The Case for a Carbon Tax

The case for putting a price on greenhouse gas emissions from human activity is not arguable. It’s undeniable. But what is arguable is the best way of achieving it in the working of a modern economy. Shi-Ling Hsu, a law professor at the University of British Columbia, argues for a currently less popular way in his newly published book The Case for a Carbon Tax. “There is no policy instrument that is more transparent and administratively simple than a carbon tax.” Unfortunately its overtness tells against it politically because voters, politicians and emitting industries see the price very clearly and can calculate what they think it might cost them. But in Shi-Ling Hsu’s view environmental measures that purport to be painless are either misleading or set to accomplish nothing.

His book is grounded in the recognition that climate change is a serious problem with unacceptably high risks of catastrophic consequences that must be addressed immediately. It is alone among environmental problems in posing the risk of such vast environmental changes that the effects could destabilise entire economies, countries, and regions.

The four main options for greenhouse gas reduction are a carbon tax, environmental regulation, cap-and-trade programmes with tradable allowances to emit, and government subsidies targeted at low-carbon technologies. A carbon tax on the consumption of fossil fuels can be levied at some point at which the ownership of a fossil fuel changes hands, from the early extraction or processing point (upstream) right up to the point immediately preceding combustion (downstream).  The distinguishing feature of command-and-control regulation is that compliance is largely an administrative matter for which there can be an administrative adjudication. Cap-and-trade programmes involve issuing allowances to polluters, and compliance is determined solely by whether the emitter has enough allowances to cover its quantity of emissions. They are not dissimilar to carbon taxes in many respects, and have begun to look more and more like carbon taxes. Subsidies are of two kinds – price-oriented subsidies and funding for research and development. The author judges them on the whole as more costly and less effective than either carbon taxes or cap-and-trade programmes.

A large section of the book is given to ten arguments in favour of a carbon tax. One is economic efficiency:

“The simple genius of a carbon tax is that it aggregates disparate pieces of information, transmitting a price signal at every stage in which there is fossil fuel usage, and transporting it in proportion to the carbon emissions of the production process.”

All of the four alternatives are in the business of creating a carbon price, but the book considers the carbon tax does it best. Command and control regulation is clumsy and uneven by comparison. Subsidization is a useful mechanism in some situations, such as preventing deforestation in developing countries, but on the whole it is “mere political grease, an overused salve for the perceived pain from the prospect of economic structuring.” Cap-and-trade programmes are generally less comprehensive in their scope than a carbon tax. A cap-and-trade programme could be as comprehensive as a carbon tax, but to do so it needs to be imposed upstream, at the point of extraction or processing of the fossil fuel. This was a particularly interesting assessment for me because a few weeks ago I reviewed Robert Repetto’s book America’s Climate Problem: The Way Forward, in which he advocates cap-and-trade as preferable to a carbon tax and I imagined that his book and Shi-Ling Hsu’s would be at odds. But Repetto is specific that an upstream cap-and-trade is best, which means there is a good deal of common ground between the two writers. And although Shi-Ling Hsu argues the superiority of a carbon tax he does so moderately and reasonably, not scorning the other instruments.

Sunk capital is often a hindrance to change, and Shi-Ling Hsu points out that power plants and coal mines can represent huge stranded costs. Government subsidies have often encouraged the formation of this kind of capital and the book argues that it is far less dangerous to spur growth by taxing that which is undesirable than to encourage capital formation around that which we think at a particular time desirable. A carbon tax is capital-neutral, one of the arguments in favour of it.

Other advantages include its ability to co-exist with the other policy measures the book considers.  It is simple to get under way and doesn’t pre-empt subsequent employment of other options.  Although both a carbon tax and cap-and-trade schemes can be effective in encouraging innovation to reduce emissions, a carbon tax has the edge. It produces a steadier price signal and the signal remains undiluted, which encourages further innovation. It is broad-based, getting at the problem of fossil fuel combustion across all sectors and activities. Cap-and-trade could also do this, but the schemes so far emerging are selective and less comprehensive than a carbon tax. A carbon tax is more readily administrable, requiring fewer delicate decisions than does setting up a cap-and-trade scheme. The book also sees better prospects for an international accord based on a carbon tax than on the capping so far strenuously resisted by China, India and other developing countries. Overall the breadth, simplicity and ability to piggy-back on existing regulatory structure which are the characteristics of a carbon tax mean it offers the greatest chance to reduce greenhouse gas emissions immediately.

The book also considers the counter-arguments against a carbon tax and responds to them. To the argument that politically the carbon tax is never going to be acceptable the author suggests the fact that the proceeds go to the public purse rather than to private companies should be an effective selling pitch. The regressive effects of a carbon tax on low-income consumers should not be overstated for political purposes. Harm to low-income households can be limited, particularly by recycling at least a large portion of carbon tax increases. Such recycling is most effective when it takes the form of the lump sum distribution of money on a per capita basis.

The chapter on carbon tax psychology is somewhat depressing reading. What makes carbon taxation as a policy so unpopular is the obviousness of the cost.  Politicians are accordingly reluctant to embrace it. The temptation is to propose other seemingly less painful measures to address climate change. The author nevertheless believes that the arguments his book proposes in favour of carbon taxes carry the potential for the politics and psychology to change.

It is the ability of a carbon tax to penetrate into every nook and cranny of the economy where fossil fuels are burned and thus to empower everybody in the world to reduce or eliminate the amount of carbon dioxide emitted which is its chief appeal for the author.  We must have faith that markets will produce the innovations necessary to reduce emissions, and a carbon tax of sufficient size will drive that innovation.  As a first step it can be instituted immediately. And it does not preclude any of the other policies also being employed. Perhaps most importantly it stands the best chance of getting the international buy-in which is essential to global emission reduction.

It’s a strong case, well-made with a great deal of patient attention to detailed discussion which can’t be mirrored in a brief review but is a major factor in the book’s success, aided by the admirable clarity of the writing.

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13 thoughts on “The Case for a Carbon Tax”

  1. I’m not convinced that regulatory responses – where they are clear and directed are as useless as tax advocates make out.

    The thermal generation ban in New Zealand was excellent at driving investment into renewables, had almost no cost structure, was politically simple, and came into effect almost immediately. It also meant that energy generators did not have to think long and hard about how they might cost or otherwise the price of emissions. The thinking was done for them. A price signal is a strong signal, a ban is an even stronger one. And often the ban is easier to sell – people can see the effects immediately.

    These aren’t exclusive instruments, and they shouldn’t replace other policies, but they are extremely useful, and it’s upsetting to see them rejected so comprehensively.

    1. I agree with you George on the ban on thermal generation which was so foolishly removed by the present government. The book’s concern over regulation seems more directed at its extension into finer detail and the possibility that it can stifle innovation.

      1. Bryan, does the book discuss California’s regulatory stance re clean air and car emissions? Again here, my understanding of that, is that the regulation became the mother of innovation.
        It looks a good read but I shall have to wait until I can get my hands on a copy – my book budget is getting low.

        1. No, not specifically. He does write briefly and appreciatively of California’s “variety of greenhouse gas-reducing measures in addition to its cap-and-trade programme”, in the context of observations of how some state and regional authorities have moved when the federal government was doing little or nothing.

          1. In common-pool resource management (e.g. water resources or the atmosphere) command and control type regulation has a place where the objective is to eliminate old and undesirable practices, habits or behaviours. Elinor Ostrom advocates a multiplicity of rules over a single rule, since potential rule evaders may find it easier to just comply.

            Any particular approach will never be all good or all bad. In this case we are up against the power, influence and wealth of the fossil fuel multinationals. Not only do they have the resources and incentives to navigate multiple rules to their best advantage, they have the power to manipulate rules during development or block their implementation. Fossil fuel is still subsidised – e.g. seismic surveys.

            Perhaps we need to get a critical mass of people to boycott fossil fuels (e.g. 15% of energy consumers). No regulation required, and no waiting for politicians – some incentives will help. A growing group of committed people would create the market for clean energy, forcing the big multinationals and politicians to follow. One a critical mass is achieved it could boycott the worst laggards, which might strike fear into the hearts of shareholders.

            Here is a great doco illustrating how we might use internet tools to rebalance power between corporations, governments and people.

            1. Yes the Critical Mass concept is a good one and certainly valid. The problem is – how do you go about achieving that critical mass of 15% of people denying themselves; in a society that is schooled from birth, in a market based economy?

            2. @Macro – perhaps the key to successfully navigating a problem is to ask the right question – and to frame it right too.

              I’ve been thinking about the 15% critical mass target a bit, and how we might get there. Firstly, just like anything new, people need a progression – i.e. they would go through stages before being able to achieve ‘fossil-free’ status.

              Secondly, it might be impossible for some people to be completely fossil-free, for example many people would not be able to afford to generate their own renewable energy, and many buses use fossil diesel. Non-essential air travel can be avoided – and some airlines are developing biofuels and have offset options in response to concerns about air travel.

              I think that people who understand the severity of the issue will not view becoming fossil-free as denying themselves anything. Particularly those who are in the business of developing renewable or clean-tech alternatives; so 15% should be an achievable target. This is an opportunity for real people to lead – which gives me far greater cause for hope than relying on governments that are shacked to the status quo.

  2. The problem with these taxes or laws is that many people think it is a case of paying the tax and keep going. In reality we have to stop burning carbon fuels as we can not go on polluting the atmosphere the way we are. We are already committed to 2c of temperature rise and over a meter of sea level rise and that’s only from what we know. It may be a lot worse.
    I read that a quarter of the Worlds stock markets consist of carbon energy businesses so its understandable that there is some resistance.

    1. “The problem with these taxes or laws is that many people think it is a case of paying the tax and keep going”
      There is something to be said for that argument Bob – but never there is also the fact that – like taxes on tobacco and alcohol – the incentive is to find either a cheaper alternative, reduce consumption, or innovate.
      I agree completely with the sentiments you express. We have to give up our addiction to Carbon, and fast.

      1. This is actually one of the benefits of a Cap and Trade system – the cap can ‘simply’ be reduced as the natural limit is reached, and so by natural market mechanisms of supply and demand, the price of the carbon emissions can float to nearer its true cost – which is high, certainly far higher than the $12.50/ton pollution subsidy rate offered by the NZ government. A tax on the other hand can only be raised occasionally, such as once per year – and then there is the question of who distributes the funds raised, and to whom? In essence, a tax implies a command-and-control structure, whereas a trading system allows competition between companies who sink carbon.

        In my opinion, the NZ government should be allowing *any* carbon sink (even those not recognized by international treaties) to create carbon credits at the market rate for carbon demonstrably sequestered (via peer-reviewed scientific methods), and float the carbon cost without subsidy. Taxpayer dollars would have to pay the difference, but it would add some certainty to new efforts to sequester carbon in the face of uncertain global agreements and probably still work out cheaper than at present. Effectively all the money spent is a moral bargaining token for the rules to change to recognize this new method of sequestering carbon. Also, it encourages science investment.

        1. Actually, there could still be competition for carbon sinking assuming a tax: for instance, the NZ government could and should be putting out RFPs for sinking the deficit of carbon it is currently running; credible proposals which supply sunk carbon at below the rate that the carbon credits are trading at should be accepted.

    2. In fact, 80% to 90% of the world’s energy demands are currently met by fossil fuels and associated CO2 emissions. Therefore it is fair to say that 80% to 90% of the world economic activity and the associated share market components are predicated upon CO2 emissions going forward unabated. The momentum of the world economy is massive. Turning the rudder around will take more than nice words and the massive resistance to change is not just in the minds of deluded tea party nutters. This highlights the enormity of the task ahead and the danger life on Earth as we know it is in at the moment.

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