CARBON FEE AND DIVIDEND. AN IDEA WHOSE TIME IS COMING.

One simple idea unites almost all environmental economists. It is the importance of pricing external costs – the social and environmental damage caused by greenhouse gas emissions – into markets so that users and consumers are forced to recognise and pay for these costs at the point of use, and not allowed to fall instead on the public at large or on future generations.

Unfortunately a simple implementation of such an approach runs head first into some major political realities. The first is that the level of pricing applied to fossil fuels that would be necessary to reduce emissions quickly or substantially is high, and would be a major economic shock both to many industries and consumers. The industries affected tend to be extremely vocal. The second is the observation that any resulting price increases are most likely to have a  disproportionate impact on poorer consumers.

Just to illustrate the point the European Union’s emissions trading scheme (the ETS) has over long periods produced carbon prices of significantly less than €15 per tonne, in a period when the price at which key technology transformations occur has appeared to be much higher, around €70 or more. Even more significantly it is now widely recognised that the world is so far from reaching safe climate targets that it will have to contemplate large scale sequestration of CO2, ie extraction from the atmosphere, with much higher costs, probably at least €200 per tonne (best available current technology puts this figure at around €600 per tonne).

Failures of the ETS reflect many factors, including industry lobbying and the post crisis recession, but they certainly include weak political will in relation to higher carbon prices.

Carbon Fee and Dividend

Citizens’ Climate Lobby[1] has proposed a carbon fee and dividend approach, in which the whole of of the revenue from a “carbon fee” is returned directly to households as a monthly dividend. The idea is that the majority of households will receive more in dividend than they pay in increased energy costs. This feature protects family budgets, frees households to make independent choices about their energy usage. The higher fuel prices spur innovation in low-carbon products.

The scheme would include border adjustments[2] to protect UK businesses, levying import fees on products imported from countries without a price on carbon, along with rebates to UK industries exporting to those countries. This would discourage businesses from relocating where they can emit more CO2 and incentivise other countries to adopt similar carbon pricing policies.

In fact this idea is part of a family of similar ideas aimed at shifting the burden of taxation towards “green taxes” which seek to redress existing market failures that comprehensively fail to address environmental problems. The counter part to these socially beneficial taxes is a reduction in other forms of taxation, and related concepts include “revenue neutral carbon taxation” and the notion of a carbon “wealth fund”, promoted in an earlier blog on this site by Adam Whitmore.

The case for action

I believe there will be numerous points of detail to get right, whatever new approach is adopted, and I have a few concerns on specifics.

·         Border adjustment taxes look fine in principle, but the administrative detail in their application looks formidable, and they would still have to comply with international rules on trade.

·         CCL propose a gradual increase in tax on carbon, starting from quite low numbers. As discussed in another page on this site, the stark message of the science is that the highest cost attaches to early emissions, since they are both cumulative and bring forward climate milestones.

·         Getting both the macroeconomics and the redistributive consequences right will be challenging, both technically and politically.

·         The idea of a wealth fund, as opposed to immediate revenue neutrality, may be the preferable route.

Despite these concerns I am more and more convinced[3] that more effective action on carbon pricing is essential, and that its combination with a redistributive agenda in domestic politics is probably the best available way to break the current logjams on climate policy.

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[1] Citizens’ Climate Lobby (CCL) is a non-profit, nonpartisan, grassroots advocacy organisation, started in the United States. There are now CCL groups in 40 countries, including the UK network established in 2015.

[2] An idea also previously promoted by Dieter Helm and Cameron Hepburn

[3] https://www.ft.com/content/9a6f8e90-0398-11e9-bf0f-53b8511afd73.  Just a final footnote. 23 December issue – Arun Majumdar in the FT discusses the issue.

ISSUES FOR A CARBON WEALTH FUND. ADAM WHITMORE RESPONDS

Adam has responded to some of the questions I raised in my recent blog reporting on his proposal for a carbon wealth fund.

John raises some interesting questions in relation to my proposal for a carbon wealth fund.  I will try to answer them briefly here.  I will assume that national funds are the only practical way forward in the short to medium term, and look at a UK sovereign wealth fund based on carbon revenue. 

Use of a global public good

First, John notes that there are some differences between conventional resources, such as oil and gas, held by nations, and the atmosphere, a global public good[1].  The distribution of a global public good will inevitably be contentious.  However existing carbon pricing regimes or simply emitting free of charge already use up a global public good.  Giving citizens and governments a greater stake in increased carbon prices is likely to decrease the quantity of emissions, and so the proportion of the global commons used[2].  This makes the approach I have proposed more compatible with good stewardship of the global commons than existing arrangements, at least for the next 50 years until revenues start to decline. 

Macro-economic effects

John also raises the issue of the macro-economic effects on exchange rates and economic activity.  However these effects would probably not be large.  The payment into a UK fund would be around £16 billion p.a. at present, a little under 1% of GDP per annum[3].  This would be unlikely to cause major economic dislocation, especially if phased in over a period of perhaps 5 years.  The fund would grow large over time, reaching around £860 billion by the end of the century[4].  However this is not vastly larger than the Norwegian fund today, which is for a very much smaller economy.  Furthermore any fund would have the effect of redirecting revenue from consumption to investment, which would probably have a positive macroeconomic effect in the context of historic UK underinvestment. 

Would it be regressive?

Then there is the question of whether increasing revenue from carbon pricing would be socially regressive.  The concern here is that poorer households spend a larger proportion of their income on energy than richer households, and so energy taxes tend to hit them disproportionately harder.  However poor households still spend less on energy, and therefore carbon, in absolute terms than richer households, so an equal dividend, as I’ve proposed, would have the potential to have net progressive effect.   Furthermore, households account for only a minority of energy use, but would get the full benefit of dividends (or at least a large proportion), increasing the extent to which it is progressive.

However there are some important intergenerational issues to consider.   The proposal for a fund takes the view that present generations should safeguard capital assets so they retain value to future generations.  This is in line with the standard definition of sustainable development[5].  However there are distributional issues here which need to be addressed.  Some present citizens will be worse off. 

Use of green taxes

The proposal is clearly consistent with using green taxes more widely as a policy instrument.  What’s different from the standard approach to green taxes is the suggestion of placing revenue in capital fund rather than using revenue to fund current expenditure.  The landfill tax to which I referred in my original post currently raises around a billion pounds per annum[6].  It would be natural to add this revenue to a UK wealth fund. 

Other uses of funds

Finally, there is no reason some of dividends from the fund should not be used to fund things like R&D.  As I have previously discussed there are many legitimate calls on revenue from carbon pricing.  However there are many compelling arguments for allocation direct to citizens, and this should in my view be a priority for the fund. 

There are also other issues to consider, such as governance structures.  Many of these have been reviewed in the wider literature on sovereign wealth funds[7].  Doubtless much work is needed to elaborate on these details, as would be the case for any new institution.  However the prize is worth the effort.

I very much welcome John raising these questions.  They are exactly the sort of issues that need to be discussed, and I hope the debate will not stop here.

Adam Whitmore - 20^th February 2017

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[1] There is an interesting question as to whether countries should have full property rights to natural resources within their territories, as is often assumed at present, but this is too large a subject to go into here.

[2] The assumption here is that increasing prices from current low levels will increase revenue.  Carbon prices would increase by a factor of say five or more in many cases, and it is unlikely that emissions would decrease by an equal factor – though if they did it would be very good news.

[3] This assumes 400 million tonnes of emissions are priced, compared with 2015 totals of 404 million for CO₂ and 496 total greenhouse gases (source BEIS), implying a high proportion of emissions are priced.  Carbon price is assumed to be £40/tonne, roughly the Social Cost of Carbon at current exchange rates and well above current levels.  This would give total revenue of £16 billion in the first year, less than 1% of UK GDP of approximately £1870 billion in 2015. (source: https://www.statista.com/statistics/281744/gdp-of-the-united-kingdom-uk-since-2000/ )

[4] Assuming that the UK reduces its emissions in line with the Climate Change Act target of an 80% reduction from 1990 levels by 2050, and then to zero by the end of the century, and that 80% of emissions are priced at the Social Cost of Carbon as estimated by the US EPA, converted at current exchange rates of $1.25/£.

^[5] Sustainable development is usually characterised as meeting the needs of present generations, without compromising the ability of future generations to meet their own needs.

[6] https://www.uktradeinfo.com/Statistics/Pages/TaxAndDutybulletins.aspx

[7] See here for a specific proposal for a UK wealth fund:  http://www.smf.co.uk/press-release-conservative-mp-calls-for-uk-sovereign-wealth-fund-to-address-long-term-and-structurally-ingrained-weaknesses-of-the-economy/  and Cummine (2016) cited in my original post for further details.

CARBON WEALTH FUNDS TO SAVE THE PLANET

Adam Whitmore argues in his recent blog “How not to squander $ 130 trillion” that carbon pricing should be used to establish wealth funds from which current and future citizens can benefit.  This is very timely given the Baker and Shultz (Republicans) proposals now under discussion in the US.  He makes the classic environmental economics arguments for carbon pricing.

At the moment only a very small proportion of greenhouse gas emissions is priced adequately.  Most emissions remain unpriced, and the growing proportion that is priced is mostly sold at well below both the cost of damages, and well below the value of an increasingly scarce resource.  A valuable scarce resource is thus being given away or sold below cost, subsidising emitters.  Huge natural wealth is being squandered.  And once gone it can never be replaced.

It would be better to use revenue from carbon pricing to create a wealth fund to benefit both current and future generations …

… in the form of a fund for citizens, with proceeds from carbon pricing (the sale of allowances or taxes) at adequate levels paid into the fund.  Carbon pricing should be comprehensive, with prices at adequate levels.  The finite volume of the resource implies it is best used to establish a wealth fund, where financial capital is built as natural capital is used up.  The fund would belong to all citizens.  Granting its value to citizens would surely encourage better management of the atmosphere, and thus the climate, and higher carbon prices than generally prevail at present.

Most environmentally concerned economists will support the arguments for much higher prices to attach to greenhouse gas emissions (GHG), and it is well worth examining some of these ideas further. Adam develops the basic idea and sets out his vision for how it might work.

Dividends from the fund could be used in many ways.  One approach with a range of advantages is distributing benefits to all in the form of a “citizen’s dividend”.  There is already a feature of the Alaskan wealth fund derived from oil revenues, where distribution is in the form of a Permanent Fund Dividend to all citizens.  This is widely considered to have helped build and maintain public support for the scheme.

This approach is closely related to the idea of “tax and dividend” carbon pricing.  I have previously argued that such approaches have merit, and indeed tax and dividend has recently been advocated by senior Republicans in the USA.  However, there is an important difference between a fund and tax and dividend as often presented, in that revenues are used to establish a fund that is intended to be permanent, whereas tax and dividend proposals often assume revenues to be distributed in full.

Adam also links his idea to other political objectives especially in the context of redistributive measures, both nationally and in a global context.

There is also a relationship between the idea of a citizen’s dividend and a universal basic income, which is much discussed at the moment and subject to a few trials.  … There is a natural case for distributing dividends equally, as all have equal rights to the atmosphere.  The atmosphere is a global resource, and climate change knows no borders, so it is natural to make any fund global.  However establishing such an arrangement is likely to be too great a political challenge. …

The global challenge is clear enough. And the idea of developed countries (sometimes deemed to have a historic responsibility in this context) subscribing to development funds to assist developing countries in both low carbon initiatives and in adapting to climate change, is already part of the currency of international climate negotiations.

Establishing national funds will have many challenges.  However the prize seems large enough to be worth pursuing.  The current system of simply allowing emissions to be dumped into the atmosphere, often free of charge and almost always too cheaply, is a waste of a unique and irreplaceable asset.  Irreplaceable natural wealth such as the atmosphere should be managed carefully, not squandered recklessly.

This amounts to a series of challenging propositions. It is intuitively appealing, and the connection of ideas in providing for the future, taxing emissions to correct a market failure, and providing for a “fair” allocation of proceeds is attractive.

However it will be necessary to explore the idea in the context of potential macro-economic and other implications, and we can expect quite a lot of exposure for these ideas in the near future, not least reflecting their surprising emergence from US Republicans. A few of the questions deserving consideration, and to which we may return in future blogs, are:

1  There are some clear differences from the sovereign wealth funds put in place to preserve the long term position of countries that are depleting a scarce natural resource eg Norway and oil. One feature of the latter is that they can prevent a potentially dangerous exchange rate appreciation which destroys part of the country’s economy. UK failure to establish a wealth fund for North Sea oil was one of the factors that undermined UK manufacturing in the 1980s. But this feature does not translate to a global context, nor, would it necessarily make sense for an individual country to set up such a fund in isolation.

[Economists will also note that oil is a “private” good, whereas the GHG absorbing capacity of the planet is very much part of the “global commons”.]

2  Would the creation of such a fund immediately remove purchasing power from the economy and, in the absence of offsetting measures, provoke recession? One can imagine, for example, some very negative effects from the immediate adoption of such a measure in the German and eurozone economy for example.

3  Is it not simpler to view the proposal simply in the context of additional sources of tax revenue, Green taxes, which would increasingly substitute for other and unpopular forms of taxation? Or should the revenues be hypothecated to other clearly needed climate policies, for example on research and development?

4  Energy taxes are often seen as quite regressive. How could this be remedied?

My own view is that this is a welcome and timely proposal and it, perhaps in a modified form, could be used as a welcome rallying point for more effective action on climate; but we will need to think hard about its practical and political aspects. As ever the devil will be in the detail. But it will also be in the packaging and the presentation.