Editorial Board

Climate March, Climate Summit, Climate Tax?

Break out the carbon tax banners.

Most economists agree that a carbon tax is the best way to slow climate change. Make energy derived from fossil fuels more expensive, they say, and let the market do the rest.

In principle, the advantages of this approach are clear -- prices are better than quantitative mandates at guiding efficient solutions -- but what about the practical drawbacks?

It's right to wonder about the unintended consequences of introducing a carbon tax. However, it's wrong to keep this discussion theoretical. More than a dozen countries have adopted such taxes, in some cases decades ago. Their experience, little discussed in the U.S., can inform the debate.

This is the first in a series of editorials on lessons from countries that have introduced taxes on carbon. Where the idea has been tried, what was the effect on the economy? When governments promised to use the revenue to reduce other taxes, did they keep those promises? Did the burden fall unduly on more vulnerable households? And how did governments make the tax politically feasible?

If carbon taxes failed to cut emissions, one need go no further. And, in principle at least, there are reasons to be skeptical. Perhaps it's hard to make the tax high enough or comprehensive enough to make a difference. This turns out to be wrong -- though it's true that the design of the tax makes a big difference.

Researchers at Cambridge Econometrics, a U.K. consulting firm, looked at greenhouse-gas emissions in some of the first countries to adopt a carbon tax -- Finland (1990), Sweden (1991), Denmark (1992) and the Netherlands (1996). They then estimated what emissions would have been without the tax, based on trends in consumption of 11 fuels across more than 40 economic sectors. As the chart shows, the taxes cut emissions, though by varying amounts.

Other studies have also found that carbon taxes work. One found that companies in Denmark cut their carbon emissions per unit of output by a quarter from 1993 to 2000. Finland's carbon tax cut emissions by 7 percent from 1990 to 1998, according to the government. In the Netherlands, one study found that the tax cut household electricity demand by 8 percent from 1994 to 1999.

Yet as the chart shows, the effectiveness of the tax varied. That's partly because its coverage, and the rate applied in different sectors, has varied from country to country. In Sweden, industrial sources of emissions paid just half the standard levy. In Finland, fuel used for agriculture was taxed at a lower rate. The Dutch tax applied to homes and small businesses, with different rates for electricity and natural gas -- one academic called the system "incoherent." Some countries offered further breaks to companies that entered agreements with the government on energy efficiency.

These complications and carve-outs are pernicious in two ways. First, by limiting the reach of the tax, they make it less effective at cutting emissions, defeating the whole point. Second, they ignore the reason for using a tax, as opposed to quantity controls, in the first place. Taxes work better than sector-specific controls because they let markets discover the cheapest way to reduce emissions. Complex tax schedules override those market-based judgments.

A better model is the approach adopted by British Columbia. The tax it introduced in 2008 applies to all emissions from all fossil fuels. The rate started at 10 Canadian dollars for a ton of carbon dioxide and was increased to 30 a ton by 2012. The province's per-capita consumption of fuels subject to the tax fell 16 percent by 2013; in the rest of Canada, it rose 3 percent over the same period.

Of course, these numbers don't tell you exactly what the U.S. could expect if it introduced a carbon tax. Patterns of consumption and sensitivity to price changes vary from place to place. What all these cases show, however, is that a carbon tax can succeed in cutting emissions. How well it works, how much it cuts emissions and at what cost, depends on how it's designed.

The next article in this series will turn to that crucial issue of cost -- and in particular to the claim that a carbon tax will destroy jobs.

--Editors: Christopher Flavelle, Clive Crook

To contact the editor on this story:
David Shipley at davidshipley@bloomberg.net