business, profiting from falling renewable prices.
  • Make low-carbon strategies a mainstream part of your business, and share this commitment with employees, customers and the communities where you operate.

This article was originally published in Tax Insights on 5 September 2017.

Summary

According to the World Bank, 101 countries are considering or drawing up carbon pricing proposals covering 58% of greenhouse gas (GHG) emissions, including three of the world’s largest GHG emitters: China, India and Brazil. Carbon has a cost and pretty soon, it seems, most of the world will be paying at least part of it.

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