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Carbon pricing is not a magic bullet

| Updated: November 17, 2021 19:54:38

Carbon pricing is not a magic bullet

Global carbon emissions have rapidly rebounded, with economic recovery following pandemic shutdowns, and are already close to pre-Covid levels. As climate meetings continue at COP26 Glasgow, a report from the Global Carbon Project finds emissions from coal and gas use have grown more in 2021 than they fell in 2020.

Meanwhile carbon pricing has been promoted as one of the principal, one-size-fits-all, means to address CO2 emissions. The European Union (EU) President urged at COP26, "Put a price on carbon, nature cannot pay". Canada's Prime Minister Justin Trudeau joined forces at COP26 to advocate for a global minimum carbon tax.

Businesses are also rallying behind carbon pricing at the COP26 summit to agree on a "effective and fair" level for carbon pricing. However, none says how the revenues raised through such a global minimum carbon tax would be distributed between countries, or to support poorer countries' adaptation and mitigation efforts. Therefore, poorer countries can be justifiably sceptical, especially when rich countries have already failed to fulfil their promise of US$100 billion a year climate financing support, and such a uniform tax is likely to affect them disproportionately.

CARBON PRICING SILVER BULLET: Carbon pricing currently covers about 22 per cent of greenhouse gases produced globally. In theory, carbon pricing works by capturing the external costs of emitting carbon -- i.e., the costs that the public pays, such as loss of property due to rising sea levels, the damage to crops caused by changing rainfall patterns, or the health care costs associated with heat waves and droughts -- and forcing the polluter to pay.

It is claimed that this market solution is "the most powerful tool" in the climate policy arsenal. It creates a strong price signal that reduces, or regulates, green house gas (GHG) emissions and at the same time provides a robust incentive for shifting investments away from high-emission fossil-fuels based technology towards cleaner technology.

However, in practice, the impact is marginal - generally between 0 and 2 per cent reduction in emissions per year. The Intergovernmental Panel on Climate Change (IPCC) states that emissions must fall by 45 per cent below 2010 levels by 2030 in order to limit warming to 1.5 °C-the goal set by the Paris Agreement.

One of the reasons for such marginal impacts is that polluters hardly pay; they easily pass on the cost to users or consumers of energy who must use certain amount of energy regardless of price (in technical terms, "inelastic demand"). Therefore, price incentives alone cannot be relied on to spark the creation of new low-carbon technologies.

SYSTEM FAILURE, NOT MARKET FAILURE: Carbon pricing faces five major issues that limit its use for accelerating deep decarbonisation. First, carbon pricing frames climate change as a market failure rather than as a fundamental system problem. Second, it places particular weight on efficiency as opposed to effectiveness, and thus ignores the urgency of the matter. Third, it tends to stimulate the optimisation of existing systems rather than transformation. Fourth, it suggests a universal instead of context-sensitive policy approach. Fifth, it fails to reflect political realities.

Research finds that the consumer cost of carbon pricing is globally regressive-it disproportionally affects poorer consumers-and more so in poorer countries.  That is, it falls harder on average consumers in poor countries than on poor consumers in average countries.

REGRESSIVE FOR POOR COUNTRIES AND THE POOR: The United Nations World Economic and Social Survey (WESS) 2009 argued that a uniform global carbon price, even if it were to be introduced gradually, would be the taxation of developing countries at several times the rate of industrialised countries, measured as a proportion of GDP. Although per capita emissions in developing countries are far low compared with those in industrialised ones, a global uniform carbon price would impose a disproportionate burden of adjustment on developing countries.

Moreover, carbon pricing will affect the level and distribution of real household income, both directly through a household's use of fossil fuels and indirectly through the prices of other commodities. A carbon tax has been found to place a disproportionately heavy burden on low-income groups, by raising not only the direct cost of energy, but also prices of all goods in which energy is used. Thus, lower-income households would pay disproportionately more in environmental compliance costs.  It is suggested that undesired distributional effects can be avoided by either introducing differentiated pricing by, for example, increasing prices commensurate with the amount of energy used (like progressive taxation), or by compensatory mechanisms, such as subsidies for lower-income groups or cash transfers.

However, such compensatory mechanisms can be administratively burdensome for poorer countries, especially in countries with weak taxation and rudimentary social assistance or protection systems. Targeting particular segments of the population has proven to be challenging, and administrative progress is needed in building social assistance programmes covering the entire poor and vulnerable population.

TRANSITING TO RENEWABLE ENERGY: A more credible solution to cutting carbon emissions remained in government investment and "old fashioned industrial policy" that promoted clean energy. This means huge investments in solar, hydro and wind energy as well as public transportation. Given the initial high cost and low return, public investment has to play the leading role.

Most developing countries lack the fiscal capacity to undertake such huge public investment programmes. Therefore, substantial increases in compensatory financing, official development lending and assistance are needed for developing countries to increase their fiscal space.

Carbon taxation would therefore need to be in the first instance an instrument for providing incentives towards mitigation in advanced countries and a source of financing of climate-related programmes of action, including in developing countries. Potentially, carbon tax could yield significant resources to cover international funding requirements.

The World Bank's former chief economist, Nicholas Stern, estimated that with a carbon price of US$50 per ton of CO2, renewable energy like onshore wind would be roughly competitive with dirty coal; and without a carbon price, wind would be competitive with coal and gas if oil prices were US$150 a barrel. Even without a market-determined carbon price, taxing GHG emitting sources of energy would help make renewable sources economically more attractive.

A tax of US$50 per ton, through which many renewables would become economically viable, could mobilise US$500 billion in resources annually and suffice to cover part of the mitigation costs. The International Monetary Fund (IMF) estimates a fund of US$10 billion a year - equivalent to about 01 per cent of the revenues from a US$50 price on G20 carbon emissions.

The IMF further estimates that the global carbon price of about US$75 a ton would be needed to reduce emissions enough to keep global warming below 2°C. However, only about one-fifth of global emissions are covered by pricing programmes, and the global average price is only US$3 a ton.

There are powerful fossil-fuel corporate interests who make sure that the price is not high enough that may force users find alternative cheaper sources of energy. Thus, the price signals to the market from existing carbon pricing policies are "modest and less ambitious" than they could be.

Carbon taxes will not provide an unlimited source of funding and will drop off as GHG emissions are effectively reduced to low levels. Nevertheless, in the initial stages, they may play an important role in sourcing a substantial part of the investment costs of the big push that needs to be accomplished in the coming decades.

ONE-SIZE WILL NOT FIT ALL: Much of the discussion of the climate challenge in developed countries is focused on the relative efficacy of alternative ways of establishing a carbon price. The mix in developing countries is likely to be different, with a much larger role for public investment and targeted industrial policies.

All policy instruments, ranging from price incentives, taxes and subsidies to regulation, and encompassing fiscal, monetary and financial measures as well, should be fully used as part of the tool kit to meet climate change challenges. Given the complexities of the issue alternative approaches that target fundamental transformations of existing socio-technical systems, such as energy, mobility, or food (i.e., "sustainability transitions") need to be explored. This may entail a mix of contextually and politically sensitive policies that simultaneously drive low-carbon innovation and the decline of fossil fuels.

It is of utmost importance to take into account the institutional limitations of developing, especially least developed countries (LDCs) when considering introducing carbon pricing and revenue recycling from carbon tax. Bilateral and multilateral development cooperation are critical if the international community wants to include more poorer countries or LDCs in the worldwide effort to limit global warming.

Unfortunately, the international community has so far failed to adequately support developing countries.


Anis (Anisuzzaman) Chowdhury is Co-editor, Journal of the Asia Pacific Economy, and Adjunct Professor, School of Business, Western Sydney University.

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