Exploring Greenhouse Gases Emissions Taxes

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Among the most pressing issues that humanity faces in the 21st century is global warming. With the potential to worsen natural disasters such as floods and droughts, global warming is currently poised to greatly decrease human welfare by making previously-arable farmlands unsuitable for growing food, flooding coastal regions where many people have built their cities and homes on, and making more areas of the world more habitable to disease-bearing animals such as mosquitoes.

Because global warming is such a serious problem and because global warming is caused by various gases trapping the sun’s heat in our atmosphere, governments and private organizations worldwide are implementing many solutions to stop the creation of these gases. One such solution is a greenhouse emissions tax, which we will discuss in depth in this article.

Brief Overview

A greenhouse emissions tax is a tax that is put on greenhouse emissions, the most common target being carbon dioxide. This encourages people, businesses, and governments to reduce activities that produce greenhouse emissions. In economic terms, Those who benefit from burning fossil fuels generally do not pay for the environmental damage caused. Instead, people around the world- even those who do not benefit from the activity that burns fossil fuels- take the cost of the environmental damage. Imposing a carbon tax can help correct this externality by raising the price of energy consumption to reflect more of its societal cost. One prominent estimate, developed by an interagency working group of the United States government, proposes that carbon dioxide emissions has a social cost of about $40 per metric ton.

Carbon taxes are currently implemented or scheduled to be implemented in at least one country in every continent except Antarctica. The first country to impose a greenhouse emissions tax is Finland, which implemented a carbon dioxide tax in 1990. Other Nordic countries such as Sweden and Norway then imposed their own taxes. The taxes then spread around the world. Now, as of April 2019, the entire European Union, Canada, Mexico, Colombia, Chile, Argentina, Kazakhstan, South Korea, Japan, Australia, Singapore, and New Zealand have implemented carbon taxes. Furthermore, China and South Africa are scheduled to implement a carbon tax. As for the United States, nine states have implemented a local carbon tax.

Average carbon dioxide (CO₂) emissions per capita measured in tonnes per year

Emission Pricing Methods

In order to reduce the release of harmful greenhouse emissions such as sulfur dioxide, carbon dioxide, and more, and promote innovation that optimizes alternative and greener process in industries, two main  pricing methods are implemented globally: taxing and trading

Emission Taxes

Emission taxes involve taxing businesses and households per unit of a target substance released and/or used. Consequently, taxes provide price certainty, as it raises the existing cost of related products by a set amount. However, it does not necessarily ensure an exact limit to the quantity released. Countries that implement emissions taxes tend to have increasing rates in an effort to gradually wean off of carbon and switch to alternative sources. As for actually determining the price to put the tax, economists say the tax should equal the marginal damage caused per ton of pollutant emitted into the atmosphere, or the social cost of carbon. However, depending on the countries’ goals, and political influences, this price may not be exactly reached, or even agreed upon.

Taxes can vary in their point of regulation, and are split into three different categories.  Let’s consider a carbon tax for this. An upstream carbon tax, for example, would tax fossil fuel producers for the amount of carbon in their emissions. A midstream tax is focused on the middle of the emission process, so it taxes the first purchaser of fossil fuels a supply chain. Finally, a downstream tax applies to the emitters themselves. Households, businesses, industrial users, and more get taxed for using goods such as natural gas or gasoline with their homes, cars or machinery. The fact that there are multiple steps along the way to levy taxes makes them a strong option for countries as it allows for a lot of flexibility, especially between various sectors since some, like the energy sector, face heavy global competition from non-restrictive countries, while others do not.

Another advantage of emission taxes is that they produce significant revenue. In 2013, carbon taxes raised $21.7 billion in government revenues globally, triple the amount from carbon trading systems. Furthermore, experts estimate that a $49 per metric ton of carbon dioxide tax in the United States could raise about $2.2 trillion over the next decade. Many speculate that the reason taxes raise so much is that they allocate more of the money back to the taxpayers, leading to them being more accepting of higher taxes. About 44% of the revenue is returned to the taxpayers through other tax cuts and rebates, and 28% is used to supplement government general funds.

The rest varies depending on the political choices made by the various countries. Some choose to reinvest in climate purposes, while others may use it to reduce existing taxes on labor and capital, something that economists say result in net economic benefits. Additionally , since lower-income households spend a larger share of their income on energy, countries recognize that these taxes have a greater impact on them. However, they may not always take steps to ensure that more revenue is allocated toward them to offset this disproportionate effect.

CO2 Emissions by Sector

Emission Trading System

Under an emission trading system, or ETS, the government grants a set amount of permits which each allow for a set amount of release of pollutants. Thus, this is a way to ensure quantity certainty in a certain country, but doesn’t provide price certainty as various caps and the distribution of permits can cause price variations. Overtime, the amount of permits granted decreases, gradually reducing the amount of harmful pollutants released.

Successful ETSs require an accurate monitoring of businesses and their pollution through very accurate methods, which is often times quite difficult due to technological limits and political influences. Furthermore, establishing a cap on the number of allowances is also a very data intensive problem that often creates a lot of controversy as well. However, once a cap is established and allowances are distributed, if a company’s emissions exceed the amount allotted to them, they must pay a fine per ton exceeded, creating an incentive to meet the cap.

Some companies have invested more into green technology and pollute less than they are allotted. Under this system, they then trade their leftover permits to companies that aren’t yet as efficient and emit more than they are allowed. Some programs allow companies to allocate unused permits for one year to future years, known as banking, or used permits issued for future years in the present, known as borrowing. The ability to trade, borrow, and bank provides companies with a lot of flexibility to transition, all while still maintaining a set cap on emissions.

One of the biggest considerations for this system is how permits are distributed because how they are allocated can have significant implications for who will bear the costs and how effectively the emissions reductions will be achieved.  For one, governments can choose to either auction permits or allocate them freely. Auctioning permits involves selling permits to companies, and is a strong choice because it considered to be the fairest and also generates revenue that can be invested toward more renewable energy development or tax breaks. However, this is very hard to start off with because traditionally large polluters would have to spend a lot to sustain their business without having a chance to transition. For this reason, many countries start off with a free allocation, where permits don’t have to be bought.

Once governments choose between free permits or auctioning, they can choose to further filter allocation via grandfathering or benchmarks. Grandfathering involves companies receiving free permits based on their historical emissions from a specified period of time. This is relatively simple to implement, but may penalize companies that choose to invest in green technology early and thus get less permits without any reward.

Benchmarking is where companies receive free allowances based on a set of performance standards within a sector. One way to do this is to establish a set of fixed standards for certain products or sectors, known as fixed sector benchmarking. This could look something like setting the benchmark at the average performance level, the average of the top 10% performers in the sector, and more. However, these implementations can often put certain sectors at a disadvantage to other sectors that are regulated differently within the same country, or even compared to other countries. For this reason, some countries implement an output based allocation scheme where they give more permits to companies the government wants to provide financial incentive for. Although this does target somewhat address the risk of carbon leakage to other countries and smaller companies, it also reduces the carbon price incentive for them.

Cap and trade also involves a reward system known as offset protocols. Through this, companies can gain extra carbon permits through eco-friendly actions. For example, in California, companies can get up to 8% back on carbon permits through U.S. Forest Projects, Livestock Projects, Ozone Depleting Substance Projects, and Urban Forest Projects, thus incentivizing even more eco friendly behaviors.

As for revenue, as discussed before, ETSs produce significantly less than taxes. For example, carbon cap and trade generated only $6.57 globally in 2013. This is partly due to the fact that many countries don’t implement auction allocations as their programs are not mature enough yet. Furthermore, unlike taxes, 70% of the revenue from cap and trade is spent on “green” subsides, while only 9% is returned to taxpayers, significantly less than with carbon taxes.

Hybrid Systems

Since carbon taxes only provide price certainty, and carbon permits only provide quantity certainty, governments implement a hybrid approach. One such option is to implement cap and trade but set price floors and ceilings to ensure some sort of price certainty. Another approach is to implement a carbon tax, but adjust it so that specific emission goals may be met, ensuring some sort of quantity certainty. And a third approach is explicitly implementing carbon taxes with some sectors, and carbon taxes on others.

However, it is important to note that with any of these systems, the amount of coverage of industries can vary greatly depending on political choices. For example, the European Union ETS, the largest in the world encompassing 31 different countries, considers per-fluorocarbons, nitrous oxide, carbon dioxide and overall covers about 45% of the EU’s greenhouse gases. However British Columbia’s carbon tax covers about 70% of provincial greenhouse gas emissions. Thus, the choice of pricing system, the regulations and price standards chosen for those policies, and the amount of coverage the government chooses to pursue with their policies are key parameters distinguishing the varying levels of effectiveness in countries across the world.

The Impact of an Emission Tax

First and foremost, businesses are one stakeholder that is significantly impacted by carbon taxes. Emission taxes impose an extra cost for industries that face them. This may lead to decreased profits for the businesses in these industries, which may thus slow down economic growth in the countries these businesses operate in. Furthermore, carbon taxes may cause businesses that operate in regions with a emission tax to be at a competitive disadvantage in comparison to businesses that operate elsewhere.

However, it is not just businesses that produce greenhouse gases that are affected by a greenhouse emissions tax. Low-income households are also negatively affected by the tax, because the tax increases their energy bills. This is caused by two main factors. The first is that carbon taxes increase energy bills because energy companies want to offset some of their increased cost of production by increasing the price of their service and because most of the world’s energy is created by greenhouse gas-emitting sources (ex. By burning oil or natural gas). The second is that energy makes up a larger portion of a lower-income household’s budget than it does for a higher-income households.

Yet, despite all of these drawbacks, greenhouse emissions taxes are still excellent for the environment. By increasing the cost of buying and producing goods and services that require greenhouse emissions to produce, greenhouse emissions taxes reduce demand for those goods and services.  Analysts from the U.S. Department of the Treasury estimated that should the U.S. implement a national carbon tax starting at $49 a ton in 2019, emissions can be reduced by up to 21% over the next decade. Thus, carbon taxes have the potential to greatly reduce global warming, increase human welfare, and save millions of lives.

One notable energy company that we should discuss in relation to emissions taxes is EXXON, which generates energy by burning coal, oil, and natural gas- all of which cause the generation of greenhouse gases. Despite an emissions tax having the potential to raise the cost of business for EXXON, EXXON has publicly stated support for an emissions tax and has even donated $1 million to a nonprofit that advocates for an energy tax. Although this may seem counterintuitive for EXXON, EXXON may be supporting a carbon tax early on to prevent a possibly-larger carbon tax from being implemented. Furthermore, by donating money for the cause of creating this tax, it increases its control over the tax. As for how EXXON will be affected by a carbon tax, a Columbia University study found that a carbon tax will make Exxon shift away from coal but increase natural gas price and production over the next 5 years.

Annual CO2 Emission, By World Region

International Response

In regards to public opinion and adaption, the greenhouse emissions tax differs vastly from one country to the next. With many countries involved in the Paris Agreement of the 2015 UN Climate Change Conference [COP21], it resulted in a number of countries using Greenhouse Tax emissions as a strategy to reduce their global footprints as agreed. In regards to specifically carbon pricing, to date 57 countries have implemented or scheduled implementations of carbon taxing and this number is expected to rise as a greater number of countries are involved in climate talks. However, the resultant effects from these taxes are slow and the worldwide temperature continues to inch upwards.

Additionally, since countries have begun to adapt more methods to achieve the COP21 goal, so too comes the barrage of public opposition which threatens the success of the emissions tax. There are a number of arguments regarding specifically the greenhouse taxation to suggest that it is not the most successful or efficient form of regulation to ultimately bring down the overall greenhouse emissions to slow global warming.

Firstly, the burden of the tax falls majority-wise onto the consumer, making affordable products/services less available to the masses. The core model of the Greenhouse tax ­­­is to make a product/service more expensive to incentivize and are influenced by the increase in UN discussions regarding Greenhouse emissions. Therefore, accessible necessities, such as electricity using 64% fossil fuels, will become more expensive and difficult to obtain while the companies slowly transition to more renewable energy to reduce their costs or mass produces to reduce overall costs and makes the emissions tax less costly.

While there are many supporters of an emissions-free economy advocating for greener products and services by having companies use alternative energy sources and overall have production be less harmful, these measures put a country’s economy at a disadvantage and therethrough reduce the incentives for a country to adapt. If the tax is large enough, companies may move towards foreign opportunities and take their production levels to a country with no, or less, emissions tax for cheaper production. Ultimately, emissions would therefore not decrease and it would putter a higher import burden for the tax-emission-based-country itself.

Furthermore, there exists the point that we need the carbon tax, but it will not be enough in the long run. Of course, there are many other policies that need to be implemented to reduce emissions levels, but the emissions tax alone will not have as great of an effect as intended. With renewable energy being slowly adopted, other difficulties still stand out, such as fracking and the increase in deforestation which also affect the levels of greenhouse gases. The difficulty of the tax is slow to adopt and with still 71% of countries not implementing or having a structured plan to implement an emissions tax, there is very little the current taxations will do to eliminate climate change once and for all.

Currently China generates the largest amount of carbon dioxide emissions than any other country, and is followed by the United States of America. China is apart of the 57 countries to adopt a carbon tax, while the US has a "Cap-and-Tax" plan. Without a large reduction in overall emissions from the largest contributing regions, including the European Union, the emissions tax will not be enough to see significant results to reduce the large scale of damage already done.

Improving Impact of Greenhouse Gas Emission Taxes

Greenhouse gas tax emissions have been proven to work, and it is clear that they can play a major role in combatting climate change. Greenhouse gas emission taxes can still drastically improve. The taxes should be further optimized in order to make that the economic cost of greenhouse gases is accurately reflected through the related taxing scheme. At this moment, for example, the cost of a ton of CO2 still varies widely across the globe. As the costs of greenhouse gas emissions are born all over the world and is not related to the place of emission, a convergence of CO2 prices in the long run could have a significant positive effect on the impact of greenhouse gas emission taxes.

Price Per Ton C02 (USD)

In order to attain this goal, multilateral coordination might be required in order to align incentives for each country. Making this transition gradually is of utmost importance in order to reduce unnecessary economic transitions costs. Therefore, it is likely that this transition will be rather slow. Furthermore, the transition is highly influenced by geopolitics as well as the general state of the global economy. As the emission per country varies extremely widely as well, conflicting incentives could pose a challenge to the improvement of impact of greenhouse gas emission taxes. Additionally, countries who are large emitters now were not necessarily large emitters historically, which further distorts incentives. Finally, some sectors are more dependent on greenhouse gas emissions than others, which adds a layer of complexity to the debate. Also note that even though CO2 is the most emitted greenhouse gas, other gases should be taxed appropriately as well.

Annual CO2 Emissions By Country, in Millions Of Tons

To conclude, many policy makers have clearly understood the importance of implementing effective greenhouse gas policies. Nonetheless, the true impact of emission taxes will only become visible after global implementation and it is still unclear how significant the impact will be.

More posts by Karina Strauch.
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TJ is a third year economics student studying business analytics and finance.
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Exploring Greenhouse Gases Emissions Taxes
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