29 th September 2009 Pricing Carbon and Taxing Energy A Guide for the Perplexed Stephen Stretton Research Associate, Cambridge Centre for Climate Change Mitigation Research (4CMR)

2 of 32 Contents Definitions What does a carbon price do? Economics of environmental constraints Carbon taxes as fiscal instruments How high? Taxes and Cap-and-trade Taxes versus Cap-and-trade Conclusions

3 of 32 Contents Definitions What does a carbon price do? Economics of environmental constraints Carbon taxes as fiscal instruments How high? Taxes and Cap-and-trade Taxes versus Cap-and-trade Conclusions

4 of 32 Definitions? An energy tax is a monetary amount charged by the government on the extraction, importation; or use of fossil fuels; A carbon tax is an energy tax levied according to the fossil fuel’s carbon content; A carbon price is a carbon tax or equivalent price for marketable permits on fossil fuels or their greenhouse gas emissions.

5 of 32 ‘Upstream’ or ‘Downstream’? ‘Upstream’ ‘Downstream’ £ € $ Fossil FuelsCO 2 Emissions £ € $ It is administratively simpler to cover all sectors with an ‘upstream’ carbon price

6 of 32 Contents Definitions What does a carbon price do? Economics of environmental constraints Carbon taxes as fiscal instruments How high? Taxes and Cap-and-trade Taxes versus Cap-and-trade Conclusions

7 of 32 What does a Carbon Price Do? 1.Reduce Demand 2.Encourage Alternatives 3.Raise Revenue £

8 of 32 Contents Definitions What does a carbon price do? Economics of environmental constraints Carbon taxes as fiscal instruments How high? Taxes and Cap-and-trade Taxes versus Cap-and-trade Conclusions

9 of 32 Economics? One goal of economics is: to study different methods to attain some goal (e.g. ‘preference satiation’) under scarcity (or constraints).

10 of 32 Prices and Constraints Price Quantity Demand The price of a good affects the amount that we can buy. If the price is high, the amount that we can buy is reduced.

11 of 32 Prices and Constraints Two types of constraint: 1.‘Hard’ physical / resource constraints 2.‘Soft’ environmental constraints Price Quantity Supply Hard constraints: price rises to choke off demand 2. Soft constraints: no price

12 of 32 Why Aren’t Environmental Constraints Automatically Priced? a)Environmental damage is an effect on parties not represented in an economic transaction (‘Externality’) b)Environmental sinks are not owned. The lack of an owner means that they are treated badly (‘Lack of property rights’). c)Overall, those affected by environmental damage are often numerous and diffuse, and distant in time and space. (‘Tragedy of the commons’)

13 of 32 Contents Definitions What does a carbon price do? Economics of environmental constraints Carbon taxes as fiscal instruments How High? Taxes and Cap-and-trade Taxes versus Cap-and-trade Conclusions

14 of 32 Fiscal Reform Strategy 1.Tax ‘bads’ 2.Remove tax on ‘goods’ 3.Tax ‘rent’ Fossil fuels are both a ‘bad’ and a ‘rent’ “Change VAT to CAT”

15 of 32 How Sensitive are Emissions to Price? Emissions less sensitive to Price (Price Inelastic’) Emissions more sensitive to Price (Price Elastic) Effectiveness of Carbon tax as climate policy LowHigh Effectiveness of Carbon tax as a tax HighLow

16 of 32 Political Constraints Carbon taxes raise revenue; That revenue can be rebated such that demographic groups (e.g. the poor) are on average no worse off.

17 of 32 Contents Definitions What does a carbon price do? Economics of environmental constraints Carbon taxes as fiscal instruments How high? Taxes and Cap-and-trade Taxes versus Cap-and-trade Conclusions

18 of 32 Oil Price Fluctuations Equivalent to $200/tCO 2

19 of 32 How High Does The Carbon Price Need To Be To Support Low Carbon Technology? Coal with Carbon Capture and Storage –$85-130/tCO 2 for new demonstration plants –$40-60/tCO 2 in 2030 for commercialized plants (Naucler et al. 2008; €1=$1.4) Concentrated Solar Power –Carbon price needed: $115/tCO 2 (Staley et al., 2009) Air Capture –Capture and Storage of Carbon Dioxide from Thin Air –Carbon price needed: at least $140/tCO 2 (Keith et al., 2006) $200/tCO 2 ?

20 of 32 Carbon Tax Effects of Different Rates $200/tCO 2

21 of 32 Effects of $200/tCO 2 Add $80 to a barrel of oil 8c/kWh on gas electricity 20c/kWh on coal electricity 46c/litre on petrol

22 of 32 UK Money: Effects of £100/tCO 2 4p/kWh on gas electricity 10p/kWh on coal electricity 23p/litre on petrol Raise £60bn/yr initially* £1000 citizens income or replace VAT* *revenue will fall as the policy works to reduce emissions

23 of 32 UK Money: Effects of £200/tCO 2 8p/kWh on gas electricity 20p/kWh on coal electricity 46p/litre on petrol Raise £120bn/yr initially* £2000 citizens income or 2xVAT* *revenue will fall as the policy works to reduce emissions

24 of 32 Contents Definitions What does a carbon price do? Economics of environmental constraints Carbon taxes as fiscal instruments How high? Taxes and Cap-and-trade Taxes versus Cap-and-trade Conclusions

25 of 32 Taxes and Cap-and-trade (cap constraining)

26 of 32 Taxes and Cap-and-trade (tax constraining)

27 of 32 Contents Definitions What does a carbon price do? Economics of environmental constraints Carbon taxes as fiscal instruments How high? Taxes and Cap-and-trade Taxes versus Cap-and-trade Conclusions

28 of 32 Taxes versus Cap-and-trade 1.Administrative Burden (Upstream v Downstream?) 2.Volatility – Investment? 3.Immediacy? 4.Do we know our budget? 5.Ability to overachieve? 6.Incentives for Countries to Participate Globally?

29 of 32 Contents Definitions What does a carbon price do? Economics of environmental constraints Carbon taxes as fiscal instruments How high? Taxes and Cap-and-trade Taxes versus Cap-and-trade Conclusions

30 of 32 A Critical Path 1.Public Understanding and Proposed Policy 2.Skills and Capacity Building 3.Govt Guarantee Carbon & Electricity Prices 4.Secure Finance e.g. with ‘Climate Bonds’ + PubFi? 5.Start Energy Efficiency Rollout 6.Build Energy Infrastructure 7.Fiscal Reform: ‘VAT to CAT’ 8.Strategy transfer around the world 9.Switch Transportation 10.Complete Decarbonization of Britain and other countries 11.Reforest the world 12.Permanently avoid fossil fuel extraction

31 of 32 Conclusions Carbon taxes can work immediately! Carbon taxes are best imposed ‘upstream’, with carbon dioxide being counted in terms of carbon at extraction or importation. They should cover all sectors with greenhouse gas emissions, including imports (‘embodied carbon’).

32 of 32 Thanks for your attention! Contact me: Stephen Stretton Links: