30 may 2019

[4C Note: The following article was sent us in an email from a 4C signatory.]

A case for second-best solutions in climate policy

By Delphine Strauss, Financial Times, May 30, 2019

Any approach that can win public acceptance is better than inaction

The Greens’ surge in last week’s European Parliament elections confirmed that a growing share of voters want their politicians to do something about climate change. But it is far from clear that the majority is ready to pay the higher energy and fuel prices that would result from any serious effort to limit the rise in global temperatures — and that would hit some groups much harder than others.

Economists, who for years have been debating the best ways to fine-tune carbon pricing mechanisms, are now turning their attention to the bigger challenges of political economy.

A paper by IMF staff, published earlier this month, shows just how far off we are from making carbon as expensive as it needs to be. Many major economies could achieve the emissions cuts pledged under the 2015 Paris accord with a carbon price of $35 per tonne, they calculate — a level that would roughly double coal prices and add 5 per cent to 7 per cent to pump prices for road fuels.

But to contain global warming to 2 degrees centigrade above pre-industrial levels would require a global carbon price of about $70 per tonne, they estimate. At present, despite a proliferation of national and sub-national carbon taxes and trading schemes, the average global carbon price is $2 per tonne.

Such a steep increase will only be possible if governments find ways to persuade voters that the burden is being shared fairly — both domestically and between countries.

In an ideal world, a comprehensive, predictable carbon pricing scheme — with the revenues well-used — would be the best way to minimise the costs of a transition to cleaner energy. In the real world, there is a huge tension between economic efficiency and political acceptability.

Free Lunch has already discussed the advantages of one of the main proposals put forward recently to address the problems of burden-sharing — the statement on carbon dividends published by a roster of heavyweight US economists last autumn, now backed by more than 3,550 of their peers.

This envisages a carbon tax that would steadily rise each year until emissions targets were met, with the proceeds returned directly to citizens through equal, lump-sum rebates. Imports from countries that shirked their climate responsibilities would incur duties, to prevent “carbon leakage”.

This proposal is compelling because it is simple, transparent and ensures that most households would see a financial gain as the carbon price rose. Janet Yellen, the former Federal Reserve chair, argues it would also be more efficient than the sweeping “Green New Deal” advocated by the Democrats, partly because the price signal would remove the need for other regulations.

But Prime Minister Justin Trudeau’s attempt to impose a national carbon tax and rebate scheme in Canada has shown that it is by no means politically straightforward.

The IMF paper, perhaps surprisingly, is also more critical of the idea.

It recognises the need for governments to support those most exposed to a higher carbon price — poorer households and workers displaced as carbon-intensive sectors become uneconomic.

But it is much more dubious about the merits of a universal compensation scheme, arguing that the economic case for carbon pricing only holds water if the revenues are used efficiently.

If universal compensation was the only way to make a carbon tax politically acceptable, the IMF argues, then it might be less costly to use other, “second best” approaches. Regulation might be just as efficient, or revenue-neutral “feebate” schemes of the kind already widely used for road vehicle pricing could be extended to other areas, taxing dirtier technology and subsidising cleaner models.

The IMF also slams the idea of “border carbon adjustments” (BCAs) penalising imports from climate laggards. Backed in this week’s FT by Lakshmi Mittal, chair of the steel group ArcelorMittal, this has a growing following among European leaders incensed by the US’s withdrawal from the Paris accord.

But it would have huge practical difficulties, and it is all too easy to imagine governments using BCAs as a tool in trade wars or as a front to protect domestic industries. The IMF’s preference is for willing countries to agree on a carbon price floor, a less contentious approach that would at least guarantee a minimum level of effort among those participating.

Clearly, there are no easy answers to the problems of burden-sharing. Nor is there any single answer, because the nature of the problem varies so much from country to country.

Perhaps the most encouraging part of the IMF’s message is its pragmatism. The pricing mechanisms favoured by economists have fallen short in practice. We are in a second-best world where other measures will be needed, and any approach that can win public acceptance is better than inaction

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