Different ways of taxing CO2

Introduction

In science, the introduction of taxing carbon emission is undisputed. For most scientists, there is no more time to waste in reacting to the imminent global warming. Thanks to the Fridays for Future movement, the need for actions accelerated and finally put pressure on politicians. On the one hand, they have to satisfy the short term demands of their voters and do not upset them with higher prices and sticky wages and on the other hand they have the responsibility of implementing sustainable policies so that our environment stays as healthy as it supposed to be. Unluckily though, there are dangers and fears that the CO2 tax might cause inequalities and favours rich over poor people, which in turn means that voters of the politicians in charge might run away. Hence, there are questions on how to impose the carbon emission tax accordingly, so that it is both efficient and fair for all social classes at the same time. So far, many policy makers struggled to implement solutions to make this happen. In the following report, the three main different ways on taxing carbon will be examined and critically discussed. Adding to this the case of Sweden, which already introduced a carbon tax in 1991, should give an insight on the challenges of this tax and how to face its problems.

Relevance of taxing carbon emissions

Opponents claim that the carbon emission tax is no universal remedy and that this tax has a too big impact on our daily lives. Yes, it has a huge impact on our daily lives, there is no point in denying this. What you have to consider though is that this might become one of the biggest crises our world has ever seen. And special situations require unique solutions, the climate change is definitely one of that sort. Countering the argument of being no universal remedy, it is very useful listening to the chief economist of the German Potsdam institute for climate research Ottmar Edenhofer. He compares the carbon emission with penicillin in the medicine sector: Penicillin is not the universal cure for every illness, but a health sector without Penicillin would not work. Same as with a carbon emission tax. Only focussing on a CO2 tax would be a waste of resources, but leaving this out would not save our environment from the upcoming struggles we face due to the climate change (Edenhofer 2019: min. 2:38).

When we talk about climate change, we should always remind each other again on the consequences it causes. In public discussion, this is something that is often forgotten, which gives fire to the people who deny the climate change, although the fact of global warming is undeniable: 97–98% of all publishing climate scientists support the consensus of climate change (Peter/Zimmermann 2009: 23).

Causes such as the rise of sea levels or the acidification of the sea and its devastating consequences like huge migration streams throughout the world or the destruction of our biodiversity should be shown to the public again and again. In order to fight this problem, the world’s population should be confronted with those problems repeatedly. So far, it seems as if only a small elite of people who are able to read and understand all those scientific papers are really aware of all the potential consequences our world faces due to the climate change. What we are lacking right now is rigid reconnaissance. A reconnaissance that is understood by everyone, and not only by elites and people who care about our environment. This topic is very complex and because it does not affect many people yet, it seems too far away to react against it. Without a consensus of all social classes, we will not be able to battle global warming and save our environment. And with that consensus, it is not only meant our rich western world, but also the last inhabitant of an island in the outlying western Pacific.

How high should the carbon emission tax be?

Before examining the different approaches to tax carbon emission, it is important to know how high this tax should be. Of course, it is not possible that the price of this tax cannot be as high all around the world. Sudan could never afford the same tax rate on carbon emissions as the US for example. Needles to say that Sudan does not produce as much carbon emissions per capita as the US does. This leads this report to look at different countries on how high the price of carbon emissions should be. In order to cover the whole world, one industrialized country, one emerging country and one third world country will be examined to give a brief overview.

Ethiopia

First and foremost, there are two important facts to mention: Firstly, the lower the development of a country is, the smaller the emissions are (Oxfam charity press release). Secondly, Africa is one or will be one, respectively, of the most affected continents regarding climate change (Shepard 2019).

For this report, Ethiopia has been chosen because both of its location and low level of development. As being a country lying in the middle of Africa with already notable geographic disadvantages, Ethiopia will be one of the countries most affected by climate change, as many other African countries as well next to the Arctic and small Pacific islands. According to a research paper from the world bank about taxing carbon emissions, researches started with a tax of 5$ per ton of carbon emission in 2018 and growing to 30$ until 2030. Those researchers point out that this emission tax functions as a fossil fuel tax in practice (Benitez et al. 2019: 11f). The impacts on the growth of the economy are very small. In the carbon tax scenario, the GDP in 2030 is only 1% lower than under the business as usual scenario (Benitez et al. 2019: 16ff.).

Mexico

The next country is considered to be an emerging economy. Mexico already has a tax on both national and imported fossil fuels excluding natural gas since 2014. The tax rate is at 2.40€ per ton of carbon emission. Compared to the suggested tax ratio of Ethiopia, this amount is very low, considering that Mexico’s households have a significantly higher purchasing power. Listening to scientists, it is true that this rate is too low and that an increase is recommended. Apart from that, the carbon tax in Mexico is believed to be inefficient. For example, diesel is taxed at a higher rate as gasoline, hence turns into an investment shift into gasoline vehicles.

According to a study from the World Resources Institute, Mexico should follow an universal carbon tax of $15 per ton of carbon emission in order to show effectivity. With a tax of $55 per ton of carbon emission, the emissions can be reduced almost totally (Altamirano et al. 2016: 38). Even in the worst scenario of high switching costs from a fossil fuel energy economy to a renewable energy economy, the economy will not have any considerable disadvantages. Obviously, the economy will have higher costs at the beginning of the implementation of the carbon emission tax because of adaptation and switching costs (Altamirano et al. 2016: 26f.). Unfortunately, the study does not calculate how high the tax should be increased over the years. The study starts in 2015 with two scenarios ($15 and $55 per ton of carbon emission) and only suggests tax adaptations according to the development of the economy. Nothing is written about the exact changes of the GDP after the scenario ends in 2030, as we can witness in the Ethiopia study, either.

Germany

Lastly, the tax rate and its potential outcomes to the economy of a developed country will be examined. It will be interesting to know now, if the tax rate will be higher as in the other two countries examined before as there has already been a slight increase from a third world to an emerged country.

So far, Germany does not have a carbon emission tax. However, plans have been drafted on how to implement such taxes. Those plans include tax incentives for sustainable investments, lowering train ticket prices, increasing air traffic tax and most importantly a carbon emission tax (Wettengel 2019).

This law, which was approved in 2019, suggests a starting period from 2021 to 2025 imposing a 10€ tax per ton of CO2 emission. This tax will steadily increase up until 2025 to 35€ per ton of CO2. This tax rate is broadly viewed to be too low and heavily criticised by many parties. The German government argues with a slow and steady implication so that a widely acceptance can be ensured. According to this research, these implications are not socially balanced as low- and middle-income households have to pay more, relatively speaking (Götz et al. 2019: 15f.).

Taking a look at the tax recommendations in both Ethiopia and Mexico, the numbers in Germany are very low as well considering the wealth of Germany and its high consumption of CO2. It is believed to be very unlikely that Germany will reach the Paris climate agreement targets by 2050 considering its low efforts to become climate neutral.

Both the Potsdam Institute for Climate Research (PIK) and the Mercator Research Institute on Global Commons and Climate Change (MCC) recommend an entry price of 20€ per ton of CO2 emission targeting 30–35€ in 2030 to reach the Paris Climate Agreement (Edenhofer/Flachsland 2018: 6). Referring the PIK, the optimum tax by 2050 should 180€ per ton of carbon emission.

Methods of taxing CO2

Worldwide, many different approaches of taxing carbon emissions exist. In the following section, the ways of taxing carbon emission will be divided into three main categories.

Sustainable tax reform

A sustainable tax reform would be the implementation of a carbon emission tax with simultaneous decreases in other taxes such as VAT or income taxes. This includes the subsidization of environmentally friendly investments as well. In other words: Work and income should be relieved and environmental pollution charged. This method is often referred to be as socially imbalanced because low- and middle-income households have to relatively pay more compared to high income households due to the universal carbon emission tax.

Sustainable tax reform with lump sum payments

The sustainable tax reform with lump sum payments tackles the problem of the social imbalance described in the section before. Households especially affected by the carbon emission tax such as countryside households receive payments at the end of the year from the costs caused by this tax. The advantage of the lump sum payments is that they increase the acceptance of the population without decreasing the impact of the tax because the households who save more, have more money at the end of the year. This in turn, gives incentives to people who are trying to avoid carbon emissions ( Steurer 2020). The benefits are that this method is fair and gives incentives to save our environment as well. However, what has to be considered is that the tax reductions cannot be as high as without lump sum payments.

Emission Trading System (ETS)

The Emission Trading System (ETS) already exists since 2005 in the EU for big companies, without significantly positive impacts for our environment though. The Emission Trading System works through the selling of emission certificates to companies. The certificates are sold in tons. With those certificates, companies are allowed to use CO2. Countries would have to set a maximum number of certificates (“cap”), and depending on demand, trading the certificates would create a market price for the certificates. The cap should be adapted to the current recommended price for carbon. The lower the cap, the higher the price of the certificates. The problem has been that the cap (supply of certificates) in the European Union has been too high so far which is why the price for CO2 remained cheap for companies (Alessi et al. 2011: 11ff.). As a result, the impact of the ETS in the EU has been too low. An important matter to add is that, of course, the ETS system can be combined with the other two methods as well.

Sweden as an example of the carbon emission tax

In Sweden, carbon emission tax is already existing since 1991. When the tax was introduced, it was at 23€ per ton of carbon emission. Now, in 2020, it is at 110€ per ton. On the same day the tax got imposed, the Swedish government decreased other taxes. As a result, the GDP did not suffer from that tax. (Swedish government report) To prove this, Sweden is one of the wealthiest countries on earth with a GDP per capita of $53.208 with a steady growth. (World Bank: Swedish GDP per capita growth) What is remarkable in the Sweden case is that households did not receive any lump sum payments up to date. Studies show that the CO2 emission decreased remarkably over the year. For example, emissions from transport sunk almost 11% on average per year since imposing the tax. Hence, Sweden should be taken as a perfect example on how to cope with climate change and that the carbon emission tax does work in practice without reducing the wealth of a country.

Conclusion

To sum up, there is no point in not implementing a carbon emission tax in every country around the world. Especially in Europe, where carbon emissions are very high and have huge impact to other countries carbon emission through trade and change in consumption and investment decisions, the carbon emission tax should be imposed as soon as possible. Not to forget to mention that countries face huge penalties when disobeying the Paris agreement rules in future. What has to be mentioned is that for a fair competition, every country in Europe, and preferably in the world, should impose such tax. Without that, the impact is by far not as big because carbon expensive investments move to countries without carbon taxes. If everyone had carbon taxes, those investments could not shift anymore. As a result, innovations in renewable energy would slow down which in turn would take more time and effort to save our environment. Time, we do not have.

Regarding the different methods of taxing carbon emissions, it all depends on how much a country can afford to eliminate the global warming. As studies prove, economic growth and saving our environment do not need to play off against each other. Sadly, hardly any country around the world is following the advice of scientists for recommended carbon prices. Right now, we lose a lot of time saving our environment without any step moving forward. The strengthening of nationalistic and populistic parties around the globe is doing our environment no favour. What we all can do is informing ourselves and check out, which (political) parties are really doing something for our environment. So far, fossil fuel lobbies still have too much power in dictating the way of countries. At the end, let us hope we can count on the penalties countries have to pay when disrespecting the concessions made in the Paris agreement.

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