This post is by Libby Peake, head of resource policy, and Jasmine Dhaliwal, policy assistant, at Green Alliance.
Economists often say the main thing needed to stop climate change and save the planet is a high enough price on carbon. The theory holds that if you attach a price to releasing greenhouse gases, that reflects the damage they do and which rises over time, it makes activities that release emissions economically irrational, so businesses and people will start to change what they do. Cheaper options will be exhausted first, meaning the market will deliver decarbonisation at ‘least cost’ and, as they say, Bob’s your uncle.
Unfortunately, this theoretically perfect economic model doesn’t exist. In the real world there are plenty of barriers to prevent this elegant solution from delivering a low carbon utopia. Here are just a few of them:
- Fear of carbon leakage undermining the system: For carbon pricing to work properly, the whole world needs to act together. And, while carbon pricing – through taxation or emissions trading schemes (ETS) – is becoming more widespread, internationally it hasn’t reached a level that will drive action across the board. Worse, this lack of co-ordination creates a fear of carbon leakage, where production shifts to countries with less strict carbon pricing to avoid costs. To combat this threat, which some say is exaggerated, governments distribute free emissions permits to supposedly vulnerable, highly emitting, energy intensive sectors. At best, this weakens incentives but, at worst, it subsidises the pollution driving climate change: Transport & Environment found that the UK aviation industry received an effective subsidy of £72 million in the UK in 2021 in this way
- Costs aren’t passed on: Firms that pay a price for their carbon impact can decide how much cost to pass onto customers and often don’t do so if, for instance, because they’re concerned about competitiveness or want to maximise market share. Incentives to change consumer behaviour are weakened when costs are absorbed upstream. And, even if carbon costs are passed on fully, it could still have a relatively small impact on product prices, as labour costs and taxes make up a greater proportion
- The least well off are the worst affected: We live in an unequal society, and the cost of living crisis means there are more and more people struggling to afford basic goods. Without careful design, carbon taxes are likely to exacerbate these problems as low income households spend more of their money on high carbon goods like heating and transport
- Sometimes, big investments should be made first not last: The idea that the market will deliver decarbonisation at least cost ignores often significant transition costs, and the risk of locking in high carbon infrastructure, if important investments aren’t made early on. When climate change mitigation involves long lived expensive assets, such as power plants or transport infrastructure, investing in these early makes more sense instead of waiting (too long) for the market to deliver.
Do we need carbon pricing?
So, the question is: in our imperfect reality with an unhelpful starting position, economically irrational actors and the pressure to take action more urgent by the day, do we really need carbon pricing with all its flaws?
The answer is yes, of course we do. Climate change is already imposing huge costs on society through health impacts, extreme weather events, nature degradation, increasing community conflicts and more. The consequence is that it is already costing the equivalent of 1.1 per cent of GDP, and is forecast to rise to 3.3 per cent by 2050. These costs are too often borne by those who directly suffer the effects and by society at large, rather than by those causing the problem. So it’s difficult to envisage a fair climate policy where the polluter is not made to pay in some way.
The government has recently – and rightly – recommitted to the publicly popular ‘polluter pays’ principle by enshrining, through the UK’s Environment Act, the idea that the costs of pollution “should be borne by those causing it, rather than the person who suffers…or the wider community”. Carbon pricing makes this principle a reality and has other benefits, including providing funding for more green, cost saving measures for homes for example. Globally, carbon pricing raised $84 billion in revenue in 2021, half of which was then spent on environmental or development projects.
What’s more, some of carbon pricing’s shortcomings can be addressed through better policy design. For example, fear of carbon leakage could be dealt with by a carbon border adjustment mechanism which equalises carbon prices for imports and domestically produced goods. The EU is starting to bring this in from October this year, and the UK government is likely to follow suit, with a consultation on the measure closing next week. The possible socially regressive impact of carbon pricing could be countered by using some of the revenue gained to compensate vulnerable households, which could increase public support for it.
It is just one useful tool of many
We’ve published a policy insight outlining what the government’s immediate priorities should be to do carbon pricing well. This should include a long term vision so businesses have the certainty they need to invest, and so that low income households are adequately protected.
Ultimately, although it’s a powerful one, it’s just one tool – rather than the only tool – the government can use to get on track to net zero. What is also needed is a strong green industrial strategy working alongside carbon pricing, so there’s a well equipped workforce, the right infrastructure, innovation, adequate regulation, subsidies and investment all working together to stimulate low carbon innovation and markets. Now that would be economically rational.