IEEFA Europe: Beyond coronavirus—why a carbon fee and dividend make sense

With the world now in economic lockdown and governments lavishing credit on all-comers with little restraint, it may seem a strange time to propose an additional tax for the crisis aftermath, across the global economy. But a carbon fee can help direct this wall of cash and credit along a more credible, safer path leading to a more stable climate, with a net benefit for citizens.

People have been talking about a carbon market, price or tax for decades. The difference now is growing understanding of what precisely works, and acceptance among more countries and even among the polluting industries themselves.

The point of a carbon tax is to put a price on the real, largely unrecognised damage caused by carbon emissions, and so tilt competitiveness and investment towards products and activities that avoid harmful practices, speeding the transition towards a cleaner economy.

Many examples today, most notably the European Union’s emissions trading system (EU ETS), impose a carbon price on particular, big carbon emitters. If the charge were levied instead on fossil fuel producers, at the top of the economy, and the revenues recycled entirely to households, with not a penny for government, then this would, in reality, be a carbon fee on fossil fuel producers, and a dividend for citizens, rather than simply a money-raising tax for governments.

My initial estimate, based on emissions trading schemes and carbon taxes in the EU, is that an economy-wide fee of €25 per tonne of carbon dioxide (CO2) emissions would raise a dividend worth about €370 ($400, £325) per household in Europe. An inspection of actual case studies suggests such a dividend would deliver a net benefit to taxpayers after accounting for higher energy bills, and that’s before accounting for the additional health and property benefits of avoided climate change and cleaner air.

AN UPSTREAM CARBON FEE WOULD WORK BY CHARGING FOSSIL FUELS – OIL, GAS AND COAL – AT SOURCE, whether at the oil and gas well or coal mine, if they are produced domestically, or at the point they are imported. These producers and importers would pass on much or most of this added cost to factories, power plants, and ultimately to consumers, and thereby the whole economy.

The alternative would be to tax the carbon dioxide emitted by particular sectors, such as factories, refineries and power plants, as with the EU ETS, a more limited approach. The EU introduced this scheme in 2005, requiring big fossil fuel burners to submit one EU allowance (EUA) for every tonne of CO2 emitted.

But the EU’s ETS is finally working, crushing power sector carbon emissions by tilting energy economics away from coal, showing the kind of level of carbon price that can drive change. The EU now is about to extend the scheme, planning a carbon border tax which would require global exporters to the EU – the world’s biggest trading bloc – to pay the tax or introduce their own carbon fees at home. Surprisingly, steelmaker ArcelorMittal last month said it supported the proposal: perhaps steelmakers are learning to live with carbon prices. And there are signs of growing acceptance of carbon pricing outside Europe, for example, South Korea has introduced an ETS, with an increasingly impactful price of around $30 per tonne of CO2. Korea is the sixth largest electricity market in the world, and an important Asian leader.

We can find a great example of the effect of carbon pricing in Britain, because of the country’s accelerated approach. Growing tired in 2010 of the low level of the EU carbon price, and wanting a more credible and durable price signal, the UK added an extra tax to power sector emissions. The result was perhaps the most effective climate policy in history. Between 2013 and 2019, coal generation was all but eliminated, falling from 40% to 3% of the country’s total electricity generation – a drop largely accounted for by the tax. Two other important factors were cross-political support for climate action, and the presence of existing, under-used gas power plants, to fill the gap.

A University College London study recently estimated that the tax of £18 per tonne of CO2 raised consumer power prices by £28 per household, in 2018. Corresponding tax revenues were nearly £1 billion, equivalent to a potential dividend of £35 per household, if the revenue were recycled to citizens. A carbon dividend approach would leave people net better off, even after accounting for higher electricity bills.

A dividend of £35 per year is not a transformative sum, but it could achieve buy-in, and underline an incentive to consume less carbon. This dividend would be more than five times bigger if the fee were applied across the whole economy, instead of only Britain’s power sector, which accounts for less than a fifth of national emissions, and bigger again after adding the EU carbon price.

LIKE THE UK CARBON TAX, THE EU ETS HAS DRIVEN DOWN EUROPE’S POWER SECTOR EMISSIONS, year on year, since 2010. In new research from Poland, one of Europe’s most carbon-intensive countries, IEEFA found that electricity generation from burning hard coal is on average loss-making above a carbon price of €27, and lignite generation, above €30. EU carbon prices go up and down, but peaked above €29 last year, and are on a long-term, upward trend. Even Poland’s most coal-intensive energy company, PGE, is now gradually investing in renewables, following the example of other more trailblazing European utilities. As the company said last year, “We are learning our lessons with respect to CO2 prices, which we don’t expect to fall.”

The EU emissions trading system, excluding Britain, last year raised auction revenues of €14.6 billion. That is equivalent to a dividend of €75 per household per year. That figure would more than double, if the EU introduced its carbon border tax and stopped giving away free EUAs to trade-sensitive sectors, such as iron and steel, and more than double again, if the system covered economy-wide, rather than only industrial, emissions.

By revealing the cost of emissions, a carbon price favours investment in low-carbon technologies, supporting more resource-efficient economies. By steering investment away from fossil fuel infrastructure, taxpayers could avoid costly, future fossil fuel bailouts. By cutting carbon emissions, countries can apply the brakes to climate change, and also cut local air pollution, improving health and welfare. Driving investment in an economic transition would also boost research and innovation. A carbon dividend would benefit especially poorer households.

A carbon price is not a silver bullet. It cannot build low-carbon cities. Only massive sector investment and visionary planning can roll out a network of electric vehicle chargers and urban mass transit, or make transformative upgrades to energy efficiency. And fossil fuel exporters will lose out: Saudi Arabia has dragged a lead weight through decades of international climate talks, for this reason. Countries that burn disproportionally more fossil fuels will see their economies become less competitive.

How might a carbon fee be introduced? A carbon fee and dividend approach avoids an expensive new bureaucracy. And the EU is showing one way to deal with competitiveness fears, through its “carbon border adjustment.” Governments should prepare carefully, and be transparent, to avoid a “yellow vest” kind of backlash, as seen in France.

Governments are waging monetary and fiscal war against the coronavirus. Why raise a carbon fee on fossil fuel producers now, as the global economy is on lockdown? First, a carbon fee is an economy-wide way to direct a vastly needed fiscal splurge into low-carbon, less-polluting industries. Second, a fee can bring more countries on the same page, to an urgent and systemic risk. Like the coronavirus, climate change is a global emergency. A raging public health debate has increasingly favoured the earliest possible lockdowns, to beat the pandemic. In the same way, we should more urgently shut the door on a climate crisis that has already started.

Gerard Wynn is an IEEFA energy finance consultant.

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