Is Carbon Tax is the Best Way to Solve the Problem of Carbon Emission?

Carbon exists in every fossil fuel and carbon is released in the form of carbon dioxide which is a greenhouse gas in the process of combustion1. Carbon dioxide, like the glass of the greenhouse, can not only let sunshine go through it but also prevent the heat absorbed by the ground from being lost. So carbon dioxide can cause the greenhouse effect and serious greenhouse effect can be regarded as a negative externality since it causes a negative effect on the third parties. Negative externality is a type of market failure which means a misallocation of resources by the market. And this negative externality caused by the carbon emission can be the largest market failure that the world is confronted with as there may be a conflict between the economic growth and people’s health. Therefore, a tax on carbon can be levied to reduce the effect of the over emission of carbon dioxide and therefore negative production externality.

The tax on carbon, different from the indirect tax levied on output which just tries to reduce the production to the social optimal quantity, creates incentives for the firms to switch to less polluting resources in order to increase the social optimal quantity of output. The fuels do not all release the same level of pollutants so the carbon tax is levied according to the amounts of carbon the fuels release and therefore more carbon emitted is corresponds to higher taxes. If the tax is imposed, the cost of the producers will increase, reducing the market quantity to the social optimum. Also, because there are other less polluting resources which emit less carbon, the high cost after taxation lets producers seek the lower-carbon-emission energy sources, which will hopefully result in a decrease in external cost and a higher social optimum quantity. So the carbon tax is aimed to increase marginal private cost to the new marginal social cost.

1. Effects of carbon tax

The aspects of the effects of carbon tax include reduction of carbon emission, economic growth, structure of energy consumption and distribution of income.

Since the emissions of carbon in developed countries are mostly luxury emissions while carbon emissions in developing countries belong to survival and development emissions, the imposition of carbon tax in developing countries may not reduce the carbon emission significantly. Therefore, whether carbon tax is effective depends on the nature of the country.

The carbon tax can also affect the economic growth. On the one hand, the large and extended tax will make the investors reduce investment, which decrease the economic growth. On the other hand, carbon tax can increase government revenue and the government will increase government spending, which can boost economic growth. Therefore, in the short run, carbon tax may affect the prices of products and have a negative effect on economic growth while in the long run, carbon tax may promote the new technologies and reduce the costs of pollution, which is good for the economy.

Carbon tax can also affect the structure of energy consumption. Since carbon tax increases the cost of production, the firms will reduce the output. Furthermore, the producers will have the incentive to develop the technology and improve the structure of energy consumption making consumers and producers less reliant on polluting energy sources.

Carbon tax has effects on the distribution of income. In order to increase the economic scale, the government will use the revenue getting from carbon tax as capital accumulation, which will increase the proportion of property income in national income and decrease the proportion of labour income in national income 2. So the carbon tax decreases the equity of distribution of income. Also, higher prices due to the carbon tax will have a larger impact on low-income consumers. All indirect taxes are regressive so if carbon taxes are imposed there will also be a tax incidence on consumers. And this may lead to a lower standard of living for low-income consumers. Therefore, if the carbon tax is imposed, the government should also improve the taxation system of property tax and income tax which can promote the equity of distribution of income to decrease the income gap between capital and labour resulting from imposition of carbon tax.

Also, there are two more disadvantages of carbon tax.

Carbon taxes are confronted with technical difficulties involving how to design the tax equal to the value of pollution. The government should consider which production methods produce pollutants as different contaminants are produced in different processes of production and the types of pollutants in different production methods should be identified. Also, the government has to find which pollutants are harmful and how harmful they are, which is even controversial among scientists and it is especially hard to attach a monetary value to the harm of pollutants.

The second is that there will be a risk that even if a large carbon tax is levied, some firms will still pollute the environment at a high level and they just pay the tax.

2. Examples of carbon tax

One of the examples of carbon tax is Sweden. In Sweden, the tax was imposed on fossil fuels and the range of tax did not include biofuels and peat. The tax rate increased from 25 euro per ton of carbon dioxide at first to about 120 euro per ton of carbon dioxide 3. The imposition of carbon tax was effective as greenhouse gas emissions in Sweden reduced by approximately 12% from 1990 to 2008 while the economy of Sweden grew by around 50% over the same period 4. Also, the tax improved the structure of energy source from fossil fuels to biofuels which are less polluting.

In Finland, the government set a low tax rate at first and then increased it gradually. In 1990, Finland imposed a carbon tax on all mineral materials, and the tax rate was 1.62 dollars/ton carbon. In 1993, the tax rate increased and expanded the range to include electricity. From 1995, Finland introduced a mixed tax on carbon and energy, the carbon tax rate was set according to the development of the economy. In 2003 the tax rate was 26.15 dollars and it was 30 dollars in 2008 5. The emissions of carbon dioxide in Finland decreased from 69.4 million tonnes to 44.4 million tonnes 6. However, research has shown that the imposition of carbon tax exerts a negative effect on the international competitiveness of the industries of Finland because the low tax preference. But long-term accumulation of carbon tax in Finland can offset part of the effects since it creates incentives of innovation of environmental technology 5.

Denmark is also one of the countries which imposed carbon tax at the earliest of time in the world. From 1980 to 2012, the total amount of energy consumption did not change significantly but the structure was improved since the industries in Denmark were less dependent on coal and oil. In 2014, the GDP of Denmark increased by 1.5 times compared with 1990 while the carbon dioxide emission decreased by 13.9% 7. So Denmark achieved the goal of less carbon emission and higher economic growth.

Another example is Australia. Carbon tax was introduced in Australia from July,2012 and the tax of greenhouse emission was 23 Australian dollars per ton. However, Australia abandoned this policy in 2014. One reason is that the carbon emissions in Australia just decreased by 0.2% until April,2013. Also, carbon tax affected the disposable income of households in Australia since the incidence of carbon tax is also on consumers 8.

3. The design of carbon tax

Considering the effects and examples of carbon tax mentioned above, the design of carbon tax should involve the following aspects.

Firstly, the tax should be levied on polluting firms but whether the tax should be levied on individuals has to be discussed as the vehicles of individuals also emit carbon and the increase of individual tax may affect the standard of living. Also, the tax should be imposed according to the different emissions of carbon.

Also, the government should consider the taxation preference system as the taxation preference system can reduce negative effect of the tax on the international competitiveness of the firms. For instance, the government can give taxation preference to the firms which reduce carbon emission through new technologies. The carbon tax, as a source of government revenue, should be utilised to invest in research and development to develop the new technologies and improve the structure of energy consumption.

Furthermore, the carbon tax should be imposed appropriately. Carbon tax is a flexible tool and it can be combined with the energy tax or tradable permits. And the government should also consider whether the carbon tax should be a main policy or it is just a supplementary policy to assist the implement of other policies.

Carbon tax should also be levied gradually. If the government can announce the relevant plan of carbon tax before it is introduced, the firms and consumers can change the pattern of energy consumption actively without paying tax. The tax rate should also increase gradually, which can give the firms and consumers time to change main source of energy and use the new technology. Also, there can be a tax exemption at first to give the firms, which are significantly affected by the tax, time to change the energy source and the tax preference should decrease gradually 9.4. Other ways to correct externality caused by pollution.

There are some other ways to correct the externality. One of them is government regulations. The government can either limit the pollution emission, or the output of the polluting firms and the government can also force the producers to install equipment that can reduce pollution 10. The direct regulations of government are very easy to implement. Also, regulations make polluting firms reduce pollution directly and effectively. However, regulations do not provide any incentives for firms to develop new technologies. Additionally, in practice, since environment protection is a public good with a high positive externality, some firms may conceal the information, saying they do not pollute the environment so much, to reduce their responsibility for the protection of environment. Also, the government cannot monitor the detailed information effectively. So the firms may still pollute the environment.

The other way is to introduce tradable permits. The government can issue the permits to the firms and the permits can be traded in a market, which means that if a firm emitting less pollution than the permitted level, the firm can sell the extra permits to other firms. Similar to taxes, this way creates incentives for firms that can reduce pollution at a lower cost to switch to less polluting equipment since if they do so, they will not have to buy the trade permits. Therefore, tradable permits can reduce the size of negative production externality. For instance, the EU have implemented the EU Emission Trading System. There is a cap set on the level of certain greenhouse gases by the installations in the system. The cap will be reduced gradually to make total greenhouse emissions decrease 11. It is effective as emissions in the EU decreased by 22% between 1990 and 2015 while the economy of EU grew by 50% over that time period 12. The tradable permits have an important advantage of the lowest total costs of controlling pollution. The firms which can reduce pollution at a lower cost will purchase equipment and sell the extra trade permits, while the firms which can only reduce pollution at a high cost will buy the tradable permits. So the transaction of the permits can make the total costs of the polluting firms to control pollution as low as possible. However, the introduction of tradable permits needs the information of the harm of each pollutant which is often not available since it is even controversial among scientists. So the trade permits have only been applicable for just a few pollutants such as CO2 and SO2 so far. Also, the distribution of permits issued to different firms should be fair and since there are different production processes and different pollutants in different polluting firms, it is hard to find a fair way.

Another way is the Coase theorem which is that as long as the property rights are well defined and the transaction cost is zero or very low, then no matter who gets the property rights, the ultimate result of the market will be efficient. What the government should do is to issue the property rights and protect them 13. So if the property rights are well defined, the market outcome will be negotiated reasonably. However, the conditions are very hard to satisfy.

5. Conclusion

Overall, aside from the carbon tax, there are three ways of correcting the negative externality caused by pollution and every method has advantages and disadvantages. Carbon tax is good for the sustainability of the economy but there are many difficulties and side effects. Government regulations are simple and direct but the total cost will be high; property rights can achieve efficiency just through the market but the conditions are hard to satisfy; tradable permits can correct externality at a lower cost but this method is faced with many technical difficulties. From my perspective, we cannot say which single policy would be the best including carbon tax. Since the market failure caused by pollution is the greatest market failure the world has ever seen, whether the country has to carry out the policy of carbon tax depends on the nature of the country and if the government determines to carry out carbon tax, the government should consider different aspects and possible effects of carbon tax. There may also be effective combinations of different policies such as a combination of carbon tax and government regulations. [[1]]

[1]Reference

[1]Carbon tax Wikipedia https://en.wikipedia.org/wiki/Carbon_tax

2Carbon tax

http://baike.baidu.com/link?url=FffUhtWa8iSzu0FBVYXzFWnYwrmDdvml7CwJOl98SRQP_vdak9BbHxaBZ9F6tEk_0KIXdKN-5zAlLe4IgsduvnPggIOrm8ttV72_HdZpw_m#4

3 Many Countries Have Begun to Impose Carbon Tax

http://news.xinhuanet.com/2013-08/25/c_125241160.htm

4The Swedish Example The Reduction in Greenhouse Gas Emissions

https://fores.se/wp-content/uploads/2013/04/Sweden_emissions_reduction.pdf

5 The Empirical Study of Effect of Carbon tax on International Competitiveness of Industries of Finland

ZHAO Yu-huan

6https://www.statista.com/statistics/535640/finland-greenhouse-gas-emissions-of-the-energy-sector/

7International Experience and Enlightenment Carbon Tax for China

http://www.doc88.com/p-9405290066943.html

8http://news.163.com/14/0723/20/A1S63AG900014SEH.html

9International Comparison and Enlightenment of Carbon Tax WANG Zeng-tao

http://www.docin.com/p-1715341472.html

10Economics Ellie Tragakes

11The EU Emissions Trading System (EU ETS) http://ec.europa.eu/clima/policies/ets_en

12Progress made in cutting emissions https://ec.europa.eu/clima/policies/strategies/progress_en

13Coase theorem http://baike.baidu.com/item/%E7%A7%91%E6%96%AF%E5%AE%9A%E7%90%86#17

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