After the Pope backed a carbon tax to stem global warming earlier this month, Louise Sunderland argues that carbon taxes will be efficient and cost-effective enough only when coupled with strategic use of the revenues.
Louise Sunderland is a senior adviser at the Regulatory Assistance Project (RAP), an independent, non-partisan, non-governmental organisation dedicated to accelerating the transition to a clean, reliable, and efficient energy future.
This month, Pope Francis announced that carbon pricing was “essential” to stem global warming, which “threatens the very future of the human family.”
Coming as it does from the head of the Catholic Church, I can’t help but see a neat parallel with the socially questionable and now defunct medieval practice of buying indulgences to pay one’s way out of purgatory. But, in this case, his Holiness might just have a point.
The Pope lends his voice to the growing rumble of interest in carbon pricing as a cornerstone policy to combat the climate emergency. A number of European Member States are considering introducing new carbon taxes.
And a foundational EU carbon policy, the EU Emissions Trading System (EU ETS), has been reformed, resulting in a fourfold increase in the price of carbon allowances.
But those of us like the Pope, who are fundamentally concerned with the social impacts of climate change and social justice in the transition to a clean energy system, have an uneasy relationship with carbon pricing. We know that, by itself, it will be both inadequate and too expensive to drive the change we need.
The social impacts of carbon pricing
When studied in isolation, carbon taxes or cap-and-trade schemes will be seen to negatively impact the poorest and most vulnerable in society. Placing any tax on consumption is more regressive than taxing income, since low‑income households spend a higher proportion of their income on consumption.
Any tax on consumption, therefore, impacts a higher proportion of their income compared to higher income households.
Looking specifically at carbon pricing on consumer energy use, a study of the average electricity taxes of 21 countries in the Organisation for Economic Co‑operation and Development found that electricity taxes were four times greater, as a percentage of net income, for the lowest income decile compared with the highest.
This means electricity taxes disproportionately impact the household budgets of low-income citizens. At a time when Europe is increasingly concerned about energy poverty, any policy that does this warrants scrutiny.
Added to this, within the EU ETS, consumers pay multiple times the market price for each tonne of carbon abated in the electricity sector. This is due to the single-price power market in which the wholesale price is set by the most expensive generation type for each time period of demand.
This generation type is usually fossil-fuel-fired (coal or natural gas). The carbon price of this carbon‑intensive generation is then added to the market price of all electricity. All generators, even renewable power generators, receive the same price, and all consumers pay it.
This means consumers pay for more carbon than is actually emitted in the generation mix, resulting in a high price being paid for each tonne that might be abated.
This summary paints a dim picture of carbon pricing policies, insofar as a tax added to fuels and goods that many consumers have limited ability to ration, disproportionately harms our most vulnerable citizens.
And it raises the question of whether the Pope and other socially conscious environmentalists can in all good conscience support a price on carbon, if apprised of this evidence.
The answer, perhaps surprisingly, is yes. Because the silver lining of carbon pricing is carbon revenues. And the revenues provide our opportunity for salvation. These revenues can be invested in ways that not only multiply the desired effects of carbon prices, but also improve the welfare of vulnerable citizens.
The social benefits of carbon revenues
We must not lose sight of the fact that catastrophic climate change isn’t fair. Extreme climactic change, extreme climate events and the worst impacts of environmental pollution are already disproportionately impacting low‑income communities.
So, robust and far‑reaching policies are essential to drastically cut carbon emissions and, in the Pope’s words, “to avoid perpetrating a brutal act of injustice towards the poor and future generations.” Pricing the social and environmental costs of emitting carbon is one of these foundational policies.
But if, in the design of these policies, we focus only on setting the price and overlook the potential uses of the revenues, we miss at least half of the policy’s reach and forgo much more than half of the potential benefit to society and to individual consumers.
Any price on carbon creates revenues. From the EU ETS, these revenues are predicted to be around €165 billion across Europe over the next decade. These monies, as with the revenues of a national carbon tax, are received into national government coffers, where they present a significant and largely overlooked potential for carbon-saving — and cost-saving — investment.
If reinvested directly into effective energy efficiency programmes, the revenues that result from a carbon price can produce seven to nine times more carbon savings than would result from the price signal alone. That is, seven to nine times more societal benefit in the form of climate change abatement — at the same cost to the consumer.
Reinvestment of revenues into end-use energy efficiency also produces power system benefits from reduced operational costs and reduced investment costs, which result from lower energy demand. And the beneficial electrification of end-uses such as heating are made possible and more cost‑effective in combination with efficiency investment.
Added to these significant societal benefits are the private benefits that households receive in the form of bill savings triggered by energy efficiency measures.
The final benefit is, from a social justice perspective, perhaps the most important. The powerful ability of investment specifically targeted on low‑income groups to eliminate the regressivity of the carbon pricing policy must be captured.
Targeted programmes to ensure affordable access to safe, reliable and affordable clean energy for vulnerable households produce energy bill savings, and health and well‑being benefits that far outweigh the costs of the carbon price.
Rather worryingly, a number of recent studies considering how to offset the regressive nature of climate policies have concluded that providing cash back to targeted households is the primary way to mitigate the negative effects of a carbon tax.
But simply providing cash back to balance the household budget is akin to filling the bath without the plug in. This payment will need to be provided year after year as long as the carbon price is in place, doing nothing to change the demand for energy services and, therefore, carbon emissions.
Funding significant energy efficiency, through targeted home retrofit programmes, reduces household bills significantly from day one, removes households from energy poverty and insulates them from future energy price rises.
Home energy efficiency improvements are the most cost-effective, long-term solution to alleviate energy poverty, more so than cash back or other forms of social support.
On our path to averting a climate disaster, carbon pricing will only get us so far. To get there faster and more efficiently, ensuring that we don’t leave anyone behind, we absolutely have to capture the revenues and put them to carbon-reducing, socially just uses.
So to his Holiness, I say, yes, let’s put some faith in carbon pricing but let’s also have our own reformation so that when that collection plate goes round, the money we raise really does help us pay our way out of purgatory.