David Pitt-Watson is a Fellow of Cambridge Judge Business School, Co-founder Hermes Focus Funds/EOS and Former Chair of the UN Environment Programme's Finance Initiative
He gives us his perspectives in advance of COP27 and on one of our TEN KEY PRIORITIES, INNOVATIONS AND ACTIONS TO MITIGATE CLIMATE CRISIS ‘Taxes & Incentives’
The governments of the world have agreed we must get to ‘net zero.’ That means we need to stop burning so much fossil fuel.
As every economist will tell you, taxes and incentives change behaviour. Tax an item and people will consume and produce less of it, incentivize it, and they will produce more. It is therefore astonishing that the IMF reckons that fossil fuels, and the fossil fuel industry receive $300 billion per annum in direct subsidy, and the similar amount received in tax breaks.
That is before you count the damage which is done by greenhouse gases. The IMF calculates that if the costs of pollution and of global warming are added, the subsidy to fossil fuels reaches $5 trillion.[1]
So how might we get taxes and incentives to work better. Fossil fuels, like many other products create ‘externalities;’ that is costs and benefits which the producer and the consumer don’t pay, but others benefit or suffer from. For example, a company which trains its workforce, gets some benefit, but the worker also receives a benefit, even if they change employment. That is a positive externality. Similarly, a contribution to global warming is a negative one.
If markets are to be efficient, subsidies and taxes can be used to encourage positive and discourage negative externalities. This notion was first formulated about 100 years ago by Arthur Pigou, and it remains the holy grail for economists in tackling climate change. Indeed, more than one hundred of them have become members of the Pigou Club, whose founder describes it as ‘an elite group of economists and pundits with the good sense to have publicly advocated Pigovian taxes, such as gasoline taxes or carbon taxes’.[2] That might be the most elegant solution to solve the climate crisis. The revenue raised could be redistributed, maybe on a per capita basis to advantage poorer countries. It would, at little ‘net cost’ (since the tax raised would be redistributed), set a sustainable economic course for the world.
‘But let us not give up hope. There are scores of initiatives to encourage green research and investment. Without it we would not have seen the technical breakthroughs which make green energy competitive.’
But so far, the diplomacy needed for such an elegant solution has simply not emerged from any of the climate talks. As we noted, fossil fuels are subsidized. But let us not give up hope. There are scores of initiatives to encourage green research and investment. Without it we would not have seen the technical breakthroughs which make green energy competitive. And a fifth of current global emissions are subject to some sort of carbon tax.[3]
A global carbon tax and green subsidy, with a cap and trading system, is the obvious, economically efficient way to encourage a sustainable economy. We should not give up trying to agree on this sort of solution, however politically difficult it may be, since this is the most efficient way to run a sustainable economy.
But let’s not put all our eggs in one basket. All agree that any global agreement is unlikely to be signed in time to address the climate emergency. That means that every other avenue needs to be explored if we are to avert climate disaster.
[1] https://www.imf.org/en/Topics/climate-change/energy-subsidies
[2] The Club does include many very eminent economists, and other supporters, from Al Gore to Neil Young, it also includes surprising advocates of Pigovian taxes, such as the CEO of Exxon. Their names can be found here https://en.wikipedia.org/wiki/Pigou_Club