Peaking in 2015: Policy options - subsidies, taxes, mandates and trading

If governments decide they want to encourage low-carbon energy, energy efficiency and reforestation, they need to deploy policies that cover the extra costs and counter the market forces which incentivised high carbon energy and deforestation. Even increased efficiency, which produces savings on a day-to-day revenue basis, incurs capital costs - which explains why seemingly obvious efficiencies are not always implemented. And renewable and alterative energy technologies are typically more expensive than fossil fuels.  The main policy options are subsidies, taxes, mandates and trading. In some markets consumers are also willing to pay more for sustainable energy or other goods and services. All of these involve a monetary cost or a price above the price of ‘business-as-usual’ that can be matched against a given volume of greenhouse gases either emitted or avoided, often referred to as the ‘carbon price’. When subsidies are used to encourage people to choose clean energy, one can calculate the price being paid to avoid a tonne of carbon dioxide being emitted – all or some of which is covered by the subsidy. Public subsidies can be used to encourage consumers or businesses to adopt cleaner energy, such as those which drove Japan’s leading solar programme A carbon tax sets a monetary cost on emitting a tonne of carbon as in the UK’s climate change levy. Quotas or mandates require a certain level of a particular market to consist of low-carbon energy – for example obliging power companies to buy 5% or 10% of their electricity from renewable sources. This generally means the buyers have to pay more for that share of their product and this is often passed on to consumers in higher prices. Quota systems include the US’s renewable portfolio standards, the UK’s renewable obligation certificates and the requirements for specified levels of biofuels in the US and Europe. Carbon trading or emissions trading is a method whereby a market system sets a price on carbon dioxide. Carbon trading systems set a limit or ‘cap’ on emissions from a group of emitters – which can be companies or countries – issuing participants with emissions allowances that together add up to the total. Participants who want to emit more than their limit have to buy allowances off others in the system so the overall cap is not exceeded. Over time, the cap can be progressively lowered to reduce emissions. Trading tends to stimulate incremental improvements in efficiency, rather than step-change investments in new technologies, although the introduction of a much lower cap might lead some participants to get ahead of the game by investing in renewable or CCS type approaches.

Stern pointed out that the price of carbon needs to be broadly similar worldwide to be effective. This is because there are significant differences in costs of abating emissions around the world and  if the carbon price is not broadly similar, there will be unexploited opportunities to abate an extra tonne of GHG more cheaply in one country compared with another and the overall cost of abatement will be higher.

Arguments continue over whether taxation, trading or regulation is the best way to create a carbon price. An internationally harmonized or co-ordinated approach to tax means countries can take their tax decisions individually, without the need for elaborate structures and institutions. However in practice, attempts to co-ordinate tax policy have foundered. Even the relatively homogenous group of four Scandinavian countries that tried to implement a uniform tax from the early 1990s ended up with a complex patchwork of partial application and exemptions. Taxes also have the disadvantage that businesses or individuals can simply opt to ‘take the hit’ and continue emitting as usual. Stern and others ultimately come down on the side of cap and trade models because they provide “an absolute global quantity constraint”, in other words a set limit on emissions. They also make for cost-effectiveness (via a common price) and fair distribution of responsibility for emissions reductions (through quota allocations).  That said, there is still an issue in persuading countries to participate. Currently the EU’s Emissions Trading Scheme is the only large-scale example, although a voluntary system exists in Chicago and others are planned in New Zealand, Australia and the US.  In practice, it’s possible that the carbon price will be set through a combination of tax, trading and regulatory frameworks.

Many experts, again including Stern, have argued that a carbon price alone will not inexorably lead to a flourishing low-carbon economy. If low-carbon technologies such as solar, wind and biofuels remain relatively costly, even when carbon is priced,  then organisations may simply halt energy usage rather than switching to cleaner options and the effort to cut GHG emissions will damage economies. Therefore there is a logic to providing transitional incentives such as subsidies and quotas which enable low-carbon technologies to be deployed widely and accelerate research and development in clean technology. Such support creates economies of scale as well as increasing the chances of technological progress and stimulating demonstration projects, all which help to drive down costs. Stern also argues that “given the contrast between short-term capital markets and the long-term nature of the climate problem, there may be a case for additional measures that could deter construction of long-lived carbon-intensive stock in favour of lower carbon options.”