Carbon Pricing and the Potential of a Global Climate Club

I recently read a book, The Ends of the World by Peter Brannen, that talks quite a lot about carbon. The amount of carbon dioxide that was in the atmosphere millions of years ago, the burning of carbon based fuels, the potential of carbon free energy, the global economy of extracting carbon, and the amount of carbon dioxide that could be in the atmosphere decades from today. Brannen reports that humans today emit forty gigatons of carbon dioxide per year, which is likely the fastest rate of emissions within the last 300 million years of history. Brannen also warns that if humanity burns through all of its current fossil fuel reserves, the carbon emissions have the potential to warm the planet by as much as twelve degrees Celsius or more. According to many models, even just seven degrees Celsius of warming would make large swaths of the planet lethally hot to mammals. Given the severity of the situation and the immediate need to reduce carbon emissions, our global society must consider a portfolio of solutions, not just one, and should include carbon pricing. Carbon pricing gained traction in the newscycle this year when William Nordhaus received the 2018 Nobel Memorial Prize in Economic Science for, among other things, making the case that a global carbon tax uniformly imposed on all countries would be the most efficient remedy for the problems caused by greenhouse gas emissions. The United Nations has also been vocal about calling for aggressive climate change mitigation policies, including some sort of carbon pricing.

The basic idea of carbon pricing is that it incorporates the negative externalities of carbon emissions into the price of the good. The hope is that a higher price of carbon intensive goods will better reflect the cost of climate change as well as the opportunities for low-carbon energy. If emitting carbon becomes more expensive, that will provide a powerful market-based incentive for companies to invest in technologies and products that generate less of it. Carbon pricing can take many different forms with carbon taxes and cap-and-trade programs being the most popular. A carbon tax typically involves a government setting a price per metric ton of carbon dioxide emitted. A cap-and-trade approach involves creating a supply-and-demand marketplace by setting a cap on the total amount of carbon an industry is allowed to emit and distributing annual carbon emissions permits that decrease over time to companies. Companies that stay well under their emissions cap can sell their permits to other companies whose emissions exceed the cap. A third form of carbon pricing has also been used, involving a hybrid of carbon pricing and a cap-and-trade program. The hybrid approaches involve programs that limit carbon emissions and set a price floor or ceiling or programs that allow a cap-and-trade program for some sectors but apply a carbon tax on others.

According to a World Bank database, are currently fifty-three carbon pricing initiatives implemented or scheduled for implementation worldwide, covering eleven gigatons of carbon dioxide emissions, or 19.8 percent of global GHG emissions. A recent report from the Organization for Economic Cooperation and Development (OECD) found that in 2018, the average carbon price across forty-two major economies was around only eight dollars per ton, far too low to have a significant impact on curbing carbon emissions. The United Nations Special Report estimated that a carbon price of $135 to $5,500 per ton of carbon dioxide pollution by 2030 would be necessary to keep overall warming below 1.5 degrees Celsius, highlighting just how far away we are from a successful carbon tax. The gap between the current average price per ton of carbon dioxide and the real cost per ton of carbon dioxide is called the carbon pricing gap, and the OECD estimates that it is currently at 76.5 percent, and that at the current rate of decline, carbon prices will not meet the real cost until 2095. Carbon pricing has proven unpopular politically, with voters in Washington state rejecting a proposal that would introduce America’s first carbon tax in November 2018.

Given the challenges of implementation and the gravity of the situation, Nordhaus’ proposal of a global climate price program is worth considering. Nordhaus proposes getting a critical mass of countries to participate in a “global climate club” and to agree on an international carbon price. Once the countries agree on a carbon price, they are free to implement any combination of a carbon tax or cap-and-trade system, as long as they adhere to the agreed-upon carbon price. In order to encourage participation, non-participating countries would be punished through methods such as member countries imposing stiff tariffs on all goods imported from non-members. Some of the main problems that have plagued agreements such as the Paris Climate Agreement include lack of enforcement and not being strict enough. This agreement would hopefully be more effective by including punishment through tariffs as an enforcement mechanism. However, Nordhaus has recently suggested a $30 per ton carbon price which is still far below the $135 to $5,500 per ton carbon price that the UN estimated would be required to maintain 1.5 degrees Celsius of warming. The best solution to this would be to start at a $30 per ton carbon price, but then slowly increase it annually until the carbon gap closes. This should be one solution in a portfolio, not the only action the global community takes.

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