Good Fiscal Policy: Governments Using Carbon Pricing to Drive Low‐Carbon Investment
| Published date | 01 September 2015 |
| Date | 01 September 2015 |
| DOI | http://doi.org/10.1111/1758-5899.12265 |
Good Fiscal Policy: Governments Using
Carbon Pricing to Drive Low-Carbon
Investment
Tom Kerr
International Finance Corporation, World Bank Group
The phrase ‘put a price on carbon’has become increas-
ingly common as discussions of how to address climate
change move from concern to action. In the past year,
the World Bank Group, governments, businesses and
investors have increasingly shown support for carbon
pricing as a key strategy to bring down greenhouse gas
emissions and drive investment into cleaner options. So
what does it mean to put a price on carbon, and why
do many government and business leaders support it?
There are several paths governments can take to price
carbon, all leading to the same result. They begin to
capture the external costs of carbon emissions: Costs
that the public pays for in other ways, such as damage
to crops and to property from flooding and sea level
rise or health care costs from heat waves and droughts.
These costs are then tied to their sources through a
price on carbon.
Instead of dictating who should reduce emissions
where and how, a carbon price gives an economic signal
and polluters decide for themselves whether to discon-
tinue their polluting activity, reduce emissions, or con-
tinue polluting and pay for it. In this way, the overall
environmental goal is achieved in the most flexible and
least-cost way. A carbon price also stimulates clean tech-
nology and market innovation, fuelling new, low-carbon
economic growth. Carbon pricing (and efforts to remove
fossil fuel subsidies) raise revenues in an economically
and fiscally efficient way, making them good fiscal poli-
cies in addition to their environmental benefits (Fay
et al., 2015). This is obvious with the elimination of envi-
ronmentally harmful subsidies, which reached about
$548 billion in 2013 according to the International
Energy Agency (IEA, 2014). Carbon taxes (and emissions
trading schemes that auction or sell allowances) can also
raise significant revenues. Raising funds in this way
makes it possible to reduce distortionary taxes like those
on labor or capital.
Finance ministries are increasingly finding carbon
pricing attractive, given that carbon emitters are an
excellent tax base –they are concentrated in a few
sectors. In the United States, for example, tax collection
covering 80 per cent of emissions could be accom-
plished by monitoring fewer than 3,000 sources (Weis-
bach and Metcalf, 2009). In Sweden, which has had a
carbon tax since 1992, tax evasion for the carbon tax
is under 1 per cent, much lower than the tax evasion
for the country’s VAT (Fay et al., 2015). Economic anal-
ysis also finds that carbon prices do not necessarily
harm competitiveness, even in heavy industries (see,
e.g., Dechezlepr^
etre and Sato, 2013 or Sartor, 2013).
Data from the UK suggests that the introduction of
the Climate Change Levy (an energy tax) had a signifi-
cant impact on energy intensity, but no detectable
effects on economic performance (Martin et al., 2009).
This is because carbon abatement costs are a small
fraction of production costs for most industries and
factors like the availability of capital and skilled labor
or proximity to markets are more important determi-
nants of industrial competitiveness (Copeland, 2012).
Carbon revenues can also be used to improve compet-
itiveness through investments in education and workers
skills or infrastructure, or through reduction in capital
and labor taxes.
Carbon pricing is gaining momentum
Almost 40 countries and more than 20 cities, states and
provinces already use carbon pricing mechanisms or are
planning to implement them (Figure 1). These jurisdic-
tions are responsible for more than 22 per cent of global
emissions. Others are developing or considering systems
that will put a price on carbon in the future. Altogether,
these actions will encompass almost half of global CO2
emissions.
There are two main types of carbon pricing: carbon
taxes as discussed above and emissions trading systems
(ETS). An ETS, sometimes referred to as a cap-and-trade
system, caps the total level of greenhouse gas emissions
and allows industries with low emissions to sell extra
allowances to larger emitters. By creating supply and
demand for emissions allowances, an ETS establishes a
market price for greenhouse gas emissions. The cap
©2015 University of Durham and John Wiley & Sons, Ltd. Global Policy (2015) 6:3 doi: 10.1111/1758-5899.12265
Global Policy Volume 6 . Issue 3 . September 2015
308
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