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.
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