The carbon tax

In my first post about large and small scale climate change mitigation, I mentioned the carbon tax. The tax is considered to be the main alternative to a cap-and-trade system.

Source

What is it?

Carbon taxing involves adding a financial incentive to cutting emissions: bodies, whether they be firms or households, are taxed for each unit of greenhouse gas emitted, with more carbon-heavy fossil fuel products levied by higher taxes (Lin and Li, 2011).

Does it work?

Lin and Li (2011) review the effect of carbon taxes in reducing CO₂ emissions in five of the countries they have been implemented in (Denmark, Finland, the Netherlands, Norway and Sweden). The authors state that there are two main positive impacts to carbon taxing:

(1)    Promotion of substitutes for fuel products, allowing for development of energy saving and energy efficiency.

(2)    Investment into environmental and clean energy initiatives through the money saved from the carbon tax.

However, there are some clear limitations of the method too. A key one of these is economically-based, in that implementing the tax will lead to increased costs for businesses and lower competitiveness. Another is that the ability of the tax to actually mitigate emissions. Lin and Li (2011) argue that rather than leading to emission reductions, businesses could just raise the prices of the their products or services, leading to customers taking on the cost of tax. Carbon leakage could also increase, as carbon intensive industries migrate from carbon taxing countries to other, more lenient countries (Lin and Li, 2011).

The authors found that the carbon tax had differing effects on mitigation depending on the country studied. In Finland, the tax has reduced the growth of carbon emissions per capita by a statistically significant amount. Denmark, Sweden and the Netherlands also experienced reductions, but not by enough to be of significance statistically. In Norway, an increase in per capita emissions was suggested, but again this was not significant (Lin and Li, 2011). This disparity is likely in some part caused by tax exemptions provided by all countries other than Finland, for example, for the manufacturing industry. It is suggested by the authors that in order to obtain the best results from a carbon tax, a single rate needs to implemented rather than differential rates.

Carbon tax vs cap-and-trade

As stated above, there is a large debate as to whether carbon taxing or cap-and-trade offers the best opportunities for mitigating emissions. Wittneben (2009) argues that the European Union Emission -Trading System (EU ETS), one of the most prominent cap-and-trade schemes (and discussed in this post), has ultimately failed at reducing carbon emissions, despite leading to heavy governmental income. The author states that because carbon taxes are negotiated at a national level, the severity of the tax will factor in the political climate of the nation itself, leading to a theoretically-limitless level of emission reductions. This is opposed to a cap on emissions, which also serves as a cap on reductions. Obviously, this is an argument based more on theory than stone-cold facts, as seen by the effectiveness of the carbon tax in the study by Lin and Li (2011).

Another key argument between the two are background financials, which were studied by Carl and Fedor (2016). Wittneben (2009) suggests that a carbon tax rather than cap-and-trade would lead to more capital being available for green initiatives; however, Carl and Fedor (2016) argue that this might not be the case. Analysing $28.3 billion that is currently generated by 40 countries via “carbon revenues”, they state that $7.8 billion of this goes towards “green” spending. Of the money collected from cap-and-trade, 70% is directed towards “green” spending, compared to carbon taxes, in which 72% of the income goes to government general funds instead. There is more complexity to the argument than this however, as carbon taxes have the ability to generate more capital than cap-and-trade Carl and Fedor (2016).

Cleetus (2011) offers a potential solution encompassing both methods, called the price collar. The hybrid focusses on capping emissions whilst also setting a minimum and maximum price for emission allowances. This method would not set a carbon price or a specific cap on emissions, but would provide bounds in which both of these could occur (Cleetus, 2011). Setting the maximum and minimum prices is a challenge as it must promote the use of low-carbon alternatives but not cause significant economic derailment.

A really good article published on the Guardian from a few years ago covers all three of these methods of mitigation. It is clear that economic methods such as these offer a great opportunity for emission reductions, but they have to be carefully selected for each country.

Finally, for an easy explanation of carbon taxing (using chickens), and a quick comparison of it to cap-and-trade, see the video below: