The Trouble with Carbon Pricing
Carbon pricing has dominated conversations around climate policy for decades, but it is ineffective. Only a bold approach that centers politics can meet the problem at its scale.
September 24, 2020
Sep 24, 2020
21 Min read time
Carbon pricing has dominated conversations around climate policy for decades, but it is ineffective. Only a bold approach that centers politics can meet the problem at its scale.
Over a decade ago, California put a price on carbon pollution. At first glance the policy appears to be a success: since it began in 2013, emissions have declined by more than 8 percent. Today the program manages 85 percent of the state’s carbon pollution: the widest coverage of any policy in the world. California’s effort has been lauded as the “best-designed” carbon pricing program in the world.
But while the policy looks good on paper, in practice it has proven weak. Since 2013 the annual supply of pollution permits has been consistently higher than overall pollution. As a result, the price to pollute is low, and likely to remain that way for another decade. This slack in the system has made the policy better at revenue collection than changing corporate behavior.
Carbon pricing provides an elegant response to a complex problem: increase the cost of releasing carbon into the atmosphere and let markets take care of the rest.
This is not a surprise. Though legislators aimed to tighten the law in 2017, oil and gas lobbyists thwarted their efforts. One powerful labor union initially supported ending free permits for big polluters, but reversed its position after Chevron offered it a union contract to retrofit refineries. The final legislation prohibited enacting new regulations on California’s fossil fuel industry—regulations that could have done more than the state’s weak carbon price. Even in one of the most progressive environmental jurisdictions in the world, California lawmakers failed to secure the necessary reforms for effective carbon pricing. Rather than carbon pricing, other regulations—clean electricity standards, clean car programs, and aggressive energy efficiency—deserve much of the credit for the state’s progress.
California is one of only twelve U.S. states to have adopted any carbon price—the idea has simply proven difficult to enact. When Oregon attempted to vote on a carbon pricing bill in 2019, Republican legislators fled the state and hid in Idaho to prevent the quorum necessary to pass the law. And this isn’t just happening in the United States—the policy is politically unpopular around the world. When Australia passed a modest carbon tax in 2011, things got ugly quickly: right-wing radio hosts hurled misogynistic invectives against Prime Minister Julia Gillard; angry protesters descended on the parliament building in Canberra; and climate-denying opposition leader Tony Abbott crisscrossed the country, accusing the government of “economic vandalism.” When he took office three years later, Abbott quickly repealed the policy. In France a proposed carbon tax fueled the country’s yellow vest movement, triggering the worst domestic riots since 1968. The proposal was soon abandoned.
Despite its political deficiencies, carbon pricing has dominated climate policy conversations for three decades. Part of its enduring appeal is that it provides an elegant response to a complex problem. Carbon pollution is everywhere. So, economists argue, increase the cost of releasing it into the atmosphere, and let markets take care of the rest.
This may be the optimal economic policy for reducing carbon pollution, but as the centerpiece of climate reforms, it has proven a political disaster. As political scientist Jessica Green argues, the policy has done “more harm than good.” It highlights the short-term costs of climate action, jacking up the public’s energy bills, while concealing the long-term benefits of addressing climate change—for the environment, public health, and the economy. This combination of clear, concentrated costs and opaque, diffuse benefits is politically toxic.
Facing coordinated opposition by powerful fossil fuel–aligned interest groups, governments struggle to set the carbon price high or wide enough. When reformers do win—as in California or Australia—they often are forced to compromise on a narrow policy with a low price that fails to cut emissions quickly or deeply enough. Worse still, these reforms may convince both politicians and citizens that the climate crisis has been addressed by giving a false sense that the “problem has been solved.”
These well-intentioned half measures also antagonize working people. Fossil fuel companies weaponize growing income inequality, targeting those suffering the most with messages to oppose carbon pricing, even while their corporate business model is left largely untouched. No wonder, then, that polluters increasingly lobby for this solution, often proposing to eliminate regulations in exchange for the carbon price. Beware of fossil fuel companies bearing gifts.
The polluters have understood the basics of climate science for more than fifty years. Rather than using their vast capital to innovate or deploy new technologies, they have funded multibillion-dollar climate denial campaigns since the late 1980s. Even today they continue to propose new fossil gas plants, refineries, and pipelines. Meanwhile climate change continues unabated. The fires that burned the West Coast this summer are a warning of what is to come. If this is what 1 degree Celsius of warming looks like, what will 2 or 3 degrees bring?
To quickly reduce carbon pollution, we must take a bolder approach that centers the politics of climate change. Our preferred solution can be distilled into three words: standards, investments, and justice. To begin, we must set the rules of the road for polluters through standards—timelines for when we must have clean electricity systems, cars, and buildings. We can back these targets and timetables with government investments in both deployment and innovation. Finally, it is essential that we hold polluters accountable and do not leave poor people and people of color behind.
While carbon pricing could play a role in setting standards, any politically viable carbon price won’t catalyze pollution reductions across numerous sectors at the necessary pace. Nor will it yield enough revenue to fund commitments such as Joe Biden’s promise to spend $500 billion a year on this problem. The window for incremental climate policy has closed. We need climate policy at the scale of the problem.
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As climate change research grew more prominent in the 1980s, economists described pollution as a “negative externality”— polluters kept the profits from selling fossil fuels while society at large picked up the tab for the harm they caused. If problems such as acid rain were “market failures,” then pricing forced polluters to “internalize” the costs. Anyone who released carbon pollution into the atmosphere would have to pay for the harm they caused. Policymakers have consistently pushed this idea at every level since the 1990s. And many economists remain attached to it: over 3,500 U.S. economists, including twenty-seven Nobel laureates, have signed a letter supporting carbon pricing.
The problem with carbon pricing is not the idea on paper—it is its application in practice.
The idea developed into two main forms: a carbon tax and cap and trade. Carbon taxes impose a price on every unit of carbon pollution released. Cap and trade—also called emissions trading—limits the quantity of carbon pollution that can be released, with polluters trading permits to cover their emissions. Both methods promise the same theoretical result: a reduction in pollution.
Like the roots of a tree branching out in search of water, a carbon price would find carbon wherever it was released. Goods made with fossil fuels would rise in cost. In response, people would make a million tiny decisions to get off carbon: buying the electric-powered lawn mower rather than the gas guzzler, jumping on a bicycle for the last mile rather than calling an Uber, switching to an induction stovetop and ditching the fossil gas. And it wouldn’t just be the public changing its ways; industries would also find places to cut back on carbon as their cost of doing business rose. Policymakers dreamed of sending these signals out across the economy to coordinate distant actors wherever the messages found them. The government could not possibly regulate all the myriad ways that carbon was emitted, but the power of the market could solve the problem—at least in theory.
The problem with carbon pricing is not the idea on paper—it is its application in practice. According to economists, an effective carbon price must be high enough to make polluters pay for the externalities they generate. It must also cover all economy-wide sources of carbon pollution.
Carbon prices now exist in 46 countries, covering about 22 percent of the carbon pollution that humans release each year. But these policies are riddled with loopholes. New Zealand’s cap-and-trade system exempts agriculture, even though agriculture is responsible for over half of the nation’s emissions. Mexico has a small carbon tax on fossil fuel production that excludes fossil gas completely. And in the United States, 11 out of 12 states with any carbon price only apply it to the power sector.
Big carbon polluters—fossil fuel companies, electric utilities, automakers, petrochemical companies, and other heavy industries—have used their structural power to receive policy exemptions, handcuffing the invisible hand of carbon pricing. The result is that carbon pricing passes in the places that already have little pollution. For example, all U.S. states with carbon pricing already had below average per capita energy-related carbon pollution in 2006, before these policies came into effect. Rather than reaching all parts of the economy, carbon prices across the world pick which industries have to pay for pollution and which get a free ride.
Even when prices do exist, they are quite low. According to the World Bank, countries need policies between $40 to $80 per tonne to meet the Paris Agreement targets. Yet half of the world’s carbon prices are less than $10 per tonne, while only five countries—Sweden, Norway, Liechtenstein, Switzerland and France—are in the target range. Even the prices in these countries are probably too low. Estimates for the social cost of carbon—a measure of the societal harm carbon pollution causes—range from a couple dozen to several hundred dollars per tonne of CO2. University of California San Diego climate scientist Kate Ricke and colleagues estimate this social cost could be a staggering $417 per tonne. No carbon price in the world comes close to that number.
Rather than reaching all parts of the economy, carbon prices across the world pick which industries have to pay for pollution and which get a free ride.
Nor are the handful of high carbon prices unambiguous successes. In Norway, which has one of the highest carbon prices in the world, emissions in the oil sector rose by 78 percent between 1990 and 2017. One reason emissions didn’t fall is because of a problem economists call “demand inelasticity”: if an economic activity is extremely profitable, or if there are no easy alternatives, people and companies may not demand less even as prices increase. Economists Geoffrey Heal and Wolfram Schlenker argue that high carbon taxes won’t effectively reduce pollution unless cheap substitute technologies are available.
The evidence is mixed, however, on whether carbon prices can drive innovation and provide more of these cheaper substitutes we need. In her study of the national U.S. cap-and-trade program for sulfur dioxide, Margaret Taylor found that innovation actually declined after the system went into effect. As Tobias Schmidt has shown, cap-and-trade systems tend to produce incremental improvements in polluting technologies rather than driving new, clean alternatives.
Other research suggests limited innovation. In their study of the EU’s carbon market, economists Raphael Calel and Antoine Dechezleprêtre estimate that patenting increased by 9 percent for regulated firms. However, given how few companies fell under the carbon price, overall low carbon technology patenting increased by less than 1 percent. Carbon price-induced patenting in the UK may have been considerably higher. Still, we lack strong evidence that carbon pricing has rapidly induced the innovation we need in new, cleaner technologies. By focusing on the low-hanging fruit—the “cheapest” ways to cut carbon pollution—we fail to build the ladder necessary to curb the more difficult emissions to reduce.
And that shouldn’t surprise us. Consider this scenario: if the United States managed to implement a $50 per tonne carbon price, gasoline prices would increase by $0.44 per gallon. That means Americans’ monthly driving costs would increase by about $25, enough to put a dent in many families’ budgets. Some people might drive a bit less; a few might set up a carpool. But corporations will not innovate new technology because of minor tweaks in the price of energy. The prices of oil already fluctuate greatly year to year, and that hasn’t exactly produced the climate technology we need. Fossil fuel companies spend next to nothing on clean energy innovation and deployment.
If it hasn’t driven the necessary innovation, perhaps carbon pricing has delivered emission cuts? That’s a tough question to answer, given pollution’s tight link to GDP. During the financial crisis, global carbon pollution levels declined by 1.4 percent between 2008 and 2009 before rebounding. This was not the result of government policy, but that of an economic downturn. We see a similar trend now during the COVID-19 pandemic. Global carbon pollution is estimated to fall by a record 4–7 percent in 2020 as a result of the economic slowdown. But these reductions will be temporary in the absence of ambitious climate reforms.
Evaluations of carbon pricing require models that make assumptions about the way the world would have unfolded if the policy hadn’t passed—what we call “business as usual” scenarios. One model suggests Norway’s carbon tax reduced carbon pollution by about 2 percent in its first decade. Similarly the EU cap-and-trade system likely reduced emissions by about 4 percent between 2008 and 2016. In British Columbia, Canada, the carbon tax may have been more successful: reducing emissions by 5–15 percent between 2008 and 2015. But these reductions, while laudable, are nothing compared to what needs to be done—we need annual cuts of almost 8 percent a year until 2030 to limit warming to 1.5 degrees Celsius.
Evidence suggests carbon pricing won’t drive emissions reductions quickly enough. It is like bringing a stick to a knife fight. The policy might help for a little while, but it’s unlikely to secure a victory without other weapons to attack the problem. Economists have tried to sharpen the stick, pushing for better policy design, higher prices, and broader coverage. But their efforts have largely failed. To understand why, we need to dig deeper into the politics of carbon pricing.
As a policy, carbon pricing has the politics backward. It starts by changing the incentives to pollute. Theoretically these incentives will undermine carbon polluters’ economic and political power. But this puts the cart before the horse: we need to disrupt the political power of carbon polluters before we can meaningfully reshape economic incentives.
Carbon pricing puts the cart before the horse: we need to disrupt the political power of carbon polluters before we can meaningfully reshape economic incentives.
The policy also makes it easy for fossil fuel companies to rally opposition. Presenting themselves as champions of the little guy, these companies highlight how the policy would increase gasoline and electricity costs for the public. Polluters have even helped school boards and local governments estimate impacts from a carbon tax on their budgets. It’s not difficult to draw attention to these costs when everywhere we drive, giant signs declare the price of gasoline. If that number rises, people notice. There are no roadside signs displaying the devastating costs of climate change: wildfires, stronger hurricanes, rising sea levels, and new infectious diseases like COVID-19.
What if we could make the benefits of carbon pricing more visible? This is the logic behind the price-and-dividend approach. Canada and Switzerland are the only two countries that have adopted this policy, though it is also part of proposed legislation in Congress. Like traditional cap and trade, this policy would cap emissions and require that companies buy pollution permits. Then U.S. residents with Social Security numbers would receive money back from the program, gathered from polluting firms. According to political scientist Theda Skocpol, a dividend would give the public a tangible benefit to organize around, thus contesting the power that entrenched polluters have over U.S. policymaking. Give the public a green check every month, the thinking goes, and it might just embrace climate policies.
This is especially true for low-income households. Recent models by economists Anders Fremstad and Mark Paul show that a U.S. carbon tax, without compensation, would impose the greatest burdens on low-income households. A dividend could be designed to disproportionately return revenues to poor households.
Carbon price and dividend gives greater attention to the politics of climate policy than earlier approaches, but it still struggles to make the benefits more salient than the costs. In the two countries with a price and dividend, the benefits are buried in income tax or health insurance forms. In our own research, we find these policies do not substantively increase public support for climate policy. This shouldn’t surprise us. Dividends are, at best, a band-aid solution to carbon pricing’s political woes. They create a debate over whether people want a check to cover their increased energy costs. Yes, some would rather have the check, but most would still prefer cheap energy.
Carbon pricing may cut pollution in economists’ models. But these models do not include a clear political pathway to turn their results into reality. The idea may be better suited for later stages in society’s decarbonization efforts, to help optimize carbon pollution reduction at the margins. But as a short-term political strategy, it’s deeply flawed.
We need to be thinking at least as hard about the politics of climate policy as we are about economic efficiency. Climate policy is a repeated game unfolding over decades. Any meaningful approach must build political allies as it weakens the fossil fuel industry. To cultivate the advocates necessary for more ambitious action, we need to grow our clean energy industries—and fast. If we want 100 percent clean electricity by 2035 in the United States, we need to deploy clean energy technologies around 4 times faster than we have in the past. This speed cannot be achieved through carbon pricing alone.
We cannot raise the cost of energy for millions of underpaid Americans—many of whom are Black and Indigenous—and expect the policy to stick. The objective should not be getting “the prices right,” but passing large-scale industrial policy that steers our society where we need to go.
Achieving this pace requires a different suite of policies, including a clean electricity standard, streamlined permitting, and government investments. Unlike carbon pricing, clean electricity standards already exist in most states and are driving progress, growing the political allies necessary to secure federal action. In late 2020 Google made the bold announcement that it would target 100 percent clean electricity by 2030, delivered 24 hours a day, 7 days a week to all its facilities. What might happen if this powerful company, which is also one of the top electricity consumers in the country, lobbied for a federal clean electricity law?
Progress also requires taking inequality seriously. We cannot raise the cost of energy for millions of underpaid Americans—many of whom are Black and indigenous—and expect the policy to stick. We need to know that when it comes time to impose stiffer costs on polluters, perhaps through a carbon tax, cheaper technologies will be available to ensure that everyone can afford to swap out their appliances. The policy goal should be to ensure that when any furnace, stove, car, or power plant comes to the end of its life, it is replaced by a low-carbon option. This will also make the transition cheaper, as we won’t reinvest in carbon polluting infrastructure that we need to discard early. We should be thinking: what policies will make the default choice the clean choice?
To make this happen, the government should spend trillions of dollars on clean energy in the coming decade. By investing in new clean energy projects, rather than imposing costs on existing assets through a carbon tax, economists Julie Rozenberg, Adrien Vogt-Schilb, and Stéphane Hallegatte suggest that the world can decarbonize without triggering a backlash through asset value destruction. In truth we may have to pay, rather than tax, to get rid of polluting assets, perhaps through loans that are conditional on deploying clean technology. Similarly, the government should make a clear plan for fossil fuel industry workers. We can’t allow this transition to hobble workers while fossil fuel executives deploy golden parachutes before declaring bankruptcy and laying everyone off.
The objective should not be getting “the prices right,” but passing large-scale industrial policy that steers our society where we need to go. The good news is that Biden has already committed to this approach. And these plans are surprisingly popular, even among Republicans. According to our research, at least three quarters of Republican voters in every congressional district support funding renewable energy research. The lesson here is that we can build successful political coalitions around climate policy when we give people something to fight for. If jobs and benefits are front and center, support for action will follow.
To get these policies passed, we’ll need our justice system to hold polluters accountable. The courts have become a key venue for challenging the fossil fuel industry’s social license to pollute with impunity. Modeled after the successful challenges to the tobacco industry, this approach has three prongs: first, using the Racketeer Influenced and Corrupt Organizations Act (RICO) to sue companies such as Exxon for climate denial and for misleading shareholders; second, public nuisance cases against fossil fuel companies and electric utilities; and third, strict regulatory enforcement.
We can build successful political coalitions around climate policy when we give people something to fight for. If jobs and benefits are front and center, support for action will follow.
Lawsuits are already underway in several states, with similar court cases playing out in countries across the globe, including from children plaintiffs arguing that governments are neglecting to protect them. These lawsuits are promising. Even if the climate advocates do not win every case, legal attacks can induce what Jacob Hacker and Paul Pierson call “strategic accommodation,” wherein policy opponents champion costly policies to forestall even worse outcomes. With the threat of never-ending legal battles on the table, fossil fuel corporations may finally be willing to negotiate a meaningful climate deal.
Credible legal threats could also pull the Republican party back from the brink of climate denial. Faced with the prospect of both a Green New Deal and legal attacks on big fossil fuel polluters, some Republicans have decided to wake up and throw their weight behind more “reasonable” approaches. Proposals, backed by the fossil fuel industry and some Republicans, have included trading a carbon tax for immunity from tort lawsuits or weakened regulations. Taking those trades would have been a terrible deal for climate activists, but the offer shows just how effective these court cases can be.
With strong regulatory enforcement, executive action also has a role to play. Under the Obama administration, the Clean Air Act was used to regulate carbon pollution from new and existing power plants. In the late 1990s, the Clinton administration filed almost two dozen lawsuits against utility companies, claiming they had made serious facility changes under the cover of routine maintenance without requesting appropriate EPA reviews. In most of these cases, utility companies settled with the government, agreeing to pay billions for in cleanup costs.
Carbon pricing ignores all of these strategies because it ignores political power. Economists argue that because all molecules of carbon pollution are identical, we should eliminate the easiest and cheapest pollution sources first. But it is more politically powerful to shut down a coal plant than it is to have everyone turn off their lights more often.
The time for incremental climate policy has passed. If the United States had adopted a carbon price in 1990, we would be in a very different world today. But fossil fuel companies and other big polluters resisted this approach. Instead of changing their business model, they spent billions funding climate denial and delaying government efforts to address the growing crisis.
The hour grows late and we find ourselves on the losing side of the battle. Carbon concentrations are now at a level unseen since humans first walked the earth. Fires have ripped across Australia and North America this year at unprecedented scales. We have run out of letters for the hurricanes this season. Some scientists believe the Greenland ice sheet has melted past the point of no return. Climate change is happening now. And it is scarier than we anticipated.
We cannot afford to wait another decade.
We must respond at the scale of this crisis—and this necessitates breaking fossil fuel companies’ stranglehold on our political system. Once we realize this, we can focus on the weapons we need in battle: new political allies—cultivated through large-scale industrial policy—and strategic lawsuits and regulations, to bring polluters to the table. Economists may have to kill their darling carbon price: beautiful on paper and woefully problematic in practice.
But this doesn’t mean that they must abandon their principles. As many economists argue, their models suggest that a clean electricity standard and a carbon price are similar from an economic perspective. Yet politically this is not true. Setting a clear target for clean energy centers the benefits of action. It says: we will make a market for good things. We will create jobs. We will make progress. A carbon price’s primary political message is: we will make you pay for doing bad things. And the amount of benefits it might provide is unclear to most people.
Economists and climate policymakers must ask themselves: is insistence on theoretical efficiency more important than delivering climate stability? This crisis demands pragmatism. We must make the benefits clear, through standards, investments, and justice that hold polluters accountable. If we are lucky enough to have a chance at federal climate action next year, let’s pass a law at the scale of the crisis and one that will stick. We cannot afford to wait another decade.
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September 24, 2020
21 Min read time