Just last month, the Intergovernmental Panel on Climate Change (IPCC) released its landmark assessment on our current climatic conditions. The report, like several other recently published scientific studies, has painted an alarming picture of our environmental situation: the Earth’s atmosphere is the warmest it’s been in the past 100,000 years, carbon dioxide levels are the highest they have been in the last 2 million years, and we are likely to cross the 1.5 degrees Celsius mark by 2030 (10 years earlier than previously predicted).
However, amidst the distressing facts and forecasts, the report highlighted that we can still prevent the worst of environmental degradation by reducing our emissions. The assessment explains that if we can take ambitious steps to stimulate transformational, systematic change to drastically reduce emissions, we will be able to prevent temperatures from rising beyond 1.5 degrees Celsius.
As the IPCC report suggests, taking concrete actions to curb emissions has never been as important. This has prompted several nations, ranging from Denmark to South Africa, to implement carbon taxes to reduce their emissions. The United Nations defines a carbon tax as “a tax capable of conferring a reduction in corresponding carbon-based emissions in the atmosphere”. Carbon taxes are imposed on companies that burn carbon-related fuels, such as coal, oil, and gasoline, and, like any indirect tax, they intend to increase the cost of fossil fuels, which will disincentivize their utilization. Since they increase the prices of fossil fuels, carbon taxes have severe ramifications on emissions and the economy.
Environmental Impact
At present, the global average price of carbon is $2 a ton, which is substantially below the $75 per ton price needed to reduce the quantity of carbon used to ensure global warming does not increase 2 degrees Celsius. To reduce carbon utilization and thus emissions, policymakers, in nations ranging from the United States to Ukraine, have argued in favour of implementing carbon taxes. Researchers from the International Monetary Fund (IMF) concluded that carbon taxes are the most effective mechanism to reduce global emissions. This is because they increase the costs associated with using carbon-related fuels. Therefore, they incentivize profit-seeking firms to reduce their carbon emissions, which results in a reduction in carbon emissions.
Furthermore, carbon taxes are likely to result in a reduction in profitability for carbon-intensive firms. This makes ESG investment relatively profitable. Therefore, research from the Climate Finance Leadership Initiative shows that carbon taxes increase investment and reallocation of capital towards green firms which have adopted sustainable methods. Therefore, the imposition of a carbon tax in Sweden resulted in an 11% decline in emissions. Moreover, this increase in investment may help spur investment in several areas, including green energy, which would help reduce global emissions. Lastly, carbon taxes, like any other indirect taxes in price inelastic goods, yield considerable amounts of tax revenue.
For instance, projections by the Tax Foundation suggest that a carbon tax of $50 per metric ton of carbon emissions will yield over $1.87 trillion in revenue in the United States over 10 years. Several policymakers have advocated allocating this revenue to environmentally beneficial causes, such as research grants for green technologies, which would help reduce global emissions.
Unfortunately, according to empirical research, carbon taxes have not driven the drastic reduction in emissions we had hoped for. A thorough reading of the literature on the subject by Jessica Green concluded that “The available information indicates that its impact on emissions has been limited at best.” An analysis of fossil fuel energy sources by David B. Goldstein from the National Resource Defence Council (NRDC) revealed that demand for fossil fuels tends to be price inelastic. Therefore, he argued that carbon taxes are likely to result in a minimal reduction in carbon emissions since the price inelasticity means that only a scant reduction in the number of fossil fuels used will occur.
Additionally, carbon taxes are unlikely to be internationally coordinated. Hence, Haitao Cheng and Jota Ishikawa from Hitotsubashi University found that carbon taxes, at least those implemented by independent states, are not an effective mechanism of reducing emissions since they often result in emissions going overseas since, instead of accepting the increased costs and lowering their emissions, firms choose to relocate their operations to nations without carbon taxes. Resultantly, the emissions are only relocated, so global emissions do not reduce.
Moreover, it is argued that, as explained below, carbon taxes are likely to have adverse economic implications due to several factors, including regressive nature. This, in turn, may result in a reduction in environmentalism amongst individuals since if a household’s income levels reduce they are unlikely to be able to afford to make consumption and purchase choices based on environmental factors. Moreover, they may result in a reduction in economic growth, which may result in the economy as a whole being able to invest lesser amounts on efficient, green methods and technologies which may slow down the green transition.
Economic Impact
Carbon taxes have a significant impact on the cost of fossil fuels, which are the most used energy source. Hence, they have important economic implications. An increase in the cost of carbon is likely to result in an increase in costs of production for most firms, which will in turn reduce profitability and competitiveness. This may cause an increase in outward investment, resulting in increased unemployment and lower standards of living.
Furthermore, the increased price of carbon, and thus increased cost of production and profitability, is likely to result in a reduction in reduction in the gross domestic product (GDP). A model by the conservative Heritage Foundation found that a carbon tax will result in a $3.9 trillion reduction in the gross domestic product (GDP). Moreover, carbon taxes are likely to harm inequality and distribution. Carbon taxes would have a greater burden on those from lower socioeconomic groups than those from higher socioeconomic groups.
This is because the increased costs associated with carbon taxes are likely to take up a larger proportion of income from those with lower income levels. Therefore the Political Economy Research Institute at The University of Amherst’s empirical analysis of a potential $49 per ton carbon tax showed that “a carbon tax would cost poor households a higher percentage of their income than the rich.”Thus, a carbon tax is likely to increase income inequality.
However, some policymakers and experts argue that most of the economic woes induced by carbon taxes can be mitigated by effectively allocating the tax revenue raised from carbon taxes. The tax revenue can be allocated towards to those from lower socio-economic groups, who are likely to be the most affected by the increased prices due to carbon taxes, or to those who face unemployment as a result of carbon taxes; for instance, those who used to work in carbon-intensive sectors which may have decreased in size.
After factoring in the protentional rebates, a model developed by Gilbert Metcalf from RFF University & Alan Finkelstein Shapiro from Tufts University found that a carbon tax capable of reducing US emissions by 30% can actually “ generate mild positive long-run effects on consumption, output, and labour force participation”, “ create negligible long-run adverse effects on unemployment”, and “in the short-term, create no effects on unemployment and gradual gains in output and consumption”.
The increased economic prosperity is explained by the rebates, and the increase in demand for green energy, and thus the creation of new, high-paying green jobs. Lastly, several policymakers have proposed implementing carbon taxes in tandem with rebates and payroll tax cuts, which, according to research from the Tax Foundation, would reduce inequality.
Taking concrete action to prevent the worst consequences of climate change is imperative. Policymakers need to issue policy decrees which help stimulate the green transition, and reduce emissions. However, before implementing carbon taxes it is paramount to analyse their effectiveness at meeting environmental objectives, based on their ability to reduce emissions, and implications on the economy, based on the economy’s reliance on carbon-intensive goods.
In addition to economic and environmental considerations, like any major economic policy, carbon taxes have several political and social consequences. Implementing carbon taxes, for most nations, will be a political struggle since it is likely to be met with opposition from industries and influential industries and stakeholder groups. Based on the available evidence, carbon taxes have the potential to drastically reduce emissions and create better jobs for some nations, while reducing economic activity and having a minimal impact on emissions for others. Therefore, policymakers need to make informed environmental policy decisions keep in mind the economic and environmental ramifications of such policies.
Written by- Pratham Dave
Edited by- Nanditha Menon
