Carbon tax solves – perfectly utilizes the strengths of capitalism to combat ecological crises

The economics textbook solution to externalities is to internalize them. If we could devise a way to price CO2 emissions, which account for the lion’s share of greenhouse gases, they could be inserted into the market mechanism. Broadly speaking, there are two ways to price carbon emissions. The first, and most intuitive, is to introduce a Pigouvian tax on carbon emissions.10 In plain language: you pollute, you pay. As of April 2021, twenty-seven countries in the world have implemented such forms of carbon taxation. As an alternative, it is possible to exploit the tight link between demand, supply, and prices by implementing a “cap-and-trade” system, building on the seminal work of economist Ronald Coase. The idea is to set a maximum level of CO2 emissions allowed per year for the entire system (the “cap”), then auction or dispense emissions permits (called allowances) among polluting firms, who can then proceed to trade these permits among themselves. Under cap-and-trade, a company must buy a permit to emit CO2, and can do so either from the government or from other firms. This might sound like the kind of abstract system that could only exist in economics textbooks but it is already widely used around the world. The EU has a cap-and-trade solution known as the Emissions Trading System (EU ETS), and so do New Zealand, Switzerland, Australia, South Korea, Kazakhstan, and China, to name just a few.11 Such schemes also exist at subnational level, as for example in California, Ontario, and the Tokyo region of Japan. These two alternatives, cap-and-trade (covering the entire economy) and carbon tax, are broadly equivalent. Either can achieve the same carbon prices and raise the same amount of revenue for a government. There are, however, some differences. One complication with cap-and-trade is price fluctuation; given that permits are auctioned and firms are allowed to trade them, the carbon price is subject to market dynamics, no less than a stock trading on Wall Street. For firms trying to decide whether to make large, long-term investments in green production methods, a nonfixed price introduces uncertainty regarding returns, weakening the incentive to proceed. Administratively, a cap-and-trade system is also more cumbersome to set up, especially for developing countries with limited administrative capacities. Once such a system is up, however, it is relatively easy to operate. In several countries, political considerations have steered policymakers toward cap-and-trade, given that any new tax was bound to be unpopular. To the public, cap-and-trade is a less visible mechanism than a carbon tax.12 For a good example of the difficult politics of carbon pricing, we need only look to the United States—the second-largest CO2 emitter in the world, after China, and conspicuously absent from the above list of carbon-pricing jurisdictions (at least at the national level). In 2009, the United States came close to adopting the federal cap-and-trade program specified by the American Clean Energy and Security Act (also known as the Waxman- Markey Bill), but it failed to pass in Congress. There is still some cause for hope given who currently leads the US Treasury. Secretary Janet Yellen spearheaded a petition supporting a carbon tax in 2019 which was signed by more than thirty-six hundred economists, including all living former chairs of the Federal Reserve, twenty-seven Nobel laureates, and fifteen former chairs of the Council of Economic Advisers.13 The problem, however, is that climate mitigation has become a strongly partisan issue in the United States. Given that filibuster rules in the Senate call for super-majorities, and the moderate democrats known as “blue dogs” remain coldhearted toward carbon pricing, it is hard to believe that Congress will pass carbon-pricing legislation in the near future. In Chapter 1, we saw that greenhouse gas emissions have been abating in advanced economies over the past few decades, but at a pace that is not sufficient to achieve net zero by mid-century. The problem goes well beyond the failures of politics in Washington. In 2017, a high-level commission on carbon pricing, co-chaired by Joseph Stiglitz and Lord Nicholas Stern, concluded that to keep global warming well below two degrees Celsius, in line with the Paris Agreement, a carbon price of $40 to $80 per ton of CO2 would be needed by 2020, and $50 to $100 per ton by 2030. In 2019, the IMF estimated the global average carbon price at around $2 per ton. It is simply not sufficient to put in place carbon tax schemes or cap-and-trade mechanisms. What matters is that the level of carbon pricing be set high enough and applied to wide parts of the economy—ideally, all of them. In mid-2021, the carbon price in the EU ETS broke the $50 mark —in principle, not far from the Stiglitz-Stern recommended levels. The EU ETS, however, currently covers only emissions from industry, the power sector, and intra-EU flights, which add up to roughly 45 percent of total EU emissions. On top of this, roughly half the allowances are given out for free. The degrowth school interprets this as capitalism’s inherent inability to shift away from greenhouse gas emission. In reality, there has simply been too low a price incentive to do so, reflecting too low of a political priority placed on this goal. Going forward, even where carbon pricing mechanisms are in place, the screws will need to be significantly tightened to accelerate decarbonization sufficiently to reach carbon neutrality by mid-century. Another policy action required to accelerate the green transition is the elimination of fossil-fuel subsidies, and related tax exemptions, as rapidly as possible. These subsidies amplify the negative externalities associated with CO2 emissions, and even create implicit incentives to produce them. According to recent estimates, global fossil-fuel subsidies remain large, at $5.9 trillion (6.8 percent of global GDP) in 2020, with the subsidizer-in- chief being China ($2.2 trillion), followed by the United States ($660 billion) and Russia ($520 billion).14 Allowing carbon pricing and fossil-fuel subsidies to coexist is essentially taking two steps forward and one step back in the march toward decarbonization. This is something that ambitious net-zero targets cannot afford. Abolishing fossil-fuel subsidies would not only lift the drag on decarbonization, it would free up precious financial resources to further accelerate the green transition.