Putting a global price on carbon

Putting a global price on carbon
A carbon tax is less likely to face political opposition while creating avenues for businesses and growth

We stand today on the brink of a long-term anthropogenic and ecological change, caused not by the forces of nature but our own exploitation of the planet’s resources. There is compelling evidence that climate change is the greatest and widest-ranging market failure ever seen, and there is a large chance of a global average temperature rise exceeding 2ºC by the end of this century. It has also been established in various scientific studies that any such warming of the planet will lead to increased natural calamities such as floods and cyclones, declined crop yields and ecological degradation. A large increase in global temperatures correlates with an average 5% loss in global GDP, with poor countries suffering costs in excess of 10% of GDP.

As a mitigation policy

A global and immediate policy response is urgently required to reduce greenhouse gas emissions and mitigate the effects of climate change. We want to reinvigorate the discourse towards adopting a multilaterally coordinated imposition of a carbon tax as a potent mitigation policy. A carbon tax aims to internalise the externality of climate change by setting a price on the carbon content of energy consumed or greenhouse gas emitted in the production or consumption of goods. Carbon tax regimes will only be effective if harmonised internationally. Different country-wise policies could lead to ‘carbon leakages’ where energy-intensive businesses will most likely move to less strict national regimes.

Harmonised carbon taxes hold advantages over quantitative limits imposed through government control and regulation. First, a carbon tax regime avoids the problems related to choosing a baseline. In a price approach, the natural baseline is a zero carbon tax. Second, a carbon tax policy will be better able to adapt to the element of uncertainty which pervades the science of climate change. Quantity limits on emissions are related to the stocks of greenhouse gas emissions, while the price limits are related to the flow of emissions. From this uncertainty arises another complication of price volatility which is the third reason why a carbon tax policy is likely to cause less volatility in the prices of carbon emissions.

Fourth, quantity limiting policies are often accompanied by administrative arbitrariness and corruption through rent-seeking. This sends off negative signals to investors. In a price-based carbon tax, the investor has an assured long-term regulation to adapt to and can weigh in the costs involved.

Addresses issue of equity

Fifth, the most contentious issue in any international negotiation on climate change mitigation either at the level of the World Trade Organisation (WTO) or at the United Nations Framework Convention on Climate Change has been the issue of equity between high-income and low-income countries. The price-based approach in the form of carbon taxes makes it easier to implement such equity-based international adjustments than the quantity-based approach. Finally, the carbon tax will essentially be a Pigovian Tax which balances the marginal social costs and benefits of additional emissions, thereby internalising the costs of environmental damage. It can act as an incentive for consumers and producers to shift to more energy-efficient sources and products.

Some countries and regions such as the U.S. and the European Union already have fairly successful carbon pricing regimes in place in the form of carbon taxes and emissions trading schemes. Some other countries have introduced general taxes on energy consumption instead of direct taxes on carbon content. This can be a good starting point for a shift in policy by countries while they deliberate on a harmonised carbon tax regime. The political consensus in favour of a direct carbon tax will be difficult to achieve in low- and middle-income countries that have developmental priorities and lack the capacity to administer such regimes. A general tax on energy consumption combined with a technology-centric policy that promotes entrepreneurs and investors who develop low-energy intensive products can be a good starting point from where they can gradually move towards a direct carbon tax. Another near-term approach can be a ‘cap-and-tax’ which combines the strengths of both quantity and price approaches. Cap-and-tax might also address the concerns of environmentalists that a price-based approach does not impose hard constraints on emissions.

Africa as a priority region

We conclude with a few areas of further deliberation to move forward on an effective harmonised carbon tax regime. Countries must negotiate and share policy experiences and researches in this area. They also must decide upon the appropriate forum to discuss and implement any such mitigation policy. The WTO could be the preferred forum, given the important nexus between international trade and climate change. Finally, any prospective policy regime must give the highest importance to the African continent. A rapidly growing African economy must then be able to learn from past lessons without having to choose between economic growth and climate change mitigation.

A carbon tax policy might not seem a magic wand, but it is also less likely to face political opposition and compromise while creating new sectors for businesses and growth.