The Six Advantages of Imposing a Harmonised Carbon Tax

A carbon tax policy might not be a magic wand programme but it is also less likely to face political opposition and compromise while creating new sectors for businesses and growth.

We stand today at the brink of a long term anthropogenic and ecological change. It has been caused not by the forces of nature but our own exploitation of the planet’s resources. There is compelling evidence that climate change is the greatest and widest-ranging market failure ever seen. There is a large chance of the average global temperature rise exceeding 2º C by the end of this century. It has also been established in various scientific studies that any such warming of the planet will lead to increased natural calamities like floods and cyclones, declined crop yields and ecological degradation. A large increase in global temperatures correlates with an average 5% loss in global GDP. Poor countries are expected to suffer costs in excess of 10% of GDP.

An immediate and global policy response is urgently required to reduce greenhouse gas emissions and mitigate the effects of climate change. The discourse must be reinvigorated towards adopting a multilaterally coordinated imposition of a carbon tax as a potent mitigation policy.

A carbon tax aims to internalise the externality of climate change – by setting a price on the carbon content of energy consumed or greenhouse gas emitted in the production or consumption of goods. Carbon tax regimes will only be effective if harmonised internationally. Different country-wise policies could lead to ‘carbon leakages’, where energy-intensive businesses will simply, and most likely, move to less-strict national regimes.

Harmonised carbon taxes hold advantages over quantitative limits imposed through government control and regulation. There are six reasons why.

First, a carbon tax regime avoids the problems related to choosing a baseline. In a price approach, the natural baseline is a zero carbon tax. Second, carbon tax policy will be better able to adapt to the element of uncertainty which pervades the science of climate change. Quantity limits on emissions are related to the stocks of greenhouse gas emissions – while the price limits are related to the flow of emissions. From this uncertainty arises another complication of price volatility, which is the third reason: carbon tax policy is likely to cause less volatility in the prices of carbon emissions.

Fourth, policies that limit quantities are often accompanied by administrative arbitrariness and corruption through rent-seeking. This sends off negative signals to investors. In a price-based carbon tax, the investor has an assured long term regulation to adapt to and can also weigh in the costs involved.

Fifth, the most contentious issue in any international negotiation on climate change mitigation either at the level of WTO or at UNFCCC: equity between high-income and low-income countries. The price based approach in the form of carbon taxes makes it easier to implement such equity-based international adjustments than the quantity-based approach.

Finally, sixth: the carbon tax will essentially be a Pigovian tax that balances the marginal social costs and benefits of additional emissions, thereby internalising the costs of environmental damage. It can act as an incentive for consumers and producers to shift to more energy-efficient sources and products.

Some countries and regions like, the US and the European Union, already have fairly successful carbon-pricing regimes in place, in the form of carbon taxes and emissions trading schemes. Some other countries have introduced general taxes on energy consumption instead of direct taxes on carbon content. This can be a good starting point for a shift in policy by the countries while they deliberate on  a harmonised carbon-tax regime.

The political consensus in favour of a direct carbon tax will be difficult to achieve in low- and middle-income countries that have developmental priorities and lack the capacity to administer such regimes. A general tax on energy consumption, together with a technology-centric policy that promotes entrepreneurs and investors who develop low-energy intensive products, can be a good starting point – from where they can gradually move towards a direct carbon tax. Another near-term approach can be a ‘cap-and-tax’ which combine the strengths of both quantity and price approaches. Cap-and-tax might also address the concerns of environmentalists that a price based approach does not impose hard constraints on emissions.

There are a few areas of further deliberation to move forward on an effective harmonised carbon-tax regime. Countries must negotiate and share policy experiences and researches in this area. They also must decide upon the appropriate forum to discuss and implement any such mitigation policy. The WTO could be the preferred forum, given the important nexus between international trade and climate change. Finally, any prospective policy regime must give the highest importance to the African continent. This is because Africa will produce the India and China of today by the middle of this century. A rapidly growing African economy must then be able to learn from past lessons without having to choose between economic growth and climate change mitigation.

A carbon tax policy might not be a magic wand programme but it is also less likely to face political opposition and compromise while creating new sectors for businesses and growth.

Armin Rosencranz is a professor of  law at Jindal Global Law School, Sonipat. Kshitij Bansal teaches law at Jindal Global Law School and is the Founding President of International Policy Analysis Network.