Why price carbon? A way to reduce the effects of human activities on the environment

There are few things almost all economists agree on, but a price on carbon is one of them. A reasonable solution to reduce the effects of human activities on the environment, many Nobel economists argue that the issue is still complex.

15 Jul 2020

A carbon tax, broadly, is a fee imposed on the burning of carbon-based fuels, including coal, oil and gas. The government sets a price emitters must pay for a certain amount of greenhouse gases they emit.

“We’ve got to have a structure for the economy that encourages ways to make money which are not harmful,” says Nobel Laureate and Senior Vice President of the World Bank Paul Romer. “If there is something bad, raise the price,” adds fellow Laureate Richard Thaler. “We should be taxing carbon.”

We’ve got to have a structure for the economy that encourages ways to make money which are not harmful.

Paul Romer

The problem is largely political, argues game theory expert Jean Tirole, “Pricing carbon is pretty simple as long as governments agree. Just imagine that for example you price carbon at 40 euros per ton in Europe which is very small, it’s actually smaller than it should be according to computations. Already with that 40 to 50 euros per ton of carbon, coal will disappear from Europe.”

Tirole believes that for a carbon tax to be effective, it requires a combination of education and compensation. People need to understand why a carbon tax is useful. “If you live 60 kilometers away from Toulouse, you take your car to get to work, you are not very rich, then a carbon tax is not very popular for good reasons.” Instead, he argues, a possible option is a carbon tax that “may be redeemed in a lump sum fashion to every citizen. The computation is that the poor people would actually gain from it.”

Cap and trade is another example of a way to tax carbon. Tirole explains it this way: “If we want to stay under 1.5 degrees Celsius warming, we can still emit that many tons of carbon. So if people or corporations or governments want to emit carbon because it’s too costly for them to reduce their emissions, then they have to buy those permits.”

“But we don’t do that because there is no political will,” he adds. “And that is very dangerous. We have a bigger responsibility toward our children and grandchildren, and we do a lot of greenwashing. We talk about the environment all the time, but we do very little.”

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We do a lot of greenwashing. We talk about the environment all the time, but we do very little.

Jean Tirole

American economist Paul Krugman agrees with Tirole. “The biggest challenge facing the world is environment,” says the New York Times columnist. “Why do we even talk about anything else? It’s not technically a hard problem to solve if we had the political will. The economics of controlling climate change are not trivial, but the problem is having a combination of denial and the problem of which country bears the burden. That dominates everything else.”

There’s resistance to multilateral cooperation on many levels, says Michael Spence. “If we don’t manage to get around to putting a price to carbon, then we can’t solve the problem for two reasons. One, we create an incentive to overuse fossil fuels and generate carbon dioxide, and the second thing is the new technologies that are clean are competitively disadvantaged because one output of the old technology, the fossil fuels, is not being priced probably, in this case negatively.”

There’s also the issue of the inherent mistrust between countries, argues Tirole. It’s always “my country first,” he says. While many leaders on the world stage claim to care about the long-term consequences of a warming planet, Tirole argues that the recent trend of populism has set many of those countries on a course opposed to a tax. “When the biggest countries in the world except Europe are run by populists who don’t want a carbon tax, it’s very difficult to create an international coalition.”

There is no possible change without geopolitical change. Bengt Holmström calls it the “free-rider problem.” In the context of a global carbon tax, it means that while a country may care about creating a cleaner environment, they don’t want to lay all of their cards (and commitments) on the table first. It’s similar to no one wanting to be the one to do all of the work in a group project.

Ultimately, though, that doesn’t matter, according to Tirole. “Whether I emit one ton of CO2, or someone in Indonesia emits one ton of CO2, it’s the same.” The harm to the environment is the same, no matter where that CO2 is produced.

No one is saying that a carbon tax is the end-all, be-all solution to the complex problem of global warming, says economist Michael Spence. “I don’t think anybody thinks that you can solve this problem by just putting a price on something, right? There are a lot of values that have to change, a lot of very microeconomic behavior that’s required. “

Fellow Nobel Laureate Paul Romer agrees, and argues that the core of the issue is the reluctance to take active steps to solve it. “All we have to do is create some incentives to solve the problem,” he says. And in the end, pricing carbon is just one great solution in a collection. You can price carbon and distribute energy and incentivize alternatives. Carbon pricing is not in a vacuum.

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