The Problem

The UN Intergovernmental Panel on Climate Change (IPCC) has experienced some negative publicity of late — a few factual errors and some loose, exaggerated language contained in four major reports produced over 18 years by thousands of the most experienced scientists throughout the world.  Despite the recent, valid criticisms, climate change is real, it’s here, and it’s going to create serious challenges for most countries.   Greenhouse gas (GHG) emissions, that have increased significantly and that continue to increase, are a major driving force in creating the climate change conditions that put many at risk.

The EU has imposed targets for reducing GHG emissions on each of its members. Under the provisions of the EU Energy and Climate Change Package agreed in December 2008, Ireland is legally obliged to reduce its emissions by 20% (from a 2005 base) by 2020 in the following sectors – agriculture, residential, low intensity energy and commerce, transport and waste.

Efforts are focusing on how to control those GHG emissions, particularly the burning of fossil fuels — coal, peat, oil, gas — that generate carbon dioxide (CO2), a major component of GHG.  A consensus among most scientists and policy makers has formed that CO2 generated from burning fossil fuels has to be reduced or the climate change impacts will become disastrous.

The challenge is how to reduce GHG emissions, particularly CO2 which accounts for about 70% of Ireland’s GHGs , when there is no cost associated with continuing or expanding these emissions. When oil gets scarce, and we continue to rely on it, the price rises.  Not so when our natural resources, including air, water, land, are getting scarce, especially because of impacts from climate change.   Actions to reduce emissions need to be rewarded and inaction or failing to reduce must cost a lot.  This simple proposition is consistent with the polluter pays principle.

Most answers to the challenge include either a cap-and-trade system, implemented for example in the EU Emissions Trading Scheme (ETS) for certain industries, or a carbon tax.  The Irish organization, FEASTA: The Foundation for Economic Sustainability, has proposed a variation which it calls a cap-and-share program where a cap on carbon is set and then each adult gets allocated a permit to generate a certain amount of carbon and any surplus can be sold by the individual adult to those individuals or businesses that need carbon credits.  Here we’ll discuss only the carbon tax, including what to do with the revenue generated by a carbon tax as it is estimated that such a tax could produce about 500 million euros in revenue each year.

Context

The 2007-2012 Programme for Government for the Republic of Ireland (RoI) introduced a Carbon Budget that reports on greenhouse gas (GHG) emissions, measures progress in implementing the National Climate Change Strategy, and assesses the GHG emissions from any measure introduced in the Budget.   The Programme also promised that “Appropriate fiscal instruments, including a carbon levy, will be phased in on a revenue-neutral basis over the lifetime of this Government.”  In 2009, the government indicated its intention to include a Carbon Levy as part of the 2010 Budget process.  Then the RoI Commission on Taxation Report 2009 proposed a carbon tax, along with other controversial measures such as a property tax and water charges.  Finally, the RoI government has issued a Framework for Climate Change Bill 2010 setting forth the outlines of its plans for a Climate Change Act along the lines of the UK Climate Change Act of 2008.  The Framework commits the government to giving the carbon budget process a statutory basis and to introducing in its Budget 2010 a carbon “levy” (apparently a tax for people who want to avoid the word “tax”).  It indicates that the carbon levy will protect those most at risk from fuel poverty, improve the fuel efficiency of the housing stock, and reduce the tax burden on labour.

This article explores the nature and terms of carbon taxes so that the final provisions for a carbon levy in the RoI’s Climate Change Act can be evaluated as that Act unfolds in the legislative process. Throughout the discussion we will use the term “tax” rather than “levy” as it seems more direct and understandable to most people, however unpopular it might be.  Focus will be on recent analyses and proposals from several organizations in the RoI.

The Economic and Social Research Institute (ESRI) Reports

The ESRI published two Working Papers on carbon tax in 2008 and explored some of the economic underpinnings and consequences of a carbon tax.  Generally, the authors take the position that a carbon tax is probably the cheapest, fairest and easiest way to set a price on carbon, and theoretically reduce CO2 emissions, but extending the ETS to all emissions would also be acceptable although politically infeasible.  Note 6 in the Report (see Sources below).

The carbon tax should be revenue-neutral and the tax should equal the futures price of tradable permits under the ETS.  Tying the carbon tax to futures price for ETS permits makes it fair since every source would pay the same amount per emitted tonne of emissions.

Any carbon tax will generate substantial revenues and an important issue, especially for making the tax fair, is what to do with the revenues.  Not many are in favor of letting those revenues go unattached into the general treasury.  The authors of the ESRI reports reject ring-fencing or hypothecating the revenues for energy efficiency or other climate change projects.  They acknowledge that such a tax will make energy more expensive, limiting business competitiveness (with non-Irish companies not paying such a tax) and reducing the amount of disposable income for households.  These costs can be offset by use of the revenues either to distribute flat sums to each household or to reduce other taxes.  In the June 2008 paper, the authors recommend applying 25% of the revenues to higher social welfare payments (for those who have no taxed income), 40% to lowering income taxes, and 35% for lowering pay-related social insurance (PRSI), benefiting businesses.  These uses of the revenues, in the view of the authors, would stimulate the economy and compensate for any negative impact on the economy from the imposition of a tax, and do so much more efficiently and effectively than a lump sum payment to households (“a cheque in the post”).

Finally, the authors recognize that the carbon tax is mildly regressive, impacting more on lower income populations, and that fuel poverty is a major concern.   The authors argue that the increase in benefits and reduction in income tax will offset this effect.

In a separate document, the Irish Rural Link (IRL) raises issues about the impact of any carbon tax on rural communities. IRL points out that rural household disposable income is already below that of urban counterparts, for example Donegal is 16.5% below the state average. The IRL is especially concerned that in the current economic recession there will be pressure on the government to impose the carbon tax but keep the revenues for the general budget without offsetting benefits and lower income taxes. In addition, IRL argues that public transportation and full implementation of the home insulation program in the rural areas are needed before any tax is levied.  The ESRI authors point out that while the rural population likely will feel the effects of the tax more than urban households — rural houses are bigger, distances are longer and life is more car-dependent — the absolute differences are small, equaling less than one euro per household per week in the lower income levels.

Commission on Taxation Report 2009

In February 2008 the government established a Commission on Taxation to review the structure, efficiency and appropriateness of the Irish taxation system.  The RoI Commission issued a report in July 2009 on a variety of tax matters including its analysis and proposal for a carbon tax, after consulting the ESRI and many other organizations and individuals.

The report proposes a tax on fossil fuels — peat, coal, oil, gas —based on tonnes of  CO2 emitted by each fuel.  The tax would apply only to energy products released for consumption in Ireland, and thus exclude products exported.  Otherwise, Irish industry might be competitively disadvantaged with an extra carbon tax not imposed in other countries.

The Commission proposes that those businesses subject to the EU ETS scheme be exempted from the carbon tax.  The price of the carbon tax would be aligned with the EU ETS permit prices, and set by reference to the carbon price for futures market for permits for the next calendar year. In this way, those subject to the EU ETS and those subject to the carbon tax will all incur the same cost as a market mechanism for driving down uses of carbon and emissions resulting from that usage.  The Commission recommends that a floor, or minimum, price be set for carbon to provide certainty and stability and avoid the volatile prices seen with the ETS permit prices.

It is suggested that the tax be collected at the earliest point of supply and that the purpose of the tax be visible to people at the point of consumption so it is not seen as just another tax but as a means of inducing behavioral change.  This last point, on the transparency of the tax, is informed by the experience with the plastic bag levy that dramatically reduced consumption of bags almost overnight from 328 bags per head to 21 per head.

The Commission expressed concern that vulnerable households from both urban and rural areas be cushioned from the effects of the tax, so as not to exacerbate the existing inequalities in income distribution.  It supported the use of carbon tax revenues to fund energy efficiency incentives for business and households, in effect at least to some degree ring-fencing the revenues.  This part of the proposal differs from the authors of the ESRI reports.

The Commission, also unlike the authors of the ESRI reports, suggests that some exemption from the carbon tax might be applied to companies that have already entered into negotiated energy-reduction agreements, e.g., with Sustainable Energy Ireland.

The Commission recommends that the carbon tax not be applied, at this time, to methane or nitrous oxide emissions, mainly associated with agriculture, because those emissions are too difficult to monitor, report, and verify.  When they do become subject to such oversight, then it would be time to subject the methane and other emissions to the carbon tax.

The Commission accepts that the purpose of a carbon tax “is not to achieve a given level of emissions reductions,” but rather it is a “visible, concrete move in the right direction towards implementing Ireland’s climate change obligation.”

Elsewhere

Other EU countries that have implemented some form of a carbon or energy tax in the 1990s include Sweden, Denmark, Netherlands, Finland, Germany and the UK.  

In the United States, much of the focus has been on cap-and-trade programs. Some states have already adopted such a system, as in the northeastern states Regional Greenhouse Gas Initiative (RGGI).  Generally, the large, national US environmental organizations have supported a cap-and-trade approach primarily because they have made the judgment that a carbon tax is not a viable option in the present US political climate.  Leading individual advocates for an aggressive approach to climate change tend to support the carbon tax, including James Hansen and Bill McKibben.  In a recent exchange in the NY Times, Hansen argued for a carbon tax and against a cap-and-trade while Paul Krugman, a widely-respected economist, at least in Democratic and liberal circles, castigated Hansen for trashing the cap-and trade option.  For Hansen, it’s a matter of timing: a cap-and-trade system takes about 10 years to negotiate and the process is so full of compromises it becomes ineffectual, whereas a direct tax can be globally effective in a short time, assuming there is the political will to impose a tax.

Very recently in the US, there may be a shift away from cap-and-trade in part because critics of climate change and of environmental protection efforts generally have successfully stimatised such programs as cap-and-tax, and in part because the cap-and-trade approach has gotten very complicated and subject to exploitation by special interests.

It seems that the choice of market fix is a matter not of economics but judgment about what is doable in a particular political environment.

Robert Emmet Hernan is head of Blue Stacks Productions Inc., the publisher of irish environment

Sources

Department of Environment, Heritage and Local Government, Framework for Climate Change Bill 2010  at  www.environ.ie/en/Publications/Environment/Atmosphere/

Thomas Conefrey John D. FitzGerald, Laura Malaguzzi Valeri and Richard S.J. Tol, The Impact of a Carbon Tax on Economic Growth and Carbon Dioxide Emissions in Ireland (Economic and Social Research Institute, Working Paper # 251, August 2008). www.esri.ie/publications/search_for_a_working_pape/search_results/view/?id=2607

Richard S.J. Tol, Tim Callan, Thomas Conefrey, John D. Fitz Gerald, Seán Lyons, Laura Malaguzzi Valeri and Susan Scott,  A Carbon Tax for Ireland (Economic and Social Research Institute, Working Paper # 246, June 2008).

www.esri.ie/publications/latest_publications/view/index.xml?id=2573

FEASTA’s cap-and-share proposal at  www.capandshare.org/

Commission on Taxation Report 2009 at www.commissionontaxation.ie/Report.asp

Irish Rural Link, Ignoring Rural Realities: The Implications of a Carbon Tax For Rural Ireland (March 2009). www.irishrurallink.ie/

Carbon Tax Center (US) at www.carbontax.org/

Regional Greenhouse Gas Initiative (RGGI), an initiative of the Northeast and Mid-Atlantic States of the U.S.     www.rggi.org/home

James Hansen, “Cap and Fade,” Op-Ed Page, New York Times, December 7, 2009.

Paul Krugman, “Unhelpful Hansen,”  Opinion, New York Times, December 7, 2009.

“‘Cap and Trade’ Loses Its Standing as Energy Policy of Choice,” New York Times, March 25, 2010.

Carbon Tax Center (US) at www.carbontax.org/