Enough promises on climate change — it’s time to pay up
By: Travis Elsum
Tags: Environment, Economics, Climate Change, Carbon Tax

Photo by Christine Roy on Unsplash

Midnight Oil achieved global success in the ’80s with their single Beds Are Burning. You’d probably know it if you heard it. And you’d probably recognise the lead singer — Peter Garrett — with his characteristic shiny head, beanpole figure and wooden-push-puppet-esque dancing style.

Up until then, the Aussie pub rock band had steadily been building a cult domestic following with their politically charged lyrics on environmental issues, consumerism and militarism. But it was ultimately a song about the treatment of indigenous Australians that the world connected with. The chorus ‘how can we sleep while the beds are burning?’ was universally relatable — it was a proxy for the guilt and anger people felt for continuing to their lives whilst injustices happened all around them.

Today, this sentiment is more relevant than ever, as we face the prospect of runaway climate change. With each passing day, there seems to be a growing sense of unease; a feeling that we can no longer sit by as the world slowly burns. Awareness is building and protesters are becoming more fervent. We must take meaningful action to stop climate change — and fast.

The problem is, stopping climate change will require substantial investment and even those who support action on climate change have proven fickle at the slightest hint of the bill arriving.

In 2005, Jørgen Randers was asked by the Norwegian Government to chair a commission tasked with finding a way to reduce greenhouse gas (GHG) emissions by two-thirds by 2050. It was a tough brief, but the commission managed to produce a workable plan that would cost three hundred dollars, per person per year. Despite Norway being the world’s sixth richest nation, the plan received virtually no support from its citizens — people would rather go shopping.

While this reaction may seem selfish, it is consistent with the behavioural economics concept of hyperbolic discounting, where people instinctively discount a future benefit heavily when comparing against an immediate one. The discount tends to be larger still where the future outcome is more uncertain. Hence, the Norwegians felt that avoiding a payment of $300 today was preferable to suffering larger (but uncertain) losses from climate change over the coming decades.

When a more appropriate discount rate is applied, numerous studies — such as the landmark Stern Review — have shown that the benefits of mitigating climate change greatly outweigh the cost.

The Norwegian example highlights the inherent challenges with implementing the measures that are required to tackle climate change — asking people to defer consumption is a hard sell.

Setting a price on carbon

The most efficient and least disruptive way to significantly reduce GHG emissions is to use market-based mechanisms, especially carbon taxes. Nobel Prize winning economist Michael Spence emphasised the importance of carbon pricing in an interview with Business Insider, ‘there are relatively few things that are almost unanimously agreed upon among economists, but this is surely one of them.’

The International Monetary Fund’s (IMF) October fiscal monitor report reiterated the efficiency of market-based mechanisms and cautioned that it would be difficult to achieve emissions reduction targets without them. The IMF concluded that global carbon taxes of $75 per tonne or similarly ambitious policy measures are needed to meet the Paris Agreement.

While carbon taxes are lauded by experts, some reject the concept of market-based mechanisms on the grounds that capitalism and the quest for unlimited growth got us into this mess in the first place.

Taking a more objective view, under a capitalist economy, markets are simply a collection of billions of actors making trillions of decisions to find optimal solutions within a set of constraints. Admittedly this can result in perverse and downright unjust outcomes. However, if we were to tweak capitalism to make it more inclusive, for example through adding new environmental constraints, then markets could be a powerful ally in the fight against climate change.

Despite the benefits of market-based mechanisms, most countries either do not price carbon at all or they underprice it. The global average carbon price is $2 per tonne, well short of the IMF’s $75 minimum. This amounts to a global market failure — participants are continuing to make decisions that would be sub-optimal if they were made accountable for the environmental cost of their actions.

How does a carbon tax work?

A carbon tax is essentially a market constraint that incentivises businesses and consumers to change their behaviours to minimise CO­2 emissions. The tax is levied on heavy emitters, but the effects spread throughout the economy.

For example, let’s assume that one tonne of CO­2 is emitted per tonne of cement produced. Now, let’s say that applying a new production method would enable a 50% reduction in CO2 emissions, but would increase production costs by $25 per tonne. In a competitive market with no carbon price and where cement is a homogeneous good, a producer would lose business if it went it alone and moved to the new method. However, if a $75 carbon tax were applied in this market, it would be optimal for all firms to adopt the new method — as they would save $12.50 per tonne — and the sector’s emissions would reduce.

In practice, until a global carbon tax applies, schemes need be designed to minimise ‘carbon leakage’. There would be little point in taxing the cement producers from the example above if it would just cause them to move to countries without carbon taxes.

Carbon tax designs to date have typically dealt with the problem of carbon leakage with exemptions or rebates, which does little to reduce emissions from the affected sectors.

A new top EU climate official has a better idea — apply a carbon border adjustment tax. That is, imports from countries with a lower (or no) carbon tax would be subject to an adjustment tax equal to the difference. This ensures local producers have a level playing field, but are still incentivised to reduce emissions. Further, it encourages trading partners to implement their own taxes; if their goods are going to be taxed anyway, they might as well be the ones to collect the tax revenue.

Now let’s consider a different example of how a carbon tax affects consumer behaviour. Let’s say you saw a great deal on a flight from London to New York for $225 one-way. By taking that flight you would be responsible for emitting about 1 tonne of CO­2. If a $75 per tonne carbon tax were applied to the aviation industry, your flight would rise to $300 (assuming the tax is fully passed on) — a 33% increase. After the tax, the price would seem less attractive, demand would reduce and airlines would cut flights and increase their focus on hybrid and electric aircraft.

While the above example relates to discretionary spending, carbon taxes also increase the cost of essential goods, such as electricity and fuel prices. For this reason, there is a raft of practical challenges associated with implementing carbon taxes.

Carbon tax challenges

The IMF estimates that a carbon tax of $75 per tonne would increase energy bills by 45% and petrol prices by 15%. Unless carefully managed, such a sharp increase would be overwhelmingly rejected by the public and possibly cause riots.

Governments are acutely aware of the public backlash that even a modest carbon tax could trigger. This prospect makes them reluctant to implement such measures.

For example, the Gilets Jaunes protest movement was triggered by a planned diesel fuel tax increase of 6.5 cents per litre. The increase was a relatively modest 4% of the total cost per litre based on today’s prices, although this was in the context of much larger increase in fuel prices over the preceding 12-month period.

It would be wrong though to jump to the conclusion that these protesters do not care about the environment. For example, 93% of French citizens support targets for the EU to become carbon neutral by 2050. Further, a communique issued by the Gilets Jaunes demanded a fairer climate change transition and made clear that they are not against carbon pricing in general.

Governments should not avoid carbon taxes altogether, but rather they should be cautious as to how they design and implement them. Carbon taxes must include compensatory measures, to reduce the disproportionate burden on poorer households. These measures could include reducing taxes on lower income bands or providing rebates to households for energy efficiency improvements.

The Australian experience — where did it all go wrong?

The Prime Minister of Australia is a position that comes with all of the perks that you might expect — a large salary, two fully-staffed residences in prime locations, a limousine and an official aircraft. If that weren’t enough, the position also comes with the dubious honour of being immortalised in bust form on Prime Ministers Avenue at the Ballarat Botanical Gardens in Victoria. Or at least that was that plan.

Australian politics has generally been fairly stable. Power has shifted every 10 years or so between the two big parties — the Liberals, who confusingly are actually conservatives, and Labor, who are liberals, but sometimes also act like conservatives. However, after an 11-year stint by Liberal Prime Minister John Howard, there was a volatile period, which saw the Prime Minister change 6 times over the next 11 years.

This unprecedented period of change caused such a strain on the Ballarat bust tradition that the bequeathed funding dried up and both the current and former Prime Minister remain absent from the park. And it is all linked to climate change, specifically the the quest to to put a price on carbon.

It all started when Kevin Rudd defeated long-standing Prime Minister John Howard in the 2007 election based on a platform of change. Rudd’s campaign promised action on climate change including ratifying the Kyoto Protocol and implementing an Emissions Trading Scheme (ETS). Midnight Oil’s Peter Garrett even won a seat and was made the Environment Minister.

Rudd commissioned a comprehensive review of climate change and worked to set a carbon price via an ETS, but ultimately he didn’t have the numbers in the Senate. After the bill was voted down, the opposition leader — Malcolm Turnbull — announced that he would support the measure, ensuring its success.

A vocal section of the Liberal party, however, was firmly against setting a carbon price and so they triggered a leadership challenge, which Tony Abbott — a self-professed climate sceptic — narrowly won. Abbott immediately withdrew support for the ETS and the bill was defeated a second time and subsequently shelved.

Meanwhile, public opinion of Rudd soured and the Labor Party had their own leadership spill. Rudd was replaced with Julia Gillard in 2010 prior to another election, which Gillard won narrowly by forming a minority government.

With a more favourable Senate position, Gillard was able to implement a simpler carbon tax, starting at AU$23 per tonne. However, there was a sustained lobbying campaign to undermine the tax, which successfully generated strong public opposition.

Rudd replaced Gillard again, but it was a lost cause, as Tony Abbott was swept to power in the 2013 election with the promise to ‘axe the tax’. The carbon tax was revoked on 1 July 2014, just two years after it started.

By 2015, Abbott was so universally disliked that the Liberals switched back to Turnbull who went on to win the 2015 election. However, Turnbull never quite managed to overcome resistance within his party to climate change action and was eventually replaced by Scott Morrison in 2018 — a man who once brought a lump of coal into parliament.

The 2019 election again focussed on climate change. Labor promised stronger action, Liberals ran a fear campaign on what that action would cost. The latter approach was ultimately more successful — particularly in coal-rich regional Queensland — and Morrison won with an increased majority. Perhaps the one consolation to climate-conscious voters was schadenfreude from hearing that Tony Abbot had lost his seat.

It shouldn’t have been like this. Australia has got a lot to lose from climate change, more than most. It faces more frequent and severe floods, heatwaves, droughts and bushfires and also faces the destruction of its national treasures like the Great Barrier Reef.

While the carbon tax design wasn’t perfect, it was effective and well-considered. In its second year, CO2 emissions reduced by 1.4%, which was the largest annual decrease in a decade. Emissions have steadily risen since the tax was abolished in 2014.

The initial design for an ETS was broadly based on recommendations from the comprehensive Garnaut Report and the subsequent carbon tax was a simplified design based on further advice from the Australian Productivity Commission.

The carbon tax included a number of the compensatory measures, such as lowering income taxes, direct offset payments for low-to-middle income households and exemptions for sensitive industries.

Labor’s fatal mistake, however, was underestimating the relative ease at which their opponents and lobby groups were able to influence public opinion. People soon forgot about the compensation they had received, but they were acutely aware of the increase in their energy bills. Meanwhile, they were subjected to a relentless fear campaign — the tax would bankrupt families, destroy jobs and kill the economy.

The very idea of a carbon tax is now so toxic in Australia that even the Greens Party don’t refer to it in their climate change policy. World leaders use Australia’s experience as a textbook example of what not to do.

Could global carbon taxes work in practice?

Fortunately, other regions’ attempts to introduce carbon pricing have fared better than Australia’s. The World Bank reports that 57 different carbon pricing initiatives have either been implemented or are scheduled for implementation. Some of these initiatives have been in force for over a decade. For example, British Columbia’s carbon tax was introduced in 2008 and is widely regarded as a success story.

Momentum seems to be building, which is encouraging, but there is clearly still a long way to go. Only Sweden and Switzerland have a carbon price higher than the IMF’s recommended minimum of $75 and their schemes have less than 40% coverage.

For carbon taxes to have any chance of success at the level required, they must have strong public support. Advocates of climate change action have an important role to play here — support needs to move to the next level of maturity.

It is not enough to demand that governments set ambitious emissions reductions targets, we must also challenge them on how they’ll achieve those targets. If carbon pricing is not a core element of their plans, we need to ask, why not?

If governments try to introduce (or increase) carbon taxes, we mustn’t baulk at the first hurdle. By all means question the fairness of the scheme design, but it would be hypocritical and counter-productive to reject carbon taxes entirely.

If we are genuinely committed to stopping climate change, we must be willing to pay our fair share to make it happen; we must be prepared to make sacrifices.

Or revisiting Midnight Oil’s Beds are Burning: ‘the time has come to say fair’s fair; to pay the rent, to pay our share.’