An effective international climate strategy would incentivise clean economic growth while at the same time raising the considerable financial resources needed for climate mitigation and adaptation efforts. There are a number of strategies to raise the funds necessary, and the most promising approach is a carbon tax, implemented in all countries across the globe.
This is the conclusion by Augusto Lopez-Claros, Co-author of Global Governance and the Emergence of Global Institutions for the 21st Century, co-winner of the New Shape Prize and a contributing expert to the Climate Governance Commission (CGC). In a paper written for the CGC, Augusto Lopez-Claros is arguing for a carbon tax as well as a more serious evaluation of other approaches to increasing the significant resources needed in the global fight against climate change.
Generating revenue
Amongst other material, Augusto Lopez-Claros refers to a report from the International Monetary Fund (IMF) from 2019, that shows that of the various recognized strategies to reduce fossil fuel emissions, implementing a carbon tax is the most powerful and efficient.
“Today existing mechanisms for addressing climate change rely on uncoordinated, voluntary arrangements that have proven inadequate. But by placing a tax on carbon that better reflects its negative externalities, governments can incentivise businesses to improve energy efficiency and conservation, and switch to cleaner sources, while generating substantial revenue.”
Frameworks exist
Augusto Lopez-Claros elaborates on the reasoning: “First of all it is a powerful tool because it has a very immediate impact on consumption of gasoline, coal, electricity and other energy sources that depend on fossil fuels. Secondly it can be introduced within the existing framework of taxation which countries have. You don’t need to set up something new, there is already a tax collection machinery everywhere in the world.”
Furthermore Augusto Lopez-Claros points out that a carbon tax is a fairly quick way to collect revenue.
“The problem is therefore not technical, conceptual or even administrative, it is more of a political problem.”
French failure
A well-known example of carbon tax implementation gone wrong is from France in 2018. The imposition of a carbon tax in that country evoked widespread protests – something that became known as the “Yellow Vests” (“Gilets Jaunes”) movement. Augusto Lopez-Claros says this happened because the tax in question was not well designed.
“Basically: the French government did not anticipate the extent to which the increase in the price of gasoline, which leads to increases in the prices of transport, was going to affect people to whom expenditures on transport are a very high percentage of their disposable income.”
Acceptance key
Whether the tax in question is a special carbon tax or not, introducing taxes is never easy for governments. It raises various questions depending on individual country circumstances. Will the revenue raised be used to compensate tax payers in some way for the higher costs they will face? Or will it be used to boost expenditure in other inefficient ways? Will the tax actually contribute to reducing emissions?
“In low income- or developing countries one of the concerns is that people don’t trust their governments. Countries often have weak institutions that don’t have credibility within the civil society and business community, and therefore governments can have difficulties making the case to introduce a new tax.”
Perceptions of rampant corruption can sometimes weaken the willingness of the public to accept a tax rise.
“In other words, there is what we economists call a “political economy issue” associated with a carbon tax which many governments are not willing to face, or not willing to do the careful design that needs to be done in order to make the tax acceptable and sustainable.”
Canadian success
In contrast to the challenges in France, one can look at the case of British Columbia, Canada, that in 2008 successfully launched a carbon tax. Augusto Lopez-Claros describes the strategy: “First of all, they introduced the tax at a relatively low level. Starting small doesn’t shock consumers, producers and the economy. Every bit of money collected was rebated to residents in order to offset the burden of the carbon tax, allaying concerns that the carbon price would shrink personal incomes. The authorities were particularly careful to ensure that vulnerable groups were not adversely affected. The tax was in that sense revenue neutral. Then the authorities increased the tax gradually over time until five years later it reached the level desired. Lastly, the tax was replicated in other parts of Canada.”
Augusto Lopez-Claros explains: “What happened in that period was that people became increasingly comfortable with the tax because the government could make a very solid case that emissions were actually coming down as a result. If people at the same time get the money back from the tax via various channels they get even more comfortable.”
Augusto Lopez-Claros highly recommends the Canadian example. “Unless governments are willing to do this kind of careful preparatory work, carbon taxes are going to be unpopular and that would be deeply regrettable because this is the most powerful tool we have.”
Carbon tax risks
Today the average carbon tax in the world today is $2 per ton of CO2 emissions.
Some might see a risk that a global tax will not be high enough, or argue that shall it be seen as a floor in the same way as the Paris Agreement can be seen as a floor?
“If we increase it gradually to $75 per ton of CO2 by 2030, it is estimated that this would be enough to keep temperature rises below 2 degrees centigrade. So, it would not be enough to have just a floor set, for example at $30 per ton. The rise has to be gradual and persistent. (At the moment only Switzerland and Sweden are above $75 per ton!).”
Another question is if there is a risk in introducing a global tax on carbon in relation to the risk in building on the different initiatives on carbon pricing that we see around the world today?
“A carbon tax does not exclude the possibility of doing other things on multiple fronts. For instance, more effective regulation, particularly in the area of standards for emission rates (let’s move to electric cars!) and creating incentives for energy efficiency as well as minimum requirements for the use of renewable sources in power generation. In our paper we mention many of these things.”
Additional ways
In the upcoming report Augusto Lopez-Claros also looks at other potentially useful instruments and financing mechanisms.
“We need to be thinking about how to get the private sector involved in providing some of the funding for the kinds of investments we need to finance the transition from a carbon economy to a renewable or low carbon economy.”
One suggestion is a global Tobin-like tax. Initially, in the 1970s the thinking behind a “Tobin tax” (named after the economist who proposed it) was to deal with volatility in the foreign exchange markets.
“It is an idea that has evolved and now people are talking about it more as a tax on financial transactions as a potential revenue resource. Since the idea first came to light the volume of the financial markets has increased by several orders of magnitude and the scale of the global economy has grown as well. So even if one would impose a very small tax on financial transactions you could potentially raise a large volume of resources for climate change mitigation projects.”
Covid effects
In this context the pandemic has catalyzed greater openness to new ideas, as governments have to deal with stretched fiscal budgets.
“Governments realise their budgets will be under pressure, so they are exploring alternative ways that are not destabilising in terms of economic activity. I still think the carbon tax is something we have to come back to, but in our paper we also say that a Tobin-like tax is worth considering and exploring, among many other proposals which we also analyse.”
