Should we reject or embrace new carbon taxes?

Analysis: Carbon taxes tend to be unpopular because they threaten to push up the cost of living. But they are a powerful decarbonisation tool, and they can be imposed in an economically and socially equitable way, explains Ben Chu

Every year over the past decade successive governments in the UK have promised to increase fuel duty but cancelled it at the last moment every time. (PA)

The government has reportedly considered introducing new “carbon taxes” as part of the plan to effectively decarbonise the UK economy by the middle of the century. There are no details of what this tax might be levied on, though The Times speculated “beef, lamb and cheese”.

The singling out of such staple groceries as items that could rise in price – something very likely to be met with disquiet– suggests this idea might have been leaked by someone hostile to the idea, in the hope of provoking a pre-emptive popular backlash. Mooting policies that would push up the price of groceries at a time of deep economic insecurity for so many households is, inevitably, controversial.

Labour’s response to the proposal was that the economy is currently too depressed to bear new taxes.

Yet should new carbon taxes be rejected for such reasons? Or are they, in fact, an important policy tool for reducing our greenhouse gas emissions? And, if so, can they be imposed in an economically and socially equitable way?

Economists have long been in favour of carbon taxes as a straightforward and powerful solution to the problem of climate change.

The logic they use is that burning fossil fuels in the production of goods and services imposes a major economic and social cost on others in the form of a dangerous overheating of the entire planet.

This is not (usually) factored into the producer’s own costs of production, which means they have no incentive to minimise their own carbon emissions.

The role of carbon taxes imposed by governments in this theoretical framework is to rectify this unfair and inefficient situation – and ensure that the “polluter pays” through levying taxes on producers in proportion to the amount of carbon dioxide their activities create.

The tax mechanism would then, in theory, drive behaviour change from producers, reducing the production of carbon-intensive goods and services and stimulating investment and research into zero-carbon ones.

Yet, despite the urgings of economists, most governments have been loath to introduce direct carbon taxes, mainly because they tend to be unpopular with vocal interest groups.

Instead, ministers have preferred more indirect methods of discouraging carbon emissions, such as using regulation to curb polluting activities, or compulsory emission-trading schemes for industry, and de facto state subsidies for low carbon technologies.

This approach has not been without success. The UK has effectively weaned itself off intensely polluting coal as an energy source over recent decades through a combination of such methods.

The case for carbon taxes is that they are more efficient.

Carbon taxes could, as described above, be imposed on "upstream" producers – manufacturers, farmers, transport firms etc - who would then pass on the additional costs to consumers and have a competitive incentive to reduce their emissions to curtail the costs of their goods and services and increase their market share.

Alternatively, governments could impose the taxes at the point of consumption by the "downstream" household. This could have an even more powerful effect on changing behaviour.

Two types of carbon tax

• Upstream: Carbon could be taxed on fuels (at the point of production or import), and on direct sources of emissions from industry, waste and agriculture

• Downstream: Applying a carbon tax on goods and services at the point of consumption, maximising consumer-visibility (through carbon labelling)

Take energy consumption as an example.

The existing Renewables Obligation on electricity suppliers does extract money from households, via higher bills, to subsidise commercial investment in wind, solar and wave power.

But the obligation does not, in itself, discourage the consumption by households of relatively high-carbon emission energy sources such as natural gas.

If consumers paid an energy carbon tax depending on what sort of fuel they use, people would be able to cut their bills by switching from gas, as their main source of heating, to electricity.

Well-targeted carbon taxes across the economy – from the purchase of food, to household appliances, to computers, to transport – would have a similar powerful effect of changing consumer behaviour, especially if the carbon tax element of the bill were clearly marked.

Carbon taxes are an important part of the policy toolkit and could raise revenues during the Net Zero transition

Climate Change Committee

Such taxes could also be imposed by the government at the border on imports that have been produced abroad through highly-polluting means with the same effects. This would have the added benefit of levelling the competitive playing field for domestic producers in selling to the domestic population.

The UK government’s independent Climate Change Commission (CCC) says carbon taxes – on producers, consumers and imports – ought to be explored by ministers as a means of accelerating efforts to eradicate emissions by the middle of the century.

“Carbon taxes are an important part of the policy toolkit and could raise revenues during the net zero transition,” it says.

The CCC also notes such taxes are “particularly attractive” when global oil prices, and therefore consumers' energy costs, are low, as they are currently.

And the International Monetary Fund (IMF) has similar advice for governments across the world, noting that there has been relatively little use of carbon taxes to date.

The challenge with carbon taxes has historically been the short-term impact, with people resenting levies which push up their costs of living.

A proposal for higher fuel taxes for environmental reasons helped to spark the mass “gilet jaunes” protests in rural France in 2018, prompting the Paris government to retreat.

Yet economists point out that governments have always had the ability to compensate those made worse off by carbon taxes, particularly the less well-off, through redistribution. Higher benefits and tax credits could leave the overall purchasing power of vulnerable groups unchanged.

This is tricky, but it is far from impossible. Canada has managed to accomplish this with a system of rebates to lower income families in conjunction with its 2018 carbon tax. The government there says that for the 2020 tax year a family of four will receive between 600 and 100 Canadian dollars (£340- 570), with a 10 per cent uplift for rural families communities. The majority will receive more back than they pay.

As for Labour’s argument that this is not the right time for tax rises, that would only apply in a macroeconomic management sense if there were to be a net tax rise – and in a way that reduced the purchasing power of those most likely to spend.

From this point of view the political failure of governments around the world has been in failing to pair new carbon taxes with new forms of redistribution, making it clear that the goal is not to raise revenue for the state but to change behaviour and reduce pollution in a way that will improve everyone’s quality of life now and for generations into the future.