Are We Ready for a Global Carbon Tax?

To address existing inequities in greenhouse gas emissions and combat climate change, leaders at the African Climate Summit in September called for a global carbon tax regime and vowed to use it as the basis of their negotiating position at COP28 in November.  Africa produces less than 3% of the world’s carbon dioxide emissions, but countries on the continent are disproportionately vulnerable to the impacts of climate change.

The idea of a shared global carbon pricing framework also is being discussed by Ngozi Okonjo-Iweala, director general of the World Trade Organization (WTO), who recently noted that there are at least 70 different and fragmented approaches to carbon pricing around the world, including carbon taxes, emissions trade systems (ETS), and indirect carbon pricing through fuel taxes. The U.S, currently does not have a carbon tax on a national level. In the U.S, 12 Eastern states that together make up the Regional Greenhouse Gas Initiative, as well as California and Washington, have cap and trade programs.

The WTO, which has and has been working with the World Bank and the International Monetary Fund to streamline carbon pricing, has launched a task force to create a global methodology to determine carbon pricing.

YSE News talked with Matthew Kotchen, professor of economics, about the significant benefits of a global carbon tax and the substantial roadblocks to implementing one.

Q. What are the benefits of a global carbon tax?

A carbon tax gets the incentives right. If there is a global carbon tax, every time somebody purchases fossil fuels or carbon-intensive goods or services, they now have to pay extra for the environmental damages. Not only does the tax discourage polluting activities, it also provides incentives for research, investment, and deployment of more efficient and low emission alternatives. It is one of the most effective ways to reduce emissions.

Q. How would the tax work?

Each country’s government would set a tax per ton of CO_2, or some other greenhouse gas equivalent, and then it would be up to individual countries to levy the taxes. There would have to be some sort of international coordination to make sure that countries are actually doing their part and assessing the tax equally across different places. Many people often don't think about how if there's a global carbon tax, countries keep their own tax revenue. In principle, countries can use the revenues however they want. One way that some of the revenue could be used is for higher-income countries to provide climate finance to fund mitigation and adaptation in lower-income countries.

Q. What are the biggest challenges to enacting a global carbon tax?

Public support is probably the biggest obstacle. There seems to be a fundamental ideology against taxes. Also, in many countries, simply administering a tax is not as easy as it sounds. There is also a big debate about what to do with the revenue. There are a lot of different options. You could rebate the tax back to people, which is what Alaska does with its royalty tax on fossil fuels. You could spend it on clean energy programs and other climate investments. You could spend it on other public projects, or even reduce other taxes. And as mentioned previously, you can use it to help fund climate-related projects in other countries. How you spend it can affect the degree of public support.

Q. Would companies offset the cost of the tax by passing it on to consumers?

Yes. That's what many people often forget. Any tax is shared between demand and supply. That is called the incidence of the tax, who actually shoulders the burden of it. So, it's not as though you enact a carbon tax, and we're going to just make the fossil fuel companies pay. The burden will be split between producers and consumers.

Q. Considering these obstacles, how likely is it that world leaders would agree to a global climate tax at the upcoming COP28 or in the future?

A global tax is a little hard to imagine right now, but the ‘Climate Club’ idea, which is part of the pioneering work of William Nordhaus (Sterling Professor of Economics at Yale and Professor at YSE) holds some promise. In a Climate Club, a set of countries all agree to impose a carbon tax and then give club members preferential trade relations as opposed to those that are outside of the club. That way you could start to build the coalition of countries that are willing to impose a carbon tax.

Q. It seems that in the U.S., with the Inflation Reduction Act, we are subsidizing clean energy more than taxing dirty energy. How should we think about that difference?

Correct. The approach that we seem to be pursuing lately in the U.S. at a federal level is subsidizing clean energy to make it more competitive with the dirty energy. There are big subsidy incentives for installing new capacity for wind and solar. This is helpful, but we should not forget that the subsidies need to be paid, and often this comes through taxes, or avoided tax revenue in the case of tax credits. The approach is generally less efficient, but seemingly more politically feasible. With subsidies we have to pick winners, and with a carbon tax the market does it.