The Case for a Carbon Tax

By Bryan Walker 12/09/2011

The case for putting a price on greenhouse gas emissions from human activity is not arguable. It’s undeniable. But what is arguable is the best way of achieving it in the working of a modern economy. Shi-Ling Hsu, a law professor at the University of British Columbia, argues for a currently less popular way in his newly published book The Case for a Carbon Tax. ’There is no policy instrument that is more transparent and administratively simple than a carbon tax.’ Unfortunately its overtness tells against it politically because voters, politicians and emitting industries see the price very clearly and can calculate what they think it might cost them. But in Shi-Ling Hsu’s view environmental measures that purport to be painless are either misleading or set to accomplish nothing.

His book is grounded in the recognition that climate change is a serious problem with unacceptably high risks of catastrophic consequences that must be addressed immediately. It is alone among environmental problems in posing the risk of such vast environmental changes that the effects could destabilise entire economies, countries, and regions.

The four main options for greenhouse gas reduction are a carbon tax, environmental regulation, cap-and-trade programmes with tradable allowances to emit, and government subsidies targeted at low-carbon technologies. A carbon tax on the consumption of fossil fuels can be levied at some point at which the ownership of a fossil fuel changes hands, from the early extraction or processing point (upstream) right up to the point immediately preceding combustion (downstream).  The distinguishing feature of command-and-control regulation is that compliance is largely an administrative matter for which there can be an administrative adjudication. Cap-and-trade programmes involve issuing allowances to polluters, and compliance is determined solely by whether the emitter has enough allowances to cover its quantity of emissions. They are not dissimilar to carbon taxes in many respects, and have begun to look more and more like carbon taxes. Subsidies are of two kinds — price-oriented subsidies and funding for research and development. The author judges them on the whole as more costly and less effective than either carbon taxes or cap-and-trade programmes.

A large section of the book is given to ten arguments in favour of a carbon tax. One is economic efficiency:

’The simple genius of a carbon tax is that it aggregates disparate pieces of information, transmitting a price signal at every stage in which there is fossil fuel usage, and transporting it in proportion to the carbon emissions of the production process.’

All of the four alternatives are in the business of creating a carbon price, but the book considers the carbon tax does it best. Command and control regulation is clumsy and uneven by comparison. Subsidization is a useful mechanism in some situations, such as preventing deforestation in developing countries, but on the whole it is ’mere political grease, an overused salve for the perceived pain from the prospect of economic structuring.’ Cap-and-trade programmes are generally less comprehensive in their scope than a carbon tax. A cap-and-trade programme could be as comprehensive as a carbon tax, but to do so it needs to be imposed upstream, at the point of extraction or processing of the fossil fuel. This was a particularly interesting assessment for me because a few weeks ago I reviewed Robert Repetto’s book America’s Climate Problem: The Way Forward, in which he advocates cap-and-trade as preferable to a carbon tax and I imagined that his book and Shi-Ling Hsu’s would be at odds. But Repetto is specific that an upstream cap-and-trade is best, which means there is a good deal of common ground between the two writers. And although Shi-Ling Hsu argues the superiority of a carbon tax he does so moderately and reasonably, not scorning the other instruments.

Sunk capital is often a hindrance to change, and Shi-Ling Hsu points out that power plants and coal mines can represent huge stranded costs. Government subsidies have often encouraged the formation of this kind of capital and the book argues that it is far less dangerous to spur growth by taxing that which is undesirable than to encourage capital formation around that which we think at a particular time desirable. A carbon tax is capital-neutral, one of the arguments in favour of it.

Other advantages include its ability to co-exist with the other policy measures the book considers.  It is simple to get under way and doesn’t pre-empt subsequent employment of other options.  Although both a carbon tax and cap-and-trade schemes can be effective in encouraging innovation to reduce emissions, a carbon tax has the edge. It produces a steadier price signal and the signal remains undiluted, which encourages further innovation. It is broad-based, getting at the problem of fossil fuel combustion across all sectors and activities. Cap-and-trade could also do this, but the schemes so far emerging are selective and less comprehensive than a carbon tax. A carbon tax is more readily administrable, requiring fewer delicate decisions than does setting up a cap-and-trade scheme. The book also sees better prospects for an international accord based on a carbon tax than on the capping so far strenuously resisted by China, India and other developing countries. Overall the breadth, simplicity and ability to piggy-back on existing regulatory structure which are the characteristics of a carbon tax mean it offers the greatest chance to reduce greenhouse gas emissions immediately.

The book also considers the counter-arguments against a carbon tax and responds to them. To the argument that politically the carbon tax is never going to be acceptable the author suggests the fact that the proceeds go to the public purse rather than to private companies should be an effective selling pitch. The regressive effects of a carbon tax on low-income consumers should not be overstated for political purposes. Harm to low-income households can be limited, particularly by recycling at least a large portion of carbon tax increases. Such recycling is most effective when it takes the form of the lump sum distribution of money on a per capita basis.

The chapter on carbon tax psychology is somewhat depressing reading. What makes carbon taxation as a policy so unpopular is the obviousness of the cost.  Politicians are accordingly reluctant to embrace it. The temptation is to propose other seemingly less painful measures to address climate change. The author nevertheless believes that the arguments his book proposes in favour of carbon taxes carry the potential for the politics and psychology to change.

It is the ability of a carbon tax to penetrate into every nook and cranny of the economy where fossil fuels are burned and thus to empower everybody in the world to reduce or eliminate the amount of carbon dioxide emitted which is its chief appeal for the author.  We must have faith that markets will produce the innovations necessary to reduce emissions, and a carbon tax of sufficient size will drive that innovation.  As a first step it can be instituted immediately. And it does not preclude any of the other policies also being employed. Perhaps most importantly it stands the best chance of getting the international buy-in which is essential to global emission reduction.

It’s a strong case, well-made with a great deal of patient attention to detailed discussion which can’t be mirrored in a brief review but is a major factor in the book’s success, aided by the admirable clarity of the writing.

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