“CO2 pricing – Reformation or revolution?”
By Dr. Malte Jahn, courtesy of HWWI
The climate policy in Germany is probably more in question than it has been since the first Renewable Energy Sources Act (EEG) passed 20 years ago. The voices of the “Fridays for Future Movement” are growing louder: they call for much more radical measures in energy and climate policy. One potential measure that will be examined in more detail in this article is the much-discussed CO2 tax.
Before the EU Emissions Trading Scheme was introduced in 2005, there was also discussion as to whether a tax would be preferable to a certificate exchange system. It was agreed then and now that putting a price on CO2 emissions is reasonable in order to mitigate or compensate for negative externalities (damage to society).
The choice of an emissions trading system as an instrument of climate policy was expected to provide efficiency advantages over a tax, as the trading system ensures, at least in theory, that one tonne of CO2 is always saved where this is the most cost-effective (macroeconomic). Among other things, due to errors in the implementation, such as the very generous allocation of allowances, the price of the certificates was long low and the savings pressure correspondingly low. However, some legal adjustments have now been made so that in the current third phase the price has reached a reasonable level.
The most important and often overlooked aspect of the current debate is the limited compatibility of an emissions trading scheme with a parallel tax. The idea of the trading system is to set the total amount of emissions, so that only the price is determined by the market. The idea of a tax is to “steer” the market price for emissions directly (upwards), so that the market reduces emissions. However, if the total amount of emissions is already set by the trading system, a tax can not, by design, cause a reduction in emissions. The same argument applies to all emission avoidance measures in sectors covered by emissions trading.
Of course, there are areas of the economy that are not yet covered by the trading system, such as large parts of the transport sector. A targeted CO2 tax for these areas would therefore in principle be suitable for reducing emissions. However, the much-coveted CO2 tax on air travel would remain largely ineffective in this regard, since the aviation sector is already part of emissions trading, albeit with some exceptions.
In the sense of an effective and efficient climate policy, the path of the Reformation or the revolution is open for the future. The Reformation, i.e. the further development of the existing one, would correspond to the extension of emissions trading to all relevant sectors. The inclusion of the transport and heating sectors would have largely covered CO2 emissions.
The introduction of a CO2 tax would be the path of the revolution, as it requires overcoming the existing system in order to be effective. An advantage of a CO2 tax would be that the future costs of the tax are easier to plan for the actors than the cost of allowances. In the overall view, however, the disadvantages outweigh this. Establishing a European emissions tax system would be a lengthy political process that could possibly take a decade. Other counter-arguments are the poorer predictability of the emission levels saved, since the “optimal” tax rate is firstly difficult to determine and secondly constantly varies. However, the most weighty argument against a carbon tax from an economic perspective remains its inefficiency.
A politically non-negligible aspect is the acceptance of the climate policy in the population. As shown for example by the protests in France, a CO2 tax does not contribute to acceptance. In fact there is little, even for political reasons, to say against the continuation of the existing “cap and trade” approach, i.e. the pricing of emissions in the context of a trading system.
Dr. Malte Jahn has been a research assistant at the Hamburg Institute of International Economics (HWWI) since September 2012. Previously he studied mathematics with specialization in statistics and application economics at the Technical University of Kaiserslautern. In March 2017 he received his doctorate from the Faculty of Economic and Social Sciences of the University of Hamburg. In his dissertation he deals with the economic theory and modeling of extreme weather events.