Carbon tax wrecks a variety of business sectors – previous taxes prove

The climate challenge requires the immediate implementation of ambitious climate policies. However, global and national financial institutions have expressed concerns that an abrupt and coordinated increase in carbon prices could lead to major shocks to the stock market, with the potential for systemic risk. Some assets will lose part of their value, others all of it, and hence become “stranded”. If the markets are not ready to absorb the shock, a financial crisis could follow. The number of jurisdictions pricing carbon has increased substantially over the last few years, mainly following the Paris Agreement, to reach 57 jurisdictions and a coverage of about 20 % of global greenhouse gas emissions (World Bank 2019). Very recently, the World Bank’s Highlevel Commission on Carbon Prices called for a global carbon price in the order of $40 to $80 per ton of CO2 (Stiglitz et al. 2017). While the increase in coverage and stringency of carbon pricing should be good news for climate change mitigation, in a recent and very influential speech Bank of England’s governor Mark Carney expressed strong concerns for the potential role that stranded assets could play in destabilizing the global economy (Carney 2015).

A global financial crisis caused by climate policy would not only disrupt the lives of millions of people, but also represent a major setback for climate action. Macroprudential measures, such as climate stress tests, have become part of the policy options considered by institutes such as the European Systemic Risk Board (ESRB 2016), and are under consideration in Canada, France, Italy, the Netherlands, Sweden, and the United Kingdom (Caldecott et al. 2016; Campiglio et al. 2017, 2018). In the United Kingdom, the Streamlined Energy and Carbon Reporting regulations seek to mandate carbon disclosure for all quoted as well as large unquoted companies. In the United States, Senator Elizabeth Warren sponsored the Climate Risk Disclosure Act, a bill requiring public companies to disclose critical information about their exposure to climate-related risks.

How well investors anticipate, and thus how large these shocks may be, is an empirical question. In this paper, we analyze stock market reactions to the largely unexpected defeat of two carbon tax initiatives in Washington state, Initiatives 732 (I-732) and 1631 (I-1631). We leverage an important difference in the design of these carbon taxes, namely that one implied a revenue-neutral reform (I-732) while the other could have been classified as an environmental spending bill (I-1631), along the lines of the currently debated Green New Deal.

Our main findings are as follows: (i) both events led to significant readjustments in the value of Washington-based firms, (ii) these adjustments are stronger for carbon intensive stocks, and (iii) all adjustments tend to be stronger for I-1631 than for the revenue-neutral I-732. These results have crucial implications for designing cost effective policies in the face of climate change. In particular, the important swings in the stock market price of Washington-based firms observed in our context suggest that even a relatively modest policy with limited jurisdiction can represent an important shock to the stock market. Hence, the concern about systemic risk in the case of a coordinated implementation of ambitious carbon prices across countries seems justified. While our analyses do not offer a direct test of the usefulness of macroprudential measures such as mandated carbon disclosure and climate stress tests, they do support the rationale for such interventions.