The case for a globally harmonized, locally retained carbon tax

Matt Burgess

Many would like to see a new binding international agreement to reduce carbon emissions at the upcoming UN Climate Conference in Paris. Though there appears to be some political will for such an agreement, early cracks in the negotiations in Lima in December call to mind the limited success of past climate agreements. The widely hailed Kyoto Protocol, for example, was not ratified by the U.S. or China, together accounting for roughly a third of global emissions. Many countries (including Canada) that did ratify Kyoto have either failed to reach their targets or pulled out.

Why are these international agreements so hard to negotiate? One big reason is that negotiating binding international emissions reduction targets requires either: (a) getting all countries to agree on the same target (e.g. 20% reduction from 2015 to 2050), or (b) getting all countries to agree on different, individualized targets. Negotiating a single uniform target is challenging because all countries are different. China has in the past argued, for example, that holding developing countries to the same emissions targets as developed countries is not fair because developed countries were not subject to the same types of regulations during their development and industrialization periods. Negotiating individualized targets is challenging because, in effect, each country has to approve each other country’s target.

If both uniform and individualized emissions reduction targets are likely to be difficult or impossible to negotiate, what are the alternatives?

One elegant alternative, proposed recently by Harvard economist Martin Weitzman, is a globally harmonized, locally retained carbon tax. Under this proposal, all countries would enter into a binding agreement to levy identical minimum fees on carbon emissions within their borders; but each country would have autonomy over how the fee is levied domestically and what is done with the revenues.

Weitzman’s rationale for a globally harmonized, locally retained carbon tax is that it seems to have three properties he suggests are key:

1. It induces cost effectiveness. This means that it incentivizes people and firms to limit emissions in the most cost-effective ways possible. Specifically, if people have to pay a price, X, for each ton of carbon emitted, they will presumably choose to cut only the economic activities which produce less benefit per-ton carbon emitted than X.

2. It allows negotiations to be focused on a single, salient dimension. With each country choosing how to levy and spend the tax revenue internally, the level of the tax is the only dimension of negotiation, in contrast to the case of individualized emissions targets.

3. It corrects the economic inefficiency caused by the public nature of climate damages. Carbon emissions tend to be higher in a free market than would be economically efficient because the emissions negatively impact (via climate change) many people other than the emitters themselves. Thus, only a fraction of the damages (those felt directly by the emitters) are accounted for in emissions decisions. The purpose of a carbon tax is to force emitters to factor the value of the larger societal damages into their decision-making. However, when countries unilaterally implement carbon taxes, they can end up being too low for the same reason that pre-tax emissions are too high: A particular country may only have an incentive to consider its domestic climate change impacts, and not those in other countries, in choosing the tax level. In contrast, when a country knows it is negotiating a carbon tax that will be applied globally, Weitzman showed that countries will be willing to adopt a higher tax level because they factor in the benefits of other countries’ likely emissions reductions.

I would also note a fourth key property of a globally harmonized carbon tax: It has a clear, verifiable, and immediate kick-in point. One of the big problems Kyoto faced was procrastination. Countries agreed to emissions reduction targets with far-off deadlines, giving them lots of time to do nothing without facing consequences or losing face. It has been suggested, for example, that procrastination was one of the main reasons for Canada’s failure to meet its Kyoto targets, and ultimately its withdrawal from the agreement. In contrast, countries that agree to implement a carbon tax would presumably have to do so right away, losing face and possibly facing penalties otherwise.

In theory, both carbon taxes and emissions reductions targets (under a cap-and-trade system) can lead to economically efficient emissions reductions, which we badly need to limit the damaging effects of climate change. However, the salience and immediacy of a globally harmonized carbon tax are compelling advantages. With little time remaining before Paris 2015 and momentum appearing to slip, Weitzman’s proposal is worth seriously considering.

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