Carbon tax?

If carbon market is not doing its job, what about carbon taxes?

Rachel Notley on carbon taxes 

Despite the concerns of its impact on economic growth, carbon tax has recently regarded as one of the emerging climate change mitigation tool.

When the carbon market has been manipulated by different stakeholders for personal interest and has failed to tackle the problem, carbon tax seems to be a more efficient tool.  Carbon tax, unlike carbon market, can have a direct impact on individuals.  Carbon tax will increase individuals' private cost so to match with the social cost of individuals' carbon emission.  For example, the cost of a person choose to drive to work rather than walk or using public transport will increase to reflect the real cost of his/her action.

The podcast is the premier of Alberta, Rachel Notley, explaining the Canadian province carbon tax scheme.  The tax of emission will be C$20 a tonne and will rise to C$30 a tonne in line with inflation.  The objective of imposing carbon tax is to 'provide incentive for people to change into a low-emission lifestyle', according to Notley.  She also mentioned in the long term, carbon tax will bring economic growth from the increase in green jobs.  While the statement is rather controversial as will discuss in later parts, there is an increasing numbers of countries and subnational governments imposing carbon tax.

Bloomberg

Indeed, carbon tax may not necessarily harm the economy and lower competitiveness.  All four countries from the graph has recorded an increase in GDP due to carbon tax.  One possible explanation could be a reduction in other form of tax which stimulates the economy.  For example in Canadian's province of British Columbia, thanks to the carbon tax revenue, BC has the lowest Canada's income tax and its GDP has kept pace with Canada's over the period.  Fuel consumption on the other hand, has reduced by 17.4% per capita. (Skeptical Science)

The scheme may success in some regions/countries, however there are quite a lot of uncertainties in economic aspect:

1. The cost of production of goods and services, especially in the electricity and transportation sector, which has large amount of CO2 emission, will increase and the cost will transfer to consumers.
2. The increase in price of goods will decrease the real wage of households.  Moreover, income inequality will increase because low-income household will suffer more with the increase of tax.  This is because low income-household has larger proportion of income spending on carbon-emission goods.  According to the US Congressional Budget Office, price hike for a 15% cut in emission will cost 3.5% of the low-income household after-tax income, compare to 2.7% and 1.9% for middle and high-income households. (Institute for Energy Research)
3. The difficulty in getting the correct tax level.  It is a basic economic problem.  Due to imperfect information, it is difficult to impose a economically-efficient tax.  The problem is more complicated if the tax is not regional but in a wider range.  This would require more information to figure out the equilibrium and there would be a risk of market failure, by over- or underestimating the tax level.

Both carbon tax and cap-and-trade is to price carbon and to raise the cost in consuming carbon to reduce carbon emission.  However, they are fundamentally different.  Cap-and-trade gives a certainty of the quantity of carbon emission as the total emission is capped, but the cost is uncertain.  This lead to the current problem of low price in the carbon market.  Carbon tax, on the other hand, provides certainty of the cost of carbon emission but with low control on total carbon emission.  Policies have pros and cons and will conflict interest of different parties.  Whether to use carbon tax or cap-and-trade or a hybrid of both may depend on one's economic structure and geographical location.  One thing for sure, carbon emission has to be reduced and we have to act now.

Source:
Government of Alberta
CBO
the Guardian

Why are carbon markets failing?

European Union Emission Trading System (EU ETS) is the most important and largest carbon market.  Its principle was from the 1997 Kyoto Protocol.  After 18 years, has the concept worked and played a significant role in combating carbon emission?

How the EU ETS works?  The regulator of the system sets a cap on the total emission EU sectors are allowed to emit and permits are distributed to polluters.  These permits are allowed to be traded between market participants.  Market participants here do not only refer to polluters (consumers) but also include suppliers, intermediaries, end users and regulator.  The EU ETS is an interactions between these participants and connects buyers of carbon credit with buyers.

The idea of carbon market is to reduce the demand by increasing the price of carbon emission and creates incentive in low-carbon technologies, why has it failed?

1.  Too much of carbon permits

Basic economic concept:  too much supply without sufficient demand, price falls.  During the first period of the trading system, too many permits were allocated by the regulator because countries had inaccurate emission data.  Whether this is resulted from countries protecting their industrial sector is not know, but asymmetric information in the market had created.  This form of market failure results from economic agents in the market do not have perfect information of the market and drives the price too high or too low.  The overcapacity is roughly around 2 billion tonnes which is around a year's emissions.  As a result, price fell by 75% from €20/tonne to €5/tonne in 2 years.  (carbon price is roughly €8.5 at the moment).  The intention to raise private cost of polluters to meet the social cost to eliminate the negative externalities is therefore not significant.

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economist

2.  Intention of participant

"If global warming is inevitable, why don't we invest in businesses that will profit as the planet gets hotter".  The problem of failing to correct the market failure as mentioned is that firms simply switch to (or maintain) high carbon emission production.  As Bloomberg reported , big energy companies are putting their efforts in increased extraction of fossil fuels rather than renewable energy as will yield more profit. (theguardian)

The inefficiency of the market is also examined by Crossland, J (2013).  Crossland mentioned in the paper that the main participant can earn profit simply using the historical price information.  If a market is not efficient it will open door for investor in the market to earn abnormal profit.  The trading system has violated the principle of efficient market because price is predictable.  A market is efficient if price don't exhibit predictability.  Carbon price followed a certain patterns within a year because it is heavily influenced by weather factors.

The focus of reducing carbon emission seem to be shifted away.

3. A single price

Certain sectors (power sector with 64% of permits) and countries have more influenced in the market.  This will create some kind of monopoly power within these agents in the market.  Because carbon price is homogenized, agents with significant market power may result in misuse of market power such as price formation.  One solution is to include the factors of carbon intensity or output based goals into the settings of carbon price.  Those sector with higher market share tend to produce largest amount of carbon emission.  The potential price differential for these sectors will force them to reduce more emission (rather than buying cheap permits from the market) and will also stop them from abusing market power.(Carbonpulse)