Tono most economists, putting a price on greenhouse gas emissions is the best way to tackle climate change. It works, allowing society to determine the equivalent of giving up the cheapest unit of CO2. It’s fair: the polluter pays; the proceeds can be redistributed. It also helps with other forms of decarbonization: Compliance with a carbon price forces companies to track their emissions and investors to find out which of their assets are the dirtiest.
According to the World Bank, there are currently 73 carbon pricing schemes globally, covering 23% of global emissions. That’s up from 7% a decade ago. The bank’s tally includes emissions trading schemes (where polluters can trade permits on a market) and carbon taxes (where prices are set directly by the government). The largest program is in China, starting in 2021. It covers the country’s energy sector and thus accounts for 9% of global emissions. Even in the United States, untouched by the allure of carbon pricing at the federal level, a growing number of states are setting their own prices. Washington state is the latest convert, launching an emissions trading program in January.
However, there is growing dissatisfaction with the policy among a growing number of centre-left economists who may be considered strong proponents of a carbon price. These criticisms focus on two points. The first is that the carbon price is not aggressive enough.this European UnionChina’s emissions trading scheme is one of the most comprehensive, but excludes buildings and transport. Subsidizing airlines and heavy industry in the name of competitiveness. Prices in Europe are relatively high, reaching a record 100 euros ($107) per tonne of carbon dioxide equivalent in February, but prices elsewhere are too low. The World Bank estimates that by 2030, less than 5% of emissions will be priced at or above the level needed to limit temperature rise to 2°C above pre-industrial levels.
This tentative move reflects a second concern of critics: fairness. They argue that the cost of carbon prices falls disproportionately on the poor instead of ensuring that polluters pay. These moves have raised energy prices – often the only sector of the economy fully affected by them – and pushed industrial jobs overseas, beyond the scope of the emissions trading scheme. Anticipating opposition on these grounds, politicians have played down the plans. As a result, the promised reductions in emissions never materialized.
These are arguments. How did the evidence stack up? Measuring the impact of a carbon price is challenging. Carbon prices, like interest rates, both affect and be affected by the economy. All else being equal, a higher carbon price would reduce economic activity and raise consumer prices. But a stronger economy also raises the price of carbon permits. Politicians may also be more willing to raise carbon taxes when the economy is booming. They may take steps to cut them in hard times.Last May, for example, the European Commission announced an auction of excess licenses to drive down prices during the energy crisis following Russia’s invasion of Ukraine
Thankfully, there are ways to untangle cause and effect.Marion Leroutier of the Stockholm School of Economics used a “synthetic control” approach to examine the European UnionThe UK’s emissions trading scheme launched in 2013.To understand the impact of higher carbon prices, Ms Leroutier used data from other institutions European Union Countries constructed a hypothetical version of the UK that would not have introduced taxes—similar to a control group in the experiment. In effect, the interconnector allows the UK to import electricity from neighboring countries, potentially allowing the control group to also be treated. But after including estimates of such “spillovers”, Ms Leroutier estimated that the tax resulted in a 20-26% reduction in emissions from the energy sector.
In a forthcoming paper, Gilbert Metcalf of Tufts University and James Stock of Harvard University try to explain the broader economic context. They studied 31 European countries, controlling for past emissions and economic growth to isolate changes in carbon prices that could not be explained by economic conditions. The authors found that carbon taxes reduce greenhouse gas emissions by as much as economists had previously predicted. Notably, they also found little effect, positive or negative, on growth and employment, possibly because there was more innovation than expected.
A final way to untangle cause and effect is to employ an “event study.” These are often used to assess the impact of monetary policy decisions. By looking at the near-instantaneous reaction of carbon prices to policy announcements, it is possible to remove the influence of background economic conditions, which do not change at the same rate. The impact of price changes can then be tracked through the economy. In a recent working paper, Northwestern University’s Diego Känzig did just that, finding that higher carbon prices lower emissions and encourage green innovation. However, these gains come at a price. Higher prices raise energy costs, which reduces incomes for the poor.
get the right green
Carbon prices, when used, successfully reduce emissions. However, they could be tastier.In another paper, Mr Känzig compared European Unionof Emissions Trading Schemes and National Carbon Prices. While state taxes are more likely to lead to leakages from cross-border transfers of polluting activity, they are less of a drag on the economy, helping to offset criticism from centre-left critics. This is because income is often recouped through tax cuts, which can target the poor.
The World Bank estimates that carbon taxes and emissions trading schemes will raise $100 billion for governments this year. As carbon pricing schemes expand, the numbers will only increase. On its own, this would help address one criticism: that the measures are not aggressive enough. To solve another problem — that they hurt the poor — policymakers must accept the importance of recycling. ■
Read more from our economics column Free Exchange:
What performance-enhancing stimulants mean for economic growth (May 25)
Robert Lucas Is a Giant in Macroeconomics (May 18)
New world order seeks to prioritize security and climate change (May 11)
For more expert analysis of breaking economic, financial and market news, sign up for Money Talks, our subscriber-only weekly newsletter.
