Yale Environment Review

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Good carbon pricing is good carbon spending

Reinhard Tiburzy via Shutterstock

Carl, Jeremy and David Fedor, “Tracking global carbon revenues: A survey of carbon taxes versus cap-and-trade in the real world.” Energy Policy 96. (2016): 50-77. ISSN 0301-4215. DOI: 10.1016/j.enpol.2016.05.023.

Tuesday, August 22, 2017

If you don’t like it, why not put a… price on it? Researchers from Stanford University prepared a guide to carbon pricing and how governments around the world are using the money generated from it.

Putting a price on carbon has long been a hotly debated yet widely implemented way to mitigate climate change. By putting a price tag on greenhouse gas emissions, carbon pricing systems aim to account for the negative impacts of carbon emissions, and reflect the true “social cost” of carbon.  Two market-based mechanisms exist: carbon tax and cap-and-trade programs. To date, 40 countries and 16 states or provinces around the world — including California and the regional states of the northeastern U.S. — have implemented either one. Economists, political scientists, and policy analysts have long argued about which tool is more effective, while some even say that the two systems lead to the same results. A recent study suggests another difference: the way “carbon revenues” are spent, which can be a key determinant in the political feasibility of either approach.

Jeremy Carl and David Fedor of Stanford University aimed to shed more light on the differences between carbon tax and cap-and-trade systems. In a study published in the journal Energy Policy, they provided a comprehensive, empirical dataset on how carbon revenues were spent in 2013. Their study notes a couple of key points. Carbon taxes — also known as levies, charges, or fees — are applied directly either to the sale of carbon-intensive fuels or to the emissions of carbon dioxide. On the other hand, cap-and-trade systems are operated through the sale of permits. These permits enable regulated entities such as power plants and large industry to emit an allowable amount of carbon dioxide. Carbon taxes have been around for longer with the first programs implemented by Scandinavian countries in the early 1990s. Cap-and-trade programs are relatively newer, with only six or seven years of revenue generation history.

The researchers found that more than $28 billion in carbon revenue was collected by governments in 2013, with about three times more coming from carbon taxes than from cap-and-trade programs. One reason for the difference is that many permits in cap-and-trade regimes are freely allocated and therefore do not generate revenue. Carbon revenues are spent on one of three ways: on green programs, “revenue recycling,” or government funds. Green spending includes programs for energy efficiency, renewable energy, and other climate change mitigation and adaptation efforts. Revenue recycling refers to returning carbon revenues to individual and/or corporate taxpayers through tax cuts, tax eliminations, or direct rebates such as checks-in-the-mail. General funds simply complement government budgets.

The researchers found that 70 percent of cap-and-trade revenues was for green spending, while 72 percent of carbon tax revenues were mostly used for general funds or were recycled. This is due to several reasons. There are a number of examples for carbon taxes that were set up with the original intent of either generating government funds (e.g., in recession-hit Ireland and Iceland) or to offset existing labor taxes (e.g., in British Columbia). However, cap-and-trade programs were never implemented with such a goal in mind. Instead, revenues generated from cap-and-trade systems are more likely to be spent on “green programs” and have the political backing to do so.

This study offers key takeaways for policymakers considering national or regional carbon-revenue systems. First, while there are several other climate change mitigation policy tools — such as mandates and subsidies for renewable energy development, and technology performance standards — only carbon pricing can lead to a new form of revenue-generation. Second, if these revenue streams are dedicated transparently to specific budgetary needs, they can ensure the longevity of the carbon pricing program in question. Third, carbon revenues can serve as one clear sign of the efficacy of climate change mitigation policies. Carbon revenues are easily accounted for, are publicly visible and reportable year-to-year. Lastly, it is advisable to introduce any carbon pricing program gradually and not to go above a certain “carbon revenue per capita burden” in order to maintain political and public support.

All in all, variation across carbon pricing systems both in approach and outcome suggests that there is no clear consensus on best practices. The carbon revenue dataset presented in this study can, however, serve as the basis of comparison of different systems and can inform policymakers on how to move forward.