An Introduction to the International Carbon Tax

By:Nathan Shuler

On World Environment Day, 5th June 2011, tens of thouands of people rallied around Australia to say Yes to a safe climate and in support of a carbon price. An Estimated 10,000 people crowded onto the lawns of the State Library in Melbourne to listen to speakers and music in a familly friendly rally with lots of placards, banners and beanies on heads.
flickr/Tavkver

A major G7 meeting just concluded this week. The upcoming climate negotiation in Paris was a major item on the agenda. And now the most prosperous nations on the planet have their cards on the table: a 40%-70% reduction of the carbon emissions levels of 2010 by 2050.

The negotiations of the United Nations Framework Convention on Climate Change (UNFCCC) have primarily focused on the establishment of voluntary (yet-somehow-binding) emission reduction goals set by each participating nation. The US-China emissions reduction agreement and the recent G7 commitment have given some hope for a “climate deal” at the Paris 2015 conference. But like many in the economics and policy spheres, I’ve come to the conclusion that climate change is a fat-tailed statistical event—something that has a non-trivial risk of disaster—and that we need to make a dramatic shift to change the foundational economics of international energy markets. I’m not sure that emission reduction goals are enough.

I’m not pessimistic though! There was news this week that made me hopeful. And it came down to a number.

A recent IMF working paper, How Large Are Global Energy Subsidies, has set the climate finance and energy world ablaze. Ladies and gentlemen, we now have a new price tag on global energy subsidies: $5.3 trillion USD. That’s right, trillion with a t. $5.3 trillion accounts for 6.5% of global GDP.

Why do you care so much about that number, Nathan?

While many nations already have carbon taxes (e.g., Switzerland and Finland), little is being done at the UNFCCC to jumpstart the conversation about carbon taxation.

The Great Recession didn’t help.

The strain on global economies from the financial collapse and the use of austerity throughout the world made few nations ecstatic to find new ways to further burden their economies. However, it should be noted that two developed countries implemented carbon tax policies in 2008: Switzerland and provinces in Canada.  Little empirical data was available on carbon tax policy and the policy was in its infancy. Developing countries also became more strongly opposed to paying any premium for climate mitigation when the majority of the problem could be blamed on countries like the US and China.

The IMF subsidy value accounts for “direct incentives, local pollution and public health effects, climate changes, and a host of other costs” (Nasdaq). Prior to the IMF report, each nation would go through the same process of valuing the impacts of switching from fossil fuel generation and increasing emission standards. The global $5.3 trillion subsidy figure provides domestic and international policymakers a starting point to challenge decades-old direct incentives for fossil fuels, opponents to renewable energy expansion, and other opposition groups.

Carbon taxation has always needed an accessible and robustly scrutinized measure of the inefficiency embedded in the global fossil fuel energy system. Without a value we only know the surface qualities of fossil fuels:  they are polluting, dirty, and come with by-products or externalities humans don’t like. The IMF subsidy could be that golden value. It could be the figure that gives the international community a global measure of the negative economic consequences of fossil fuel consumption. That’s why I care so much about that number.

Do you just need an accessible and robustly scrutinized measure of inefficiency of the fossil fuel energy system to push for a carbon tax?

Absolutely not, but to keep it simple, I’ll say it needs just one more component. Carbon taxation also needs to be in line with a common goal for the international community. Most advocates look at 100% cheap, equitable renewable energy generation as the best image of the future. Luckily for them, the IMF subsidy value is incredibly close to what we need to spend over the new few years to get to that reality. $5.5 trillion dollars is what Bloomberg New Energy Finance (BNEF) forecasts the world needs to invest to transition from a fossil fuel infrastructure to one based on renewable energy.

The two previously stated components necessary to make a carbon tax a reality—a measure of inefficiency and a goal of equitable clean energy—aren’t new needs for international negotiators in the broader climate conversation. So why hasn’t a carbon tax been brought up more in the international negotiations? For one thing, it is called a tax. Unfortunately, tax is one of the few words that people universally dislike.

What people do like is innovation and we’ve had quite a lot of that in the energy sector. Technological advancement and innovation in financing helped to rapidly expand the renewable energy industry, especially solar. The plummeting drop in renewable energy prices has given lots of politicians and climate negotiators hope that their emissions reduction goals would be achieved without government intervention. In many places across the globe, renewable energy has achieved grid parity with fossil fuels and a renewable energy revolution is a matter of fact and not just a possibility at this point.

One salient question needs to be addressed by those who are optimistic about global renewable energy prices: Is the global energy market allocating resources quickly and accurately enough in order to bring renewable energy generation up to the speed of deployment it needs to be at to supplant fossil fuels? It’s a question of simultaneous speed and effectiveness, both promises of a carbon tax.

What makes a carbon tax better than the emission reduction goals?

On June 1 a new episode of EconTalk, a podcast from Stanford University’s Hoover Institute, showed up in my email. Harvard’s climate economist, Martin Weitzman, appeared on the show to discuss the merits of a carbon tax (among other things). Weitzman very subtly critiques emissions capping mechanisms while elevating a carbon tax in the following excerpt:

“. . . If we can get everyone to agree on a uniform price [(i.e., a carbon tax)] and then they vote on it or negotiate what that price is going to be—you are then negotiating with a one-dimensional entity, the price, instead of n-dimensional different caps.”

Weitzman’s argument is simple and economical: a carbon tax is uniform, non-discriminatory and singular; caps or reduction goals are inconsistent, (potentially) discriminatory and n-dimensional. Weitzman isn’t saying that countries shouldn’t set reduction goals but rather that our negotiations got off on the wrong foot. We should have been thinking about economic foundations and frameworks that will shift consumption and production from the very the beginning of the negotiations. The cap and trade model and emissions reduction goals are both bandages: they come in a variety of sizes and not all of them have the same level of stickiness.

UNFCCC_parties with legend
” UNFCCC Parties” Wikimedia Commons/Canuckguy

Will poor countries have to front the bill for a carbon tax?

Not necessarily. Take a note from Switzerland. 100% of the tax revenue generated by their carbon tax is reshuffled back into the hands of citizens and enterprises. The international community can model an international carbon tax similar to their approach. After we remove the $400-$800 billion dollars that many nations like Russia and Venezuela use as direct incentives for fossil fuels and other deflationary financial mechanisms that keep fossil fuel prices low, the international community can tax energy uniformly and then redistribute it from across the participating countries.

For example, let’s look at a two-part scenario: the US taxes itself at $45 per lb of CO2 and we fund the Green Climate Fund.

Part 1

Another carbon subsidy estimator, the controversial White House-produced Social Cost of Carbon (SSC), was used by two Democratic Senators to craft a new bill with a carbon tax priced at approximately $45 per ton of CO2. The Senators claimed that such a carbon tax would generate $2 trillion in revenue for the government over ten years.

The US GDP is $16.8 trillion. The Gross World Product (GWP) is assumed to be $87.3 trillion. Keeping a simple model, let’s assume that the US GDP is 20% of the GWP. Thus, multiply the $2 trillion in revenue for the government over ten years by five to get the global revenue from CO2 emissions: $10 trillion in ten years.

Part 2

For those climate wonks, the 2010 UNFCCC meeting in Cancun ushered in a very important program: the Green Climate Fund. This fund “will support projects, programmes, policies and other activities in developing country Parties using thematic funding windows.” The Green Climate Fund aims to raise $100 billion a year by 2020, a measure that the international community has struggled to achieve.

Let’s treat the Green Climate Fund as a representation of those people that would be most affected by the higher energy prices from a carbon tax. In the very basic example above, the nations of the world raise $1 trillion a year from carbon taxation. The wealthy nations that can afford to contribute some private and newly found government revenue to the Green Climate Fund do so. Those countries that are most negatively affected by the new policy are given some assistance to develop sustainably.

Lastly, one looming problem related to helping the developing nations faces the developed nations. According to France (the host country of the next round of climate negotiations), Western nations have to pay their fair share or risk delaying the climate negotiation process.

How can we get the international community to agree on a carbon tax?

Now that’s the $5.3 trillion dollar question.


NateShulerNathan Shuler is a Client Support Analyst with the Energy and Sustainability Services department of Schneider Electric. His professional career has focused on assisting businesses with carbon footprint data management & reduction as well as renewable energy projects and financing in the United States. He holds a B.A. in Economics from Centre College.

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