Opinion: Rebalancing taxes – eliminating the carbon externality

What I term “The Carbon Externality” is that cost being borne by current and future society as a result of greenhouse gas emissions, being produced over the past century or so at a rate that exceeds the capacity of the planet to absorb them without perceptible harm.

Externality is an accounting/economics term for any cost that is borne by an external party, and therefore not part of the internal cost analysis. It is the fundamental flaw in Friedman economics and why those calling for small government are missing the point.

Government exists to account for and address externalities. Effective regulation of the market reduces or eliminates externalities so that the costs of doing business are increasingly borne by those who benefit from the business, in the form of reduced profits and higher end-user costs. Taxes are the principle mechanism for this.

The existence of a well-educated and healthy workforce is paid for by both employers and the employed through their taxes, which fund health care and education. The same argument can be made for everything else that governments do – national security, policing and justice, the welfare state, transport infrastructure are all paid for through taxes because they provide benefits to people and businesses that they would not otherwise pay for.

So how do we address the Carbon Externality? I am not a fan of piecemeal tinkering at the edges, and ill-aimed taxes that encourage or discourage the wrong things. The fairest taxes are those that impose a flat rate that increases progressively with the rate of accrued benefit.

A recent report, as noted in The Guardian suggested that:

if all taxes on petrol are taken into account, the implicit carbon tax is £220 per tonne of carbon

I don’t agree with the report’s solution to use the VAT mechanism, but it is worth considering adopting the idea to put a carbon tax on all fossil fuels at source, coupled to an abolition of other taxes on them (including both fuel duty and VAT) and the one remaining direct subsidy (the deep field allowance). The tax should be designed to be revenue-neutral, but with a built in escalator to predictably ramp up the floor price of carbon so that businesses can plan for a carbon-free future.

The impact on petrol and diesel will be to lower the price, initially, which should make the move popular and give a boost to industries struggling under these volatile and rising costs. The continuing price disruption caused by peak oil supply will soon eradicate that incentive to keep driving ourselves to death, and other incentives can be introduced or extended to push forward the electrification of the vehicle fleet.

The costs will show up in gas and electricity bills, and we will need to make them more progressive – at the moment the higher rate per unit is paid for the first few units, with additional units charged at a lower rate. I suggest (not my idea) that we require the utilities to reverse this pricing structure for domestic users, providing the first few units at a lower than cost price, subsidised by higher prices for heavy usage.

This will protect the energy-poor and incentivise the wasteful and profligate users to find ways to use less, including early adoption of the Green Deal.

For energy-intensive industrial users, they have the scale and security of demand needed to be early adopters of renewable technology. A big rise to their utility bills, balanced by a drop in their transport bills, will give them a strong nudge towards seeking their own renewable supply. There are those that argue that any more energy costs on these intensive industries will drive them out of business at precisely the time we want to be supporting manufacturing. I agree that such industries are vulnerable, so I would suggest additional measures to assist with financing the innovation and investment needed to convert them to zero-carbon energy sources.

It should be noted that as a tax on pollution it is intended that the carbon tax eliminate the thing it is taxing, so revenue will fall over time if it successful, even as the rate at which fossil fuels are taxed rises. Therefore the escalator should be structured so that the tax rate rises in line with anticipated or budgeted emissions reduction under the Climate Change Act, keeping the overall level of revenue static, or falling slowly and predictably.

Finally there is the issue of embodied carbon – imported goods manufactured in places with no mechanism to eliminate the carbon externality. It is not yet clear if it is permitted under WTO rules to vary tarrifs on imported goods for reasons of environmental protection. However, both the US and EU are considering such, and if coupled to an effective carbon tax, a clear price mechanism would permeate every buying decision we make, driving down emissions and cleaning up the global energy supply.

Simon Oliver is Chair of Redditch and Inkberrow Liberal Democrats and Members’ Secretary of Green Liberal Democrats.

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20 Comments

  • simon mcgrath 24th Aug '11 - 3:29pm

    “A big rise to their utility bills, balanced by a drop in their transport bills, will give them a strong nudge towards seeking their own renewable supply”
    Or to move to other countries which don’t have hughe additional extra energy costs.

  • You are right in that it is essential to balance internally imposed carbon tax , on home grown manufacturing and services, with some form of carbon tariff on imported goods and services. To not do so would simply deny a level playing field for our manufacturing.

    But I believe this statement you made, adds a further dimension:
    ” The continuing price disruption caused by peak oil supply will soon eradicate that incentive to keep driving ourselves to death, and other incentives can be introduced or extended to push forward the electrification of the vehicle fleet. ”
    So as well as placing a (fair) carbon tax on goods, we must also surely engage the public to use less energy. And, with Peak Oil in prospect, that energy use will also have to be a descent over several years. I believe there is a parliamentary group working on an energy rationing system called Tradable Energy Quotas (TEQ’s)

    http://www.teqs.net/

    It’s not a perfect system, but I believe such a rationing system will prove necessary in the not too distant future.
    A carbon tax is only half the picture, we have to ‘engineer’ or ‘incentivise’, the public to use less energy.

  • Simon
    The beauty about TEQs is the fairness, and the ability to pull quotas out of the system to induce a descent of energy use gradually.
    The fairness element comes from everyone being allocated the same number of quotas per year. The incentive is to live within your energy quotas, and if you are very energy frugal, and have any spare you can sell them. If you are rich or you insist on driving a large 4×4, you still can, but in order to get fuel for it you will have to first buy quotas, from someone who has been frugal in their energy use.
    TEQs would also be designed to reduce energy use over time. For example in year one each person is allocated (say) 200,000 eqs. In (say) year three, the quota drops to (say) 190,000 eqs., and so on. With such a gradual ‘managed’ descent of quotas,, Jevon’s Paradox would not (could not) apply.
    Sorry if my apostrophes are not where they ought to be, but its about ideas not grammar surely?

  • Simon. Thanks for the response.

    If we wait for a system that does not have a risk of corruption, fraud and under the counter activities we will wait forever. Also trying to solve a carbon problem at the World level, or even a European level, means we will wait forever. I don’t think we have forever; moreover I suspect if we don’t get a structure in place very soon , it will be game over.

    TEQs are not perfect, but their simplicity is their greatest asset. Also, we must do something at the level where we have a modicum of control. That is at the UK level. I also see TEQs as another vehicle. They are a method of engaging with the public and coaxing / training / or nudging them in the direction of living on less energy.
    That training will be very valuable in ten years when we, as a nation, HAVE TO live on less energy.

  • Simon, by the way (one pedantry deserves another!) tariff, not tarrif!

  • It’s been nice to chat to you Simon, but I’m afraid your last comment, just floored me.!!

    “I disagree that anyone has to live on less energy – energy is abundant and clean energy is getting rapidly cheaper.”

    It’s so far off base from reality, that I need to guard myself from commenting further.
    All I ask is that you check the math on what you say. Please check on the energy density of oil in comparison with anything, including coal, natural gas, wood, bio-fuel, shale gas, tar sands, electricity (Wind or Solar), hydro, nuclear, hydrogen, etc.

    The BTU of oil is way in excess of anything on the energy radar screen. I’m afraid the days of happy motoring are almost over.

    “……abundant and cheap, and rapidly getting cheaper……..?, Really?
    How is filling your car at £80 per tank for you?
    How is the 18% hike in electricity looking this winter?
    How is the 12% hike in gas this winter going to play out?
    Take care.
    David

  • Simon McGrath 26th Aug '11 - 1:43pm

    “I disagree that anyone has to live on less energy – energy is abundant and clean energy is getting rapidly cheaper.”
    a pity that the link is rather misleading. It shows solar energy is same cost as coal AFTER subsidy. So not really comparable.

  • Simon
    So we’re going to run our cars on recycled aluminum beer cans mixed with sodium hydroxide!!?

    Is this the twilight zone?

    Turning Solar to petrol??
    The best current project admits that they would need an array of mirrors the size of a football field working for about three days (assuming no cloud!), to make enough hydrocarbon, for one car, which would probably get you from Birmingham to Stoke on Trent. (But not back!)

    Simon. I’m not baffled by your word ‘clean’.
    There are NO scalable energy alternatives (clean or dirty!), that will keep us in a Business As Usual (BAU) situation.
    The party is over.

  • I realise that the scenario I’m painting above is a little grim, but I can only tell it as I see it, and as others, far smarter than me, see it.

    I do not have some kind of NVQ in doom mongering! I have children,… I want to be wrong!!

    Yes, I too went through the whole Kubler Ross grieving thing two years ago, because if the implications of Peak Oil don’t give you sleepless nights, then you haven’t understood Peak Oil. Do some thorough research on the subject; I dare you. Download the (pdf) 2010 Peak Oil Report : The Oil Crunch, from UK Industry Taskforce on Peak Oil and Energy Security, of which the Virgin group is chair. That would be a good start. Then for something positive Try the Transition Towns Initiative.

    If you want a template of the direction of our future economy, you could do worse than study Cuba, post 1991.
    In the mean time, don’t drive too far from home in case you have to walk back.

  • Simon
    I don’t recall saying the world would end.

    But it will be very different from the one you expect. And I can assure you there will be no cars powered from recycled beer cans.

    For a proper research of peak oil, I would go a little further than Wikipedia.

  • In an earlier comment you said
    ‘Sorry about the apostrophe aside – I blame Lynne Truss.’

    That should have told us all we needed to know.

    When most people get something wrong, they apologize for their error, they don’t pass the blame on.

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