Decoder: Can pricing carbon brake climate change?

It costs nothing to pollute. That has long been the driving force of our economy. But a movement is growing to change that calculus by putting a price on carbon.

A traffic jam in New Delhi, India, 6 March 2018 (EPA-EFE/Harish Tyagi)

It costs nothing to pollute.

That has been the driving force of our carbon-based economy since the Industrial Revolution, and it has led the world to the brink of climate disaster.

But now a movement is gathering strength to change that economic calculus by putting a price on carbon.

No country or company has ever been billed for its contribution to the climate catastrophe we face. Worse, fossil fuels have been generously subsidized over decades, boosting corporate profits and keeping energy and fuel bills artificially low.

So producers and consumers alike have had little or no incentive to change their habits. This impunity seems illogical given what we know now about climate change. But it is simply the result of our industrial society’s economic accounting.

Traditionally, economics views any costs that fall outside the strict value chain, like pollution, as external to the process. That means those who cause such costs are not liable for them. But more recently, economists see such “externalities” as a source of inefficiency in the way prices are set for goods and services.

“Climate change presents a unique challenge for economics: it is the greatest and
widest-ranging market failure ever seen,” according to the Stern Review, a detailed report on the economics of climate change that was published in 2006.

Putting a price on greenhouse gas emissions, in particular on the most prevalent one, carbon dioxide (CO2), is seen as the best remedy for this failure. Regulations alone have had only a limited impact — witness the scandal of automakers rigging pollution tests for their diesel cars.

Carbon can be priced either through local, national or border taxes — in which case the price is set by governments — or through a market mechanism known as an emissions trading system (ETS). Businesses can also adopt a price for carbon in their accounts.

These methods are increasingly being implemented across the world with the aim of making it increasingly expensive to pollute, so stimulating a shift away from carbon and into clean technologies.

Carbon markets

These are based on a system called “cap and trade.” An upper limit, or cap, is set for the volume of particular greenhouse gases that industries are allowed to emit. Companies buy and sell permits to emit, known as carbon credits for CO2, whose price is determined by the balance between supply and demand. This puts a price on polluting.

If a company emits less than its carbon credits allow, it can sell its surplus credits to companies that go over their allowance. Businesses like forestry can sell credits representing the carbon their activity saves, known as carbon offsets.

The first and largest ETS until now was phased in gradually by the European Union from 2005, but others are much more recent. The second biggest, in South Korea, was launched in 2015. China is rolling out its ETS this year, and this will become the world’s biggest carbon market by far.

Such schemes can also be sub-national, as in California or Tokyo, or industry-wide, like the aviation industry’s carbon offset system planned for January 2019.

But carbon markets have built-in flaws. They are highly complex and sometimes perverse: Actions to cut emissions can result in oversupply of carbon credits, which drives down their price, so polluting becomes cheaper.

Carbon taxes

This is why economists tend to favor carbon taxes for their clarity and simplicity. They offer a way of equating efficiently the amount of carbon released by any particular activity with the amount of tax levied on it. But initiatives on this front have suffered from the inherent unpopularity of taxes.

“Politically, cap-and-trade has functioned as a ‘safe harbor’ for politicians who grasp the need for pricing carbon emissions but cling to the need to ‘hide the price’ to appease interest groups and/or ordinary citizens,” says the U.S.-based Carbon Tax Center, which militates for carbon taxes.

So far, carbon taxes have a mixed record. Developed countries mainly tax fuel for road transport. But despite levying such taxes over a decade or two, road traffic has increased rather than diminished.

There have also been fiascoes. Australia, a heavy polluter, introduced a carbon tax in 2012 only to repeal it in 2014. France had planned a transit tax on heavy goods trucks but backtracked in 2014 in the face of a lorry drivers’ revolt.

However, Britain clocked up a notable success after bringing in a carbon price floor – effectively a carbon tax – in 2013 to compensate for low carbon prices in the EU’s ETS. Its coal use fell in 2016 to the lowest level since 1934. Now France has called for an EU-wide carbon price floor.

Probably the best-known successes are in Sweden, with a carbon tax since 1991, and British Colombia, which brought in a carbon tax in 2008. Both have experienced rising economic growth while cutting their carbon emissions.

Prices are too low.

The bare figures are encouraging. According to the World Bank’s latest report on carbon pricing released in November 2017, 67 jurisdictions representing over half the world economy now put a price on carbon. This represents around 15 percent of global emissions, a figure that will rise to 20-25 percent as the Chinese ETS gets underway.

But there’s a snag. To date, the price of carbon has mostly been far too low.

About three-quarters of these emissions are priced at less than $10 per tonne of CO2 equivalent (tCO2e), according to the World Bank. Yet the Paris Agreement’s goals for reining in global warming require a much higher price of $40–80/tCO2e by 2020. “Currently, only one percent of emissions covered by a carbon pricing initiative are priced within that range,” it said.

The World Bank’s report covers both carbon markets and carbon taxes. A report by the Organisation for Economic Co-operation and Development that was published in February focused on taxes alone and found the price of carbon levied has generally been well below the cost of the damage it causes.

There is also a major drawback to carbon taxes that accounts for their political unpopularity. They fall disproportionately on the poorest households because they make energy and fuel more expensive.

British Colombia addressed this by redistributing the proceeds of its carbon tax. It cut income and corporate taxes and increased a tax credit for low-income families.

And in a surprising political development, some U.S. Republicans are now advocating a carbon dividend that would be paid to households out of the proceeds of a carbon tax.

(For more “decoders” explaining major global issues, click here.)

Sue Landau is a freelance writer and translator based in Paris. She worked in financial and business journalism for 25 years at the International Herald Tribune, Reuters and the Investor’s Chronicle, chiefly in London and Paris. She reported on energy, new technologies, media and advertising, corporate and industry issues, wealth management and investment, and regional development.