The Case for Carbon Taxation – IMF F&D | DECEMBER 2019
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- Authors: IAN PARRY
- Published: December 2, 2019
Overview
- Author: IAN PARRY, principal environmental fiscal policy expert, IMF Fiscal Affairs Department.
- Central thesis: Carbon-pricing strategies, particularly carbon taxes, could be a key tool for meeting global climate stabilization goals under the 2015 Paris Agreement.
- High-level context: Current country pledges would cut global emissions by only about one-third of the amount required to meet climate stabilization goals.
Rationale for carbon taxation
- Core mechanism:
- Carbon taxes are charges on the carbon content of fossil fuels.
- They increase prices of fossil fuels, electricity, and consumer products, and lower prices for fuel producers, thereby incentivizing fuel switching, energy conservation, and cleaner vehicles.
- Example price impacts (2030, illustrative):
- A tax of $35 a ton on CO2 emissions would typically increase prices for coal, electricity, and gasoline by about 100, 25, and 10 percent, respectively.
- Investment signal:
- Carbon taxes provide a clear incentive for redirecting energy investment toward low-carbon technologies like renewable power plants.
- Emissions responsiveness:
- A $35 per ton carbon tax by itself would exceed the level needed to meet mitigation commitments in China, India, and South Africa.
- The same $35 a ton would be about right for Indonesia, the Islamic Republic of Iran, Pakistan, the United Kingdom, and the United States.
- Even $70 per ton would fall short in some countries like Australia and Canada.
- Emissions are most responsive to carbon pricing in countries consuming a great deal of coal (China, India, South Africa).
Revenue potential and use
- Revenue magnitude:
- Carbon taxes could raise a significant amount of revenue, typically 1–2 percent of GDP for a $35 a ton tax in 2030.
- The average price of emissions worldwide is currently only $2 a ton.
- Productive use of revenue:
- Advanced economies: revenue might be used mostly to cut taxes on labor and capital income (retooling the tax system rather than increasing overall tax burden).
- Developing countries: revenue might be used mostly to fund investments for achieving the United Nations Sustainable Development Goals.
- Up-front use: funding clean-energy infrastructure upfront could enhance carbon pricing’s effectiveness and credibility.
Domestic environmental and administrative benefits
- Domestic health benefits:
- Carbon taxes can generate significant reductions in premature deaths from local air pollution.
- A $35 a ton carbon tax in 2030 would save an estimated 300,000 premature deaths a year in China and an estimated 170,000 in India.
- Administrative ease:
- Carbon charges can be integrated into existing road fuel excises and applied to other petroleum products, coal, and natural gas.
- Option to integrate into royalty regimes for extractive industries, with rebates for exported fuels.
Alternatives to carbon taxes
- Emission-trading systems (ETS):
- Firms acquire allowances; government controls supply; trading establishes price.
- To date, ETS have been mostly limited to power generators and large industry, reducing CO2 reduction benefits by 20–50 percent across different countries compared with more comprehensive pricing.
- ETS limit potential revenues from auctioning allowances and provide less certainty on emission prices (which may deter clean-technology investment).
- ETS require new administration and significant numbers of participating firms.
- Regulations:
- Can control energy efficiency or emission rates, and a comprehensive package can mimic many behavioral responses, but cannot encourage less driving or lower household energy use and tend to be inflexible and hard to coordinate cost-effectively.
- Feebates (revenue-neutral):
- Sliding scale of fees for above-average emissions intensity and rebates for below-average intensity.
- Example: feebates for power generators charging producers a tax proportional to electricity output times the difference between their CO2 emission rate per kWh and the industry-wide average.
- A package of feebates delivering the same economy-wide emissions reductions as a tax would typically impose a burden on all households of less than 1 percent of consumption.
Policy design, acceptability, and distributional considerations
- Phasing and support:
- Pricing can be phased in progressively to allow adjustment.
- Up-front targeted assistance (using only a minor fraction of revenues) can help vulnerable households, firms, and communities via social safety nets and worker assistance programs.
- Use of revenues to improve acceptability:
- Example distributional scenario:
- A $70 a ton carbon tax in Canada and the United States and a $35 a ton tax in China and India would impose extra bills for the average household of about 2 percent of their consumption in 2030.
- If transfer payments compensate the bottom 40 percent of households and the remaining revenue (about 70 percent) is used for broad income tax reductions or increases in productive investment, then the bottom 40 percent would be better off overall, while the average overall burden on higher-income households would be about 1-2 percent.
- Clear communication of these distributional outcomes could reduce public opposition.
International coordination and price floors
- Carbon price floor arrangement:
- A price floor among heavily emitting countries could guarantee a minimum level of effort and reduce competitiveness concerns.
- Coordination on price floors (rather than fixed price levels) would allow countries to exceed floors to meet Paris pledges.
- Floors could accommodate carbon taxes, ETS, and approaches like feebates that achieve the same emission outcomes.
- Accounting and monitoring challenges:
- Need procedures to account for exemptions and changes in preexisting energy taxes that might offset/enhance carbon pricing.
- Illustrative floor scenario:
- If advanced and developing G20 economies were subject to carbon floor prices of $70 and $35 a ton of CO2, respectively, in 2030:
- Mitigation effort would be well over twice as much as reductions implied by meeting current mitigation pledges.
- To reach a 2˚C-consistent level, additional measures equivalent to a global average carbon price of $75 a ton would still be needed.
- Strategic focus:
- Three countries—China, India, and the United States—account for about 80 percent of the low-cost mitigation opportunities across G20 countries; coordination among these three would be a major step forward.
Reasons for optimism and constraints
- Political and structural challenges:
- United States withdrawal from the Paris Agreement in 2020 (as described), entrenched coal in India, and limited coverage/ambition in China’s planned nationwide trading system.
- Grounds for optimism:
- Fiscal consolidation pressures in the United States could make carbon taxation politically easier than other revenue sources or spending cuts.
- Debate over Green New Deal-style policies could position carbon pricing as pivotal to rapid decarbonization.
- Domestic health co-benefits in China and India strengthen the case for pricing.
- Remaining gap:
- Current pledges and illustrative floors still leave additional measures required to meet a 2˚C target.
Source: The Case for Carbon Taxation – IMF F&D | DECEMBER 2019
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- The Case for Carbon Taxation – IMF F&D | DECEMBER 2019