If the Price is Right: Taxing Carbon

Image Credit: Ralf Vetterle

Carbon taxes are extremely unpopular, why should governments bother implementing them?

What does a tonne of carbon cost? On the free market, emitting costs nothing. Treated as a commodity, the value of CO2 might be the price that Coca-Cola is willing to pay for it to make fizzy drinks. Yet releasing carbon does come at a cost - it’s just contentious deciding how to levy it.

The Cost of Carbon: Priceless or Pointless?

Estimating the economic damage caused by emitting greenhouse gases, the Social Cost of Carbon, is a messy science. The accounting spans the cost of resettling coastal communities, agricultural productivity loss, and disruption to hydropower resources due to drought. The calculation is further complicated by the nonlinear nature of climate change and disagreements over how to discount the future, relative to the present. Obama’s administration calculated this at $45 per tonne, before Trump’s first administration lowered it to about $3 per tonne, by ignoring climate damages outside of America’s borders. This was raised again in 2023 to $120-190 per tonne by the American EPA. For all the debate, the US has never achieved the political consensus to introduce a carbon price anyway.

Alternatively, carbon could be priced based on the cost of reducing the next cheapest tonne of emissions, known as the Marginal Cost of Abatement. If a power plant can spend €100 to avoid a tonne of CO2, the cost of abatement is €100 per tonne avoided. If a carbon tax is levied at €101 per tonne, it’s in the generator’s economic interest to make the switch.

Under this scheme, power plants and industry need permits to emit CO2, with the total allowance shrinking yearly to push prices higher and incentivize greener tech.

In reality, politics sets the price. 

In Ireland, the carbon tax is not just a Green Party policy, having the endorsement of Fianna Fáil, Fine Gael, the Social Democrats, and Labour. The 2018 Citizen’s Assembly on Climate Change saw 80% support for gradually increasing the carbon price from the original €15 per tonne of CO2 in 2009. This has risen to €63.50 and will reach €100 per tonne in 2030. This annual increase of €7.50 per tonne corresponds to 2 cent extra per litre of petrol. 

First-movers Finland, Sweden, and Denmark introduced carbon taxes in the 90s, but the EU stole the spotlight in 2005 with its cap-and-trade system. Under this scheme, power plants and industry need permits to emit CO2, with the total allowance shrinking yearly to push prices higher and incentivize greener tech. China followed suit, albeit with a softer touch, tying its emissions trading scheme (ETS) to carbon intensity rather than absolute caps. This approach may avoid pushing industries offshore — an issue the EU struggles to mitigate.

Undettered by Europe-wide backlash to sustainability measures in the agricultural sector, Denmark has broad political consensus to introduce a tax on methane and nitrous oxide emissions from livestock. This follows months of extensive discussion between political parties, farmers, the industry, trade unions and environmental groups. 

A Game-Changer? Market Breaker?

The carbon offset market has long been criticized for relying on hard-to-verify projects, such as tree planting and forest conservation, which often face issues like double-counting, permanence, and monitoring. Direct Air Capture (DAC) could shake up carbon markets with verifiable, permanent carbon removal. The higher the concentration of CO2, the easier it is to extract it. Since CO2 is present in the atmosphere on the scale of parts per million (0.042%), this is inherently difficult and energy intensive. The scientific wing of the European Commission estimated in 2011 that it would cost a prohibitive €440-€1000 per tonne of CO2. In 2018 this estimate was down to a potential €80-€200 per tonne. These costs don’t account for transporting and pumping CO2 underground or locking it away in concrete. If emitting a tonne of CO2 incurred a tax of €300, but offsetting privately with DAC was available for only €200, why pay the tax? DAC could create an effective price ceiling. This isn’t a concern in the medium-term. Leading startup Climeworks is still, however, charging $1000 per tonne for DAC and the technology is not on the precipice of scaling, anywhere. Point-source carbon capture, such as on power plants, can be achieved at lower costs because the concentration of CO2 in emissions is greater, having not yet mixed with the atmosphere. It is still pricey.

Governments that have vehemently opposed carbon taxes may find themselves reconsidering - if a carbon price must be paid, they might prefer that it be paid domestically than in Brussels.

Professor of Geosystems at the University of Oxford, Myles Allen believes that the fossil fuel industry could stomach the cost. Allen claimed that with the profits earned on gas in the UK in 2022, “[fossil fuel companies] could have captured every single molecule of CO2 that gas generated back out of the atmosphere and stuck it back under the North Sea - twice over”. 

In the meantime, without large-scale carbon removal, emitters face a choice: adopt cleaner tech or pay the price. A third option remains - relocate to a carbon tax haven. Only 23% of global emissions are subject to a price, according to the World Bank. To combat this, the EU is implementing a Carbon Border Adjustment Mechanism in 2026. The embodied carbon in imported goods will be subject to levies, unless they can prove that a price on carbon was paid in the origin country. Governments that have vehemently opposed carbon taxes may find themselves reconsidering - if a carbon price must be paid, they might prefer that it be paid domestically than in Brussels. The EU is dragging the world into carbon markets. 

Unlike industry, consumers struggle to respond to carbon taxes. Clean energy is capital intensive. Despite paying for themselves in the long-run, solar panels, heat pumps, and electric vehicles can set households back tens of thousands. This is unaffordable to many. How best to spend carbon tax revenues is a tricky question. After all, a successful carbon tax yields no revenue. Ireland has ringfenced carbon-tax funds for further measures to reduce emissions, such as funding home retrofits. Much of the revenue has not been spent this way, as recently reported by the Auditor General. Canada redistributes the funds as equal payments to all citizens, ensuring that heavy polluters pay more than they receive, while smaller emitters (the poorest in society) are net beneficiaries of the scheme. Although fair in principle, Justin Trudeau cannot testify to the long-term political dividends.