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Article

Jorge H. García and Thomas Sterner

Economists argue that carbon taxation (and more generally carbon pricing) is the single most powerful way to combat climate change. Since this is so controversial, we need to explain it better, and to be precise, the efficiency gains are largest when the costs of abatement are strongly heterogeneous. This is often—but not always—the case. When it is not, standards can fill much the same role. To internalize the climate externality, economic efficiency calls for a global carbon tax (or price) that is equal to the global damage or the so-called social cost of carbon. However, equity considerations as well as existing geographical and sectoral differences in the effectiveness of carbon taxation at reducing emissions, suggest earlier implementation of relatively high taxation levels in some sectors or countries—for instance, among richer economies followed by a more gradual phase-in among low-income countries. The number of national and subnational carbon pricing policies that have been implemented around the world during the first years following the Paris Agreement of 2015 is significant. By 2020, these programs covered 22% of global emissions with an average carbon price (weighted by the share of emissions covered) of USD15/tCO2 and a maximum price of USD120/tCO2. The share of emissions covered by carbon pricing as well as carbon prices themselves are expected to consistently rise throughout the decade 2021–2030 and beyond. Many experts agree that the social cost of carbon is in the range USD40–100/tCO2. Anti-climate lobbying, public opposition, and lack of understanding of the instrument are among the key challenges faced by carbon taxation. Opportunities for further expansion of carbon taxation lie in increased climate awareness, the communicative resources governments have to help citizens understand the logic behind carbon taxation, and earmarking of carbon tax revenues to address issues that are important to the public such as fairness.

Article

Carbon has been part of the Earth since its beginning, and the carbon cycle is well understood. However, its abundance in the atmosphere has become a problem. Those who propose solutions in decentralized market economies often prefer economic incentives to direct government regulation. Carbon cap-and-trade programs and carbon tax programs are the prime candidates to rein in emissions by altering the economic conditions under which producers and consumers make decisions. Under ideal conditions with full information, they can seamlessly remove the distortion caused by the negative externality and increase a society’s welfare. This distortion is caused by overproduction and underpricing of carbon-related goods and services. The ideal level of emissions would be set under cap-and-trade, or be the outcome of an ideally set carbon tax. The ideal price of carbon permits would result from demand generated by government decree meeting an ideal fixed supply set by the government. The economic benefit of using the ideal carbon tax or the ideal permit price occurs because heterogeneous decision-makers will conceptually reduce emissions to the level that equates their marginal (incremental) emissions-reduction cost to the tax or permit price. When applying the theory to the real world, ideal conditions with full information do not exist. The economically efficient levels of emissions, the carbon tax, and the permit price cannot be categorically determined. The targeted level of emissions is often proposed by non-economists. The spatial extent and time span of the emissions target need to be considered. The carbon tax is bound to be somewhat speculative, which does not bode well for private-sector decision-makers who have to adjust their behavior, and for the achievement of a particular emissions target. The permit price depends on how permits are initially distributed and how well the permit market is designed. The effectiveness of either program is tied to monitoring and enforcement. Social justice considerations in the operation of tax programs often include the condition that they be revenue-neutral. This is more complicated in the permit scheme as much activity after the initial phase is among the emitters themselves. Based on global measurement of greenhouse gases, several models have been created that attempt to explain how emissions transform into concentrations, how concentrations imply radiative forcing and global warming potential, how the latter cause ecological and economic impacts, and how mitigation and/or adaptation can influence these impacts. Scenarios of the uncertain future continue to be generated under myriad assumptions in the quest for the most reliable. Several institutions have worked to engender sustained cooperation among the parties of the “global commons.” The balance of theory and empirical observation is intended to generate normative and positive policy recommendations. Cap-and-trade and carbon tax programs have been designed and/or implemented by various countries and subnational jurisdictions with the hope of reducing carbon-related emissions. Many analysts have declared that the global human society will reach a “tipping point” in the 21st century, with irreversible trends that will alter life on Earth in significant ways.