Pricing carbon: regressive or not?

Economists are famous for disagreeing about almost everything. A joke I heard in London a few years back was that if all the economists in the world were laid end to end they would never reach a conclusion.

But it looks like economists are agreed on one thing: climate change and how to tackle it. A report last year by several of the world’s top economists was emphatic. They concluded that: a well-designed carbon price is an indispensable part of a strategy for reducing emissions in an efficient way.[1]

At the One Planet summit in December 2017—on the second anniversary of the adoption of the Paris Agreement—leaders of governments, businesses and international organisations all agreed on the need for ambitious action on carbon pricing.[2]

And among the 175 countries that have ratified the Paris Agreement, half of them have either implemented carbon pricing or are seriously considering it.

In the US, although Donald Trump has shut down almost all federal action on climate change, many US states and cities have forged ahead. These initiatives include the expansion of the US Climate Alliance–which has 16 US states and Puerto Rico as members, the Regional Greenhouse Gas Initiative (RGGI) which covers nine Eastern states, and the nine US states in the Carbon Costs Coalition—which brings together legislators to share best practice aimed at strengthening regional momentum and advancing progress on carbon pricing. [3]

In Canada, the Federal government’s climate change policy was clearly set out after the Paris Agreement in a document that placed carbon pricing at the heart of the proposed program.[4]

Worldwide, 51 carbon pricing initiatives have been implemented or are scheduled for implementation. Of these initiatives, 25 are emissions trading schemes (ETS), mostly located in at the subnational level, and 26 are carbon taxes primarily implemented at a national level. These programs cover about 11 billion tonnes of carbon dioxide equivalent (GtCO2e), or about one fifth of global emissions of greenhouse gases.  However, it is widely acknowledged that current climate action is insufficient to achieve the main Paris Agreement objective of limiting warming to 2°C or less.[5]

These initiatives brought in a lot of money for the jurisdictions that implemented them: in 2018, governments raised about $33 billion in carbon pricing revenues—from allowance auctions, direct payments to meet compliance obligations and carbon tax receipts. [6] In British Columbia, Canada, the carbon tax currently provides 3 percent of the province’s budget.[7]

Organisations and jurisdictions generally invest this money in programs that are aimed at directly reducing emissions.  The most common programs focus on improving energy efficiency—in transportation systems and  buildings, and in promoting renewable energy for utility power generation.

For example, in 2017, the RGGI in the northeast US spent about half of its revenues, 52%, on energy efficiency programs, followed by 17% on renewable energy. Seven of the nine states spent more on energy efficiency than any other category over the  past three years—led by New York and Massachusetts.

However, New Hampshire spent 80% of its RGGI revenue on utility bill assistance, and Maryland also spent more on bill assistance than energy efficiency initiatives.

The investments made by the nine RGGI states have been hugely successful. Together, these states gained $1.4 billion in economic benefits from the program over the past three years because of the way they invested the proceeds from the cap and trade mechanism. The biggest payoff came in investments in energy efficiency programs—which have led to more businesses and jobs in activities such as energy audits and installing energy efficiency equipment.[8]

Moreover, the price on carbon coupled with investment in energy efficiency and renewable energy have substantially reduced emissions—which have fallen by half in the RGGI states since they launched the US’s first cap and trade program in 2009.[9]

Putting a price on carbon pollution and investing the income in programs that promote renewable energy and energy efficiency sounds like a winning combination.

But there’s a problem.

The fly in the ointment

Putting a price on carbon is a regressive tax.  Under either a cap-and-trade program that limits carbon emissions or a carbon tax that imposes an outright tax on emissions, low-income households are the hardest hit– because they spend a greater share of their income on energy than higher-income families.

A recent study by the US National Bureau of Economic Research calculated that for a levy of $15 a ton of CO2, the households in the bottom 20 percent of income distribution would be paying out four times as much as wealthier households relative to income.[10]

On July 25, 2018, Ontario’s Progressive Conservative tabled legislation to scrap the Canadian province’s cap and trade program that it had established in collaboration with California and Quebec. Justifying the cancellation of the program, Environment Minister Rod Phillips stated: “We’re sending a clear message: Ontario’s carbon-tax era is over.  It’s a punishing, regressive tax that forces low- and middle-income families to pay more.[11]

However, the financial burden on low-income households can be alleviated by measures that provide assistance to these families. As noted above, New Hampshire spends most of its carbon tax revenues from the RGGI program helping low-income families pay their utility bills.

The regressive impact of carbon pricing may get worse. Modeling studies indicate that in order to achieve the Paris Agreement target of 2°C, carbon prices will need to rise to between $40 to $80 per tonne of CO2 equivalent in 2020–and then even higher.  Perhaps as high as $200/tCO2e in 2050.[12]

In spite of the agreement among economists that carbon pricing is indispensable, it is also widely acknowledged that carbon pricing alone will not be able to induce a transition at the pace and the scale required to meet the Paris Agreement targets without unacceptable energy costs and regressive impacts on household budgets.  Programs that aim to reduce carbon emissions through a portfolio of coordinated policies are therefore essential—and over the longer term can reduce the need to increase carbon prices.

A sectoral approach

A first step is to identify the sectors where the potential emission reductions are greatest.

The chart above shows the potential global emission reductions for the economic sectors where substantial reductions in greenhouse gas emissions are possible by 2030. Taken together, the total reductions are those required to get the world back on track by 2030 in order to have a good chance of meeting the Paris targets.[13]

Can these reductions be achieved without setting a price on carbon?

In the energy sector, unsubsidized solar and wind are now less expensive than coal, and fully competitive with natural gas.  The transition to utility-scale renewable power is well underway. All that is required is for governments and subnational jurisdictions to remove the roadblocks erected by fossil fuel vested interests, and simply get out of the way.

In industry, regulations that control emissions of pollutants into the atmosphere and water resources have been in place for decades. These regulatory instruments can be slowly tightened, and if non compliance is punished with substantial fines and unavoidable costs, will logically induce firms to reduce their carbon emissions. Governments could help this along by subsidizing research into carbon capture and storage—a technology that is going to be essential for many heavy industries that will struggle to reduce their emissions without it.

Forestry is a sector where carbon pricing may even lead to increased emissions because of the higher transportation costs of sustainably managing forestry resources.  Most agencies responsible for pricing carbon don’t look at forestry even though well managed forests are a substantial global carbon sink.

Transport is a sector where a range of incentives to encourage the purchase of electric vehicles (EVs) have been introduced across north America and Europe.  Studies show that the lack of charging infrastructure is a major impediment to the uptake of EVs, and this problem is being addressed in the US, Canada, and Europe. But there is still too much carrot and not enough stick.

As an example, the cost of renewing my annual vehicle permit in Ontario, Canada, is $120 (CAD).

This is ridiculous. I thought the polluter was supposed to pay?

Driving a car in Canada or the US will pump around 4 or 5 tonnes of carbon dioxide a year into the atmosphere. Although economists’ estimates of the social cost of carbon differ widely, a figure of at least US$100 is a reasonable value.  That means I should be paying more like CAD$500 to put my car on the road.

It’s not an extra 5 cents on the price of a litre of gasoline that going to make me consider an electric vehicle—it’s a hefty annual permit fee for my gasoline car.[14]

So maybe I should forget the car all together and switch to public transport? This is the other missing piece of the puzzle. How long do I have to wait to hop onto an electric bus to take me downtown, and how much will I pay for the ride? Substantial subsidies for zero-emission and super efficient public transport are essential and long overdue.

Next we have agriculture and the build environment. Promoting conservation agriculture must be part of the global program, but it’s difficult to see how putting a price on carbon emissions and raising the cost of electricity, gasoline, and diesel fuel is going to help.

But substantial improvements in the energy efficiency of buildings are definitely possible.  Here, building codes are the key to significant reductions in emissions. In Europe, the Energy Performance of Building Directive mandates that all new buildings are to be ‘nearly zero energy buildings’ by the end of 2020.[15]

All of the emission reduction actions discussed above should be implemented in parallel with a comprehensive carbon pricing policy. By reducing emissions in parallel with those induced by a levy on carbon, these policies will reduce the pace at which carbon prices will need to be increased in order to achieve the Paris Agreement targets.

Meanwhile, back in Ontario

Abrogating the emissions reduction agreement with California and Quebec is a senseless and irresponsible act. Assistance to low-income households to help with utility bills is already in place in Ontario through the Ontario Trillium Benefit (OTB)—a subsidy which explicitly includes help for utility bills.  A regressive carbon tax can be turned around and made progressive by subsidizing low income families through the OTB, and increasing the cost of licensing larger autombiles—which tend to be owned by higher-income families. Other actions can be taken which will support low-income families—cheap public transport for one.

In short, the Government of Ontario’s argument that a carbon tax is regressive and should therefore be scrapped is nonsense.


For a deeper dive:

[1] See the Report of the High-Level Commission on Carbon Prices. Available at https://www.connect4climate.org/sites/default/files/files/publications/CarbonPricingReportFinal.pdf  For more jokes about economists look here: https://www.equities.com/news/a-look-at-some-of-the-best-jokes-about-economists

[2] See: State and trends of carbon pricing 2018, World Bank Group 2018. Available at https://hdl.handle.net/10986/29687

[3] See https://www.ncel.net/carbon-costs-coalition/

[4] See the Pan-Canadian Framework on Clean Growth and Climate Change: Canada’s plan to address climate change and grow the economy.  Available at: https://www.canada.ca/en/services/environment/weather/climatechange/pan-canadian-framework.html

[5] See the Report of the High Level Commission on Carbon Pricing, cited above.

[6] See: State and trends of carbon pricing 2018, cited above.

[7] See the Report of the high level commission on carbon prices. Cited above.

[8] See: Carbon markets pay off for these states as new businesses, jobs, spring uphttps://insideclimatenews.org/news/16042018/cap-and-trade-economics-energy-efficiency-jobs-rggi-regional-greenhouse-gas-initiative-carbon-market-data

[9] See the article in InsideClimateNews cited above.

[10] See How regressive is a price on carbon? At www.nber.org/digest/jan10/w15239.html.  

For a more detailed analysis, see the report by the US Congressional Budget Office: Effects of a carbon tax on the economy and the environment. Avalailable here

[11] See the Toronto Star, July 26, 2018. Page A4.

[12] See the reports: State and trends of carbon Pricing 2018, and the report of the High Level Commission on Carbon Prices, both cited above.

[13] The data are from the Emissions Gap Report published annually by the UN Environment Programme.  Available at: https://wedocs.unep.org/bitstream/handle/20.500.11822/22070/EGR_2017.pdf?isAllowed=y&sequence=1

[14] While the transition to electric vehicles is underway, US and Canadian fuel efficiency standards for international combustion engines should be tightened up to the levels proposed by President Obama in 2012

[15] See the Factsheet: Nearly zero energy building definitions across Europe. Accessed at : http://bpie.eu/uploads/lib/document/attachment/128/BPIE_factsheet_nZEB_definitions_across_Europe.pdf

 

 

One Reply to “Pricing carbon: regressive or not?”

  1. Ron Tolmie

    The premise: “They concluded that: a well-designed carbon price is an indispensable part of a strategy for reducing emissions in an efficient way.[1]”

    The carbon price is barely relevant to the choice of the most suitable technology. An alternative like exergy storage could almost completely eliminate GHG produced by heating systems, by electricity production in countries like Canada, and most of the GHG produced by cars and trucks. Exergy stores collect and store heat in the summer for use in the winter (much like GSHP’s) but they do not rely on grid power. That reduces the electric energy consumption but more importantly it radically reduces the peak power demand. The cost of building power systems to meet that peak demand is the primary cost element, so reducing that peak demand directly reduces the capital cost of generation facilities in Canada by many billions of dollars. An exergy store can also be designed to provide inexpensive (and ubiquitous) fast chargers for vehicles. (Google “exergy storage tolmie rosen” for papers on the subject).

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