When is a tax not a tax? When it’s a carbon dividend

Oil extraction

Expect to hear more about carbon dividends in the next few years. The latest IPCC report and the increased frequency and intensity of extreme weather events this year in particular, is perhaps finally focusing minds across party lines on ways to make carbon taxes politically acceptable.

Scientists and economists have long advocated carbon taxes as the most effective way to remove carbon from the world economy. While left of centre Europeans like me want increased funding for public services, history shows it’s an uphill task selling the tax increases needed to pay for them, even when voters say they want better schools, hospitals or more police on the street. Taxing carbon may be vital but people rarely vote for new taxes. With climate change the real cost is in the future, and it’s too easy for voters and politicians to think short term and let future generations pay, with the cost of inaction rising all the time.

The carbon dividend is gaining traction with Republicans and Libertarians, and needs proper consideration across the ideological spectrum, as it may be the only way to get carbon taxes implemented – and perhaps more importantly, keep them in place through successive changes of government.

Can a dividend deliver meaningful progress to decarbonise our economy? Having read The Future of Carbon Pricing from centre right UK think tank Policy Exchange, and the Republican leaning Climate Leadership Council’s The Conservative Case for Carbon Dividends1 here is a brief summary of how carbon dividends would work, and some key issues that stood out for me.

What is a carbon dividend?

Carbon would be taxed to discourage emissions, but governments would not keep the revenue for general expenditure, or even programs to counter climate change. Instead the carbon tax revenue is distributed as a quarterly or monthly dividend between all citizens. Every adult would receive the same amount, which would offset the inevitable rise in living costs created by a new tax.

I believe for this to gain and keep cross party support it’s vital that every Pound, Euro or Dollar collected in carbon tax goes back to the pockets of every citizen. They must be ringfenced and separate from other taxes. If not carbon taxes will be attacked by right wing media as the establishment building ‘big government’ by stealth. Creating carbon taxes that the government does not gain from – call them neutral taxes, or no-gain or no-take taxes – should make them difficult for the fossil fuel lobby to attack.

Who benefits?

The majority of us should be better off. A 2011 study by the Rowntree foundation found the wealthiest 10% are responsible for two and a half times as much carbon as the poorest 10% in society2.

So although goods prices will rise until renewables become the norm in our economy, the wealthiest will be paying more in carbon tax than they gain from the dividend. Whereas the majority will gain more from the dividend than they lose with increased prices. And by making lower carbon choices everyone has scope to further reduce living costs, while keeping the dividend of course.

There are some cases where the poorest could be worse off – someone on a low wage living alone in the country who drives to work and has an energy inefficient home for example. These cases will be rare but certainly will exist. So people on already low incomes who might suffer must be identified in advance and given additional help so they are no worse off. One proposal is to allow people to use future dividend payments to pay for energy efficiency measures, which then reduce living costs.

The key point is because the rich are responsible for more greenhouse gas emissions, they will pay in more. The carbon dividend is a mild form of income redistribution because everybody qualifies for the same payment. It may even be a (very) small step towards a universal basic income (UBI).

At what rate would carbon be taxed?

The Conservative case for Carbon Dividends suggests a starting price on carbon of $40 per ton. This would steadily increase year on year, the price being set independently of governments to meet climate targets. This is higher than the current market price of the EU CTS, which has only just reached €20 per ton.

At $40 per ton the dividend paid out is likely to be a few hundred dollars/pounds per person per year3.

What happens at the border?

Imported goods are an issue for any carbon tax. For example, although the EU has made some progress with energy efficiency and getting renewables onto the grid, Europeans have for years been effectively offshoring increased emissions to developing nations like China, because the Chinese grid used by manufacturers has a high proportion of coal generation.

So nations trading with a carbon tax nation have a reason to adopt compatible carbon tax and dividend schemes. If they don’t, imported goods would have carbon taxes applied based on the average emissions of that nation’s grid. This would push up the prices of imports, but again as with domestic carbon tax revenue, the revenue goes to the citizens and cancels out the price increase. (Carbon bordering is addressed in both documents).

So the carbon tax and dividend appears to be a simple solution that should attract support across the board. But there are always potential risks in relying on a market solution to fix what in many ways is a basic failure of human nature to take responsibility for the long term.

No carve-outs or exceptions

Politicians and the public must resist industries pushing for exemptions. Take aviation for example.

Electric cars and buses are viable now, but electric or hydrogen airliners are technically difficult and a long way off. As carbon taxes increase, the cost of flying will likely rise at a faster rate than other purchases. Of course for most of us the dividend increases our ability to pay for airline tickets, so only those who fly frequently will lose out.

However it is possible to make synthetic fuels by sucking hydrocarbons from the air, producing carbon neutral air fuel (so exempt from carbon tax) for existing aircraft. Currently synthetic fuels can be produced for about 25% above standard fuel costs4. But as air fuel prices rise with carbon taxes, we will reach a point where the synthetic carbon neutral fuel is cheaper! From then the synthetic fuel would likely continue reducing in cost due to economies of scale. This could also have a knock-on effect for other fuels, giving us cheap carbon neutral petrol in applications where petrol is more difficult to replace.

So it’s vitally important the politicians do not surrender to lobbyists and special interests. That would prevent the decarbonisation of aviation and hamstring the development of cleaner technologies like synthetic fuels. The true cost of carbon must always be paid.

Could it trigger a fossil fuel price war?

In neither of the two proposals have I seen a discussion on potential risks of a fossil fuel price war.

Unlike most industries, oil producers can to an extent control price simply by varying their output.

If oil producers are not on board with carbon taxes and dividends, might they increase production for a few years to keep down the price of a barrel of oil, thus negating the carbon tax and preventing wider adoption of renewables, and perhaps even increase fossil fuel use? Unlike most industries, oil producers can to an extent control price simply by varying their output. Could a sudden ‘dash for cash’ – producers taking profits while the world is still dependent on oil – throw a spanner in the works?

Certainly the world’s most accessible oil reserves have already been tapped and burned. New developments include oil from tar sands, shale, or reserves located in wilderness areas like the Arctic and other places previously considered out of bounds. These new developments of oil frequently put clean land and water in greater danger (Deepwater Horizon in 2010 for example).

Difficulties in extraction suggest profit margins for crude oil production are decreasing. This may prevent the oil price dropping below a certain point, and so keep the carbon tax effective. On the other hand, high cost and high risk extractions are still going ahead, which suggests there is room for the price of crude to drop and even the most dirty fossil fuel production to remain profitable.

Would a carbon tax and dividend not then require some sort of lowest price set for crude oil, as well as setting a price for emitting carbon? If so this would no longer be the entirely free-market mechanism the Libertarian right want it to be. Or equally possible, what if oil producers slash production to drive the oil price up rapidly, in an attempt to force politicians to abandon the tax?

I wonder if the influence oil producers still have in a world dependent on oil has been properly considered.

Scrap environmental regulations?

One appeal of the dividend for industry and the right is the reduction of carbon limiting regulations, on the basis that the carbon tax and dividend will make these redundant. This does mean relying on a market solution to rapidly repair a problem created by market forces. Given there is little room for failure, perhaps the dividend should run for a few years and prove it can deliver, before attempting wholesale removal of existing carbon regulation?

Additionally a carbon dividend must not be used as a bargaining chip for industry to demand other environmental rules get scrapped. Returning to the point above, one reason newer and dirty fossil fuels have lower profit margins is surely because of the regulations that protect clean land and water. Without these regulations, operating costs come down and more fossil fuels get extracted and burned, defeating the purpose of the carbon dividend.

No mention of Methane. Or inflation

Although volumes of methane released are much lower than carbon, its affect on warming the planet is 25 times worse than carbon. So the carbon tax and dividend should include methane as well. This is perhaps assumed, but the word ‘methane’ does not appear in either document.

Another potential barrier for politicians may be how the carbon taxes effect inflation. For the consumer, price increases will be negated by the dividend. However inflation is a measure of prices including sales taxes like VAT, not prices relative to earnings, so a carbon tax can be expected to increase inflation. Normally central banks react to inflation by raising interest rates. So would inflation be calculated minus the carbon tax? Or would central bank policy change on inflation?

Clearly this is something that can be factored in. I’m just pointing out that any carbon taxes are likely to affect inflation, a key economic marker used by governments and the financial sector to determine the health of an economy.

Conclusion: Why even climate skeptics should vote for carbon dividends

For those convinced the scientists have it all wrong, or that climate change is a left-wing hoax, a carbon tax and dividend is still something to support.

Remember a thing called Peak Oil which was all over the media a few years ago? Attention may have shifted, but the fact is there is only a finite amount of fossil fuel available, and the easily extracted fuel has mostly been used up. What remains, be it from Canadian tar sands or a National park somewhere, is increasingly difficult and expensive to extract without trashing the clean land and water that remains on this planet.

So surely it’s better to deal with our dependence on fossil fuels now and make a phased switch to renewables, rather than wait passively for the day fuel prices jump, giving an unwelcome shock to a world economy unable to function without cheap fossil fuels?

A renewable energy economy can give a quality of life equal to what we have now. After more than a century of development fossil fuels have reached the limit of what they can do for us, so it’s time for humanity to use something smarter. Electric cars are a good example. An electric car has about 100 moving parts, a standard combustion engine vehicle several thousand parts, which generate friction and waste energy. Even according to the US government, existing electric cars convert more than half their energy into motion, whereas for a combustion engine 21% is considered a good return.5

This is the advantage of renewable energy. Not only are renewables cleaner, they are already more efficient. And as renewables become the norm the level of efficiency will only increase, making energy cheaper and improving quality of life. As well cleaning up the air in our cities and reducing the risks of extraction, potentially more nations can become energy independent, which should also increase global political stability.

So even with all the issues and caveats I’ve described above, a carbon dividend is I believe the most likely way to get carbon taxes enacted, because carbon taxes must overcome deeply embedded climate skepticism in the political right to have any chance of implementation. If done properly and soon, a carbon tax and dividend may reduce carbon emissions for decades to come.

endnotes:

1. PDF’s of UK Policy Exchange The future of Carbon Pricing and US Climate Leadership Council The Conservative Case for Carbon Dividends ..return to text..

2. In a 2013 study the highest income households’ carbon footprint was 14 tonnes, for the lowest income households it was 5.5 tonnes. Rowntree foundation study ..return to text..

3. The Conservative Case for Carbon Dividends says “a family of four would receive approximately $2,000 in carbon dividend payments in the first year.” so I’ve approximated this to a few hundred pounds per person. ..return to text..

4. Canadian company Carbon Engineering estimate a 25% difference for production of synthetic diesel. I’m assuming synthetic air fuel would have a similar price differential to conventional air fuel. ..return to text..

5. Efficiency of electric and internal combustion engines compared in this US government document. ..return to text..

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