OECD Observer
Price the carbon

Carbon dioxide (CO2) is a long-lived gas. Almost half of the CO2 emitted in 2013 will still be in the atmosphere a century from now. This means that its concentration, and warming potential, increases over time, unless the rate of accumulation can be cut to zero. This is the goal that the OECD is urging all countries to achieve: zero net emissions by mid-century. To accomplish this, the explicit price of carbon dioxide emissions should be aligned more closely with their true cost, while avoiding expensive policy options that could be replaced by more cost-effective ones. 

Today, explicit carbon prices are far too low, and there is insufficient incentive to reduce emissions as a result. In most countries, low taxes on petrol and diesel fail to fully capture the true cost that running a vehicle has on human health and the environment. Where attempts to put an explicit price on carbon emissions have been made, it is often distorted by a number of conflicting policies. For example, the same governments that are trying to cut greenhouse gas (GHG) emissions are providing subsidies to fossil-fuel industries and consumers that are currently estimated at over US$500 billion per year globally. What can governments do to correct this?

First, they need to adopt policies that put an explicit price on carbon. Taxes on carbon emissions or fossil fuels can generate a carbon price, as can emissions trading schemes whereby a “capped” amount of carbon emission allowances are traded in an open market, much like a stock exchange.

While such policies normally are much more cost-effective than alternative policy instruments used to limit GHG emissions, their introduction could face political opposition. But experience shows that this can be reduced if the introduction of new policies is announced in advance to give industry time to get prepared, and potential negative effects on competitiveness are addressed via accompanying measures, such as revenues being recycled to the industry. Good communications strategies are essential in this respect, not only to raise awareness about the dangers of uncontrolled climate changes if GHG emissions are not dramatically reduced, but also to make sure that the public sees how tax revenues will be spent. The Canadian province of British Columbia, for example, was able to move forward with a carbon tax and saw opposition turn into support by a majority of citizens once the tax had been in place for a short time (see Review section, page 45).

Governments need to have a clear understanding of what an optimal policy package should look like. Because policies that are not price-based such as taxes and emissions trading can also end up placing a price on carbon, governments must take careful inventories of all mechanisms that implicitly define a carbon price, or risk pushing abatement costs up to prohibitive levels. In the electricity sector, for example, capital subsidies cost €176 per tonne of CO2 abated; feed-in tariffs (long-term contracts for energy producers, typically based on the cost of generation of renewable energy) cost €169 per tonne; and trading systems €10 per tonne of CO2 on average. Yet capital subsidies and feed-in tariffs are much more commonly used in spite of being more costly. Similarly, governments need to review the broader fiscal policy in place to ensure that it is coherent with their climate policy goals. This means ensuring that budgetary transfers and tax expenditures do not, directly or indirectly, encourage using or producing fossil fuels. In OECD countries the culprits are more often exemptions from energy taxes than direct subsidies.

Consumers, producers and investors all need to understand that efforts to put an explicit price on carbon emissions are part of a greater goal to curb damaging climate change, and that everyone will benefit as a result. This is a challenge that governments cannot let up on, even in today’s tough economic environment; easing up on efforts risks making climate change policies look like a lot of hot air.

See: www.oecd.org/environment/climate-carbon.htm

Also see: http://www.oecd.org/env/tools-evaluation/carbon-prices.htm

©OECD Observer No 297, Q4 2013