Fiscal climate policy

Carbon tax: The International Energy Agency is trying to put a price on global warming. In its new World Energy Outlook, the policy advisory group set out targets to reduce carbon emissions, and also calculated the carbon prices needed to achieve them. By focusing on price rather than quota systems, the IEA may help shift global warming policies towards market-friendly carbon taxes and away from distorting cap-and-trade systems. As well as being a market-friendly way to tackle climate change, taxes would also provide much-needed government revenues.

The IEA’s approach of setting a moderate long-term carbon emissions target and calculating what carbon price changes are needed to reach it seems sensible. Both the target of a 38 per cent reduction in emissions by 2030 — sufficient to reduce the risk of destructive climate change — and the price target of $50 a tonne of carbon emissions seem reasonable. For reference, carbon emissions permits currently trade in Europe at around $21 a tonne.

The price-oriented method adopted by the IEA focuses attention on market-led mechanisms to control emissions. The Waxman-Markey bill passed by the US House of Representatives in June demonstrates the dangers of the alternative government-led approach. It would set up a huge permitting bureaucracy, allowing politicians to reward favoured constituencies while achieving only minimal emissions reduction because of its exemptions and loopholes.

Policymakers around the world have mostly resisted carbon taxes in the past. However, most developed-world governments are now running unsustainable budget deficits. With drastic spending cuts politically difficult, that suggests taxes will soon have to rise. If that is going to happen anyway, a carbon tax is no more economically damaging than most other forms of tax, and probably less so than restrictive tariffs or punitive income tax rates.

A globally-agreed $50 a tonne carbon tax would raise $1.4 trillion annually, reducing global budget deficits by an average 3 per cent of GDP, a helpful offset to the current US deficit of 10 per cent of GDP, for example. Once instituted, it could be increased if global warming alarm escalated, or eliminated if it diminished. Carbon taxes could thereby kill two birds with one stone — and with precious little bureaucracy.