Thursday, 22 July 2010

The Case for a Revenue-Neutral Carbon Tax (aka 'Fee-and-Dividend' System)

Jerry Jones

After 20 years of international policy debate and protocols, and some 30 years since the scientific evidence that human generated carbon dioxide from the consumption of fossil fuels was causing global warming was first being assembled, almost no progress has been made towards doing something about it. It has been ‘business-as-usual’, with the rate of increase of carbon dioxide going into the atmosphere, if anything, accelerating. It is becoming increasingly obvious that the policies that have been advanced so far are not working. We clearly need to be doing something different. And it is urgent. The evidence is that average temperatures increasing a few degrees more will start to release the methane from methane hydrates currently locked in ocean floors and in permafrost. Methane is a much more potent greenhouse gas than carbon dioxide, and its release will turn what still is a manageable problem into perhaps a terminal catastrophe for humanity and life on earth, as we know it.

The task is to drastically reduce the amounts of carbon dioxide going into the atmosphere, and to stimulate research into the development of new technologies to produce energy without adding to the carbon dioxide already there – and to foster lifestyles and the development of equipment, appliances and transport that make more efficient use of energy. The key step towards achieving those goals must be to make the price of energy that adds to the carbon dioxide in the atmosphere prohibitively expensive. The point is fossil fuels are only cheap compared with other sources of energy because their true costs to society – their externalities in economists’ jargon – are not taken into account.

There are two major approaches towards raising the price of energy produced by fossil fuels: either the imposition of a carbon tax (charged on the basis of the amount of carbon dioxide the technology puts into the atmosphere); or so-called ‘cap-and-trade’ (that is imposing a global cap on the quantity of carbon dioxide that can be released into the atmosphere and then allocating or auctioning tradable permits to producers of energy and fuels allowing them to release carbon dioxide up to a certain amount into the atmosphere).

Economists concerned with climate change are more or less unanimous that the carbon tax approach is by far the more efficient. Yet it is the ‘cap-and-trade’ approach that policy-makers more or less unanimously have adopted. The supposed advantage of ‘cap-and-trade’ is that it sets the amount of carbon dioxide that is permitted to be released into the atmosphere and allows market prices to adjust for achieving that target. With a carbon tax, the price of carbon is fixed, but it leaves the amount of carbon dioxide released into the atmosphere uncertain, which supposedly is its disadvantage. In fact, we do not know how much carbon dioxide in the atmosphere is safe, so the target in ‘cap-and-trade’ would have to be set somewhat arbitrarily anyway (which could prove costly if set too high or too low). With a carbon tax, the rate of tax can be adjusted as new evidence came in and as new technologies were developed.

A major advantage of the carbon tax is that producers and consumers would know what the costs or savings of their actions were (for example, investing in new methods of power generation, giving up the car, heating the home less, installing insulation, and so on). When doing a cost benefit analysis, as it were, they would not be faced with the uncertainty of not knowing what the carbon price will be next month, next year, or whatever, due to the volatility characteristic of carbon prices in the ‘cap-and-trade’ system (as has been observed in practice with the embryonic forms of ‘cap-and-trade’ already in existence), which would likely be made worse by speculators.

If a carbon tax is so much better than ‘cap-and-trade’, why is it the latter that governments the world over is pushing? Even economists, after stating that the carbon tax is more cost effective, come out in favour of ‘cap-and-trade’. The simple answer is that it is because most governments and most economists are in thrall to the bankers and big financial institutions. As Cameron Hepburn, puts it (after previously stating that ‘a carbon tax appears more efficient than tradable allowances’):

"[P]ractical recommendations need to start from where we find ourselves, rather than where we might like to be. The institutions we have so far successfully developed are centred on emissions quantity targets and timetables. This approach has hard-won momentum, and a degree of institutional lock-in. Financial institutions within the emissions trading community, including some of the world’s major banks and hedge funds, now have a vested interest in ensuring that emissions trading continues, with tighter caps to increase carbon process and the value of their carbon assets….
While such schemes are still far from perfect, the institutional switching costs of moving from a quantity-based to a price-based scheme, such as harmonized tax, seem rather large."

Or to put it more straightforwardly, switching to a carbon tax, even though it is better, would be unpopular with big business. Meanwhile, for us consumers of energy, ‘cap-and-trade’ is more costly than a carbon tax because we have to pay for the expenses and commissions of the traders involved, including those in futures markets and other derivatives that go with such trades – which is precisely why ‘cap-and-trade’ is so popular with the big financial institutions.

A carbon tax saves on all of that. All that is required is a simple system for collecting the tax at the point of power generation or manufacture of fuels. This would require minimal administrative costs, especially as these activities are highly concentrated among a small number of large firms. In short, from the point of view of society as a whole, a carbon tax has to be the more rational approach towards controlling carbon emissions.

Of course, the extent to which the carbon tax would be passed on to consumers in the form of higher prices of the goods and services would not make it popular – except to note that the prices would be even higher in the ‘cap-and-trade’ system for the reasons just given. Then there would be the question of what the government would do with all that extra revenue? Would it be used efficiently and wisely? Would it be invested in the research and development of alternative sources of energy? In short, can we trust governments to act properly in the interest of everybody? On the evidence to date, as Hansen notes, the answer has to be a resounding no.

That is why Hansen proposes, which is what I am now proposing here, that all of the revenue from a carbon tax (less very small administrative costs) be re-distributed on a per capita basis to every citizen, with children being allocated half the amount of adults (reflecting the extent to which parents act on behalf of their children). This is the dividend element of the ‘fee-and-dividend’ approach, which is what Hansen calls the carbon tax. By distributing the revenue to citizens, it would be they who made the decisions. Those with a small ‘carbon footprint’ would benefit, while those with ‘gas-guzzling SUVs’ and air conditioners would have to pay dearly for their habit. In short, it would encourage everybody to think carefully about his or her patterns of consumption. Even more important, it would make investment in the development of alternative sources of energy and in conservation much more rewarding.

Furthermore, a carbon tax along these lines has the advantage that it does not require complex international negotiations for it to be introduced. It can be done unilaterally. Of course, the more that governments everywhere adopt such a scheme, the better it would be for the planet. But in the meantime, in order to prevent the economies of countries introducing such a tax being undermined by imports from countries operating on a ‘business-as-usual’ basis, and the migration of energy intensive productive activities to those countries, there would have to be a border tax on all imported goods on the basis of the average emissions arising from their manufacture (the revenue from which could perhaps be used to help poor countries develop low emission energy systems). Such a proposal has already brought shouts of ‘protectionism’ from big business and their supporters. But they should be ignored because it is only fair that countries prepared to do something about global warming should be allowed to protect their economies. In any case, we need to challenge the ideology that lies behind the neo-liberal economic policies that have so much benefited big business at the expense of everybody else. As I have argued elsewhere, if countries are to develop their economies optimally, governments have to be allowed to impose selective tariffs on imports (preferably subject to international agreement) – indeed it is their democratic right. But such tariffs should be kept quite separate from border taxes on carbon emissions.

Finally, it should be noted that a carbon tax does not preclude other measures to combat global warming, such as energy efficiency regulations. On the other hand, the existence of a carbon tax would likely make such other measures more effective.

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