Loss and damage funding for Africa will be back on the table at COP28
Key details of the landmark loss and damage fund launched at COP27 need to be ironed out this year.
Economists overwhelmingly agree that a carbon tax is a necessary policy for speeding up the transition to a lower carbon economy by incentivising companies and people to change their behaviour. As long as the tax is high enough (experts say a price of USD 40-80/tCO2e is needed to meet a 2°C goal), it can both help companies and individuals move away from high-emission products and incentivise new, sustainable industries. And carbon taxes have proved to be effective. One analysis found that Norway’s carbon tax reduced carbon pollution by 2% in its first decade, while another study found that the EU cap-and-trade system probably reduced emissions by 4% between 2008 and 2016. This was achieved with a much lower carbon price than we see today. Another consideration in favour of introducing a carbon tax now, during a period of economic recovery from the COVID-19 pandemic, is that there is an opportunity to put spare labour capacity to more productive use.
Denmark is currently considering raising its carbon tax from 170 crowns to 1500 crown/tCO2e (USD 27 to USD 234/tCO2e) to help meet its 2030 target to cut greenhouse gas emissions by 70%. It is following other countries around the world that are raising carbon prices, including Canada, Germany and Ireland. Globally, there are now 46 countries with a carbon tax, covering 22% of global emissions. All Scandinavian countries have a carbon tax, with Sweden’s currently the highest at EUR 114/tCO2e.
In theory, putting a price on carbon shows companies the true cost of the products they make and consumers the real price of the goods they buy, because they include externalities (the impact of the products that are not accounted for in the price, such as pollution and CO2 emissions). For example, people buying big new cars or big new homes pay more carbon tax as these items have a bigger carbon footprint, making smaller alternatives more attractive. According to one estimate, in 2015 the richest 10% of the world’s population were responsible for 52% of cumulative CO2 emissions, with the top 1% alone accounting for 15%. Heavily taxing the materials and energy they consume could be a way to even out income inequality in countries where higher income taxes have been unpalatable in the past.
Carbon taxes are not necessarily regressive (they disproportionately burden low-income groups, as opposed to progressive, that try to shift the burden onto those who can better afford it). In theory, because low-income households earn less, basic necessities take up a greater proportion of their income than is the case for high-income households. This means they are disproportionately impacted by any rise in the cost of these necessities. But while this is generally true for electricity, it is less the case for transportation and heating fuels. This is because instead of spending more money on fuels, they will often just use less of them.
The regressive effects are also less significant when measured against household consumption, as opposed to income. This is because low-income households can under-report key components of their income, and consumption is typically higher than stated incomes.
Whether a carbon tax has a higher impact on poorer citizens for any country largely depends on:
Sweden’s experience in implementing one of the highest carbon taxes in the world may be most analogous to Denmark. The two countries have similar Gini-coefficients – Denmark’s is 0.26, Sweden’s is 0.28, indicating that both have low levels of income inequality. Sweden introduced its carbon tax in 1991 at EUR 25/tCO2e and slowly increased it over a number of years to EUR 114/tCO2e in 2021. The carbon tax was introduced at a high level for motor fuels and heating fuels in households and services, and a low level for heating fuels in industry. The slow increase in price gave households, businesses and supporting policies time to adapt.
Between 1990-2018, Sweden’s GDP grew 83% while its emissions decreased by 27%. Analysis showed that different deciles of Sweden’s income distribution pay roughly the same share of income on transport fuels. Similarly, the inequity in phasing out fossil-fuel-based heating fuels was compensated for by measures that provided temporary aid for moving to lower-emission alternatives. In other words, some of the revenue from the carbon tax was redistributed through welfare programmes.
The Swedish example is confirmed by other studies that found that a country’s underlying distribution of income will influence the equity of a carbon tax. The more equal the income among citizens, the more likely it is that the carbon tax will not have a disproportionately negative effect on low-income citizens.
In Italy, a carbon tax on transportation fuels was found to have a progressive impact even in the absence of revenue redistribution. A survey focusing mostly on northern European countries (Norway, Sweden, Finland, UK and Ireland) found that a carbon tax can be progressive if the tax revenues are redistributed. US studies concurred that a carbon tax can have a neutral or progressive effect, depending on how the tax revenue is redistributed.
A slow and considered increase in carbon pricing, taxing different energy products at different levels, and redistributing carbon tax revenues can eliminate distributional effects and enhance economic efficiency.
If there is a regressive impact, there are ample opportunities in advanced economies for adjusting tax and benefit schedules to alter the overall impact on lower-income households.
An important note on assessing the equity of carbon taxes
Determining whether a particular carbon tax is progressive or regressive is no simple task. There are plenty of academic analyses of the impact of a carbon tax at an income, sector, regional and country level. But the parameters and assumptions in the research must be examined closely. For example, studies on North-American data on car fuel taxation will not transfer to Europe, as the geography of urban areas, the distribution of income, the relative importance of public transportation and the prevailing levels of fuel taxes are completely different. A UK study found that simple assumptions such as considering all households or just car-owning households when assessing the impact of a fuel tax will change the distributional outcome completely.
When trying to understand the equity implications of imposing a carbon tax, the key things to look out for in the available literature should include:
Key details of the landmark loss and damage fund launched at COP27 need to be ironed out this year.
A growing number of countries include climate change and emissions considerations in their environmental frameworks. Australia does not.