Suppose I’m planning to get a new fence put in.
How Does A Carbon Tax Work?
- A fence maker, anticipating new business, is planning to buy some rolled steel.
- A steel refinery, anticipating increased demand, is planning to run its furnace for a bit longer, releasing a ton of CO2 into the atmosphere.
- In a few decades, sadly, this extra CO2 causes some damage to our descendants through climate change.
This is a sad consequence of my decision to build a fence. Perhaps it could be made happier if something were done reduce CO2 emissions today. The next question is easy to ask, and much harder to answer :
Who should take responsibility to keep emissions down?
There are many people who could, and many ways we could.
- I could decide to build a different kind of fence, a lower fence, or do without a fence altogether.
- The fence maker could look for an eco-friendly steel substitute, or use thinner steel.
- The steel refinery could re-fit to burn gas instead of coal, or attempt to capture and store their emissions, or both.
- Even the descendant in the year 2060 could take responsibility, by accepting that my decision to buy the fence and cause the pollution was acceptable, so he should just bear the cost of climate change himself.
So there are many people who could take responsibility. There are even more ways to decide who should take responsibility.
- We could say that the wealthiest individual should bear the load, or the poorest.
- We could say that the emitter should mitigate, then argue about exactly who that is.
- We could argue that those who most want to help should help,
- We could say instead that the ones who least want to help should be forced to.
- We could even say, as many do, that we don’t care who pays, as long as it’s not us.
One halfway reasonable way of deciding is to say :
The responsibility for dealing with CO2 emissions should fall on the one for whom this costs the least.
This, at least, would ensure that the maximum amount of CO2 emissions reduction would be obtained at a minimum overall cost. It’s a good, pragmatic philosophy. It doesn’t try to attach blame.
For each person in the chain, there’s a cost involved if they try to reduce this 1 ton of emissions. Each one could analyse his or her options, and figure out the best course of action, should they decide to take any.
- Perhaps the steel refinery might decide that, instead of burning coal, they could pipe gas in from interstate. This would lower their emissions at a cost of, say, $100/ton.
- Perhaps the fence maker might realise that they can use slightly thinner steel. This reduces the quality of their fences, so they’ll lose some business. However, it will only cost them $10/ton of CO2 emissions.
- Perhaps I might decide that the best way to save CO2 is to build a brick wall instead of a steel fence. Suppose this costs me the equivalent of $50/ton of CO2.
- Perhaps none of us in 2011 do anything, so our descendant in CO2 suffers a broken window in a storm made slightly more severe by that extra ton of CO2. The bill to fix it, and the inconvenience, costs $800 in 2060 dollars, or $23 in 2011 dollars.
In this scenario, we would decide that the fence-maker should bear the cost. After all, it only costs him $10/ton. Anyone else would lose more.
There are a few problems here.
- First of all, only the fence-maker could really know how much it costs him to reduce CO2 emissions. After all, nobody else – not even other fence makers – knows the ins and outs of his business and clientele. Likewise, only the steel refinery can know how much it really would cost them to reduce their emissions, and only I know how much I prefer a tall steel fence to a short one or a brick wall.
- Another problem is that even the steel maker doesn’t really know his CO2 emissions. He is, however, an expert on the price of steel and the expected sale price of various types of finished fence.
- A final problem – the biggest of all - is that everyone in the chain has an incentive pass the buck. Why would the fence maker use thinner steel if they can persuade the steel refinery to pick up the climate change tab? Why should the steel refinery do anything if they can impose the cost of their emissions on my unborn grandchildren?
There’s no way known to mankind of solving these problems, except to put a price on Carbon. Whether in the form of a tax or an emissions trading scheme, a price on pollution stops people passing the buck, and helps them know if they are doing stuff worth polluting for.
Suppose, for example, the government imposes a tax of $23/ton of CO2 emissions.
- The refinery could pay the $23/ton of CO2, or pipe in gas. Piping gas in would cost more, so they pay the tax and raise their prices.
- The fence maker finds that steel costs more now. The price rise, though they may not realise it, is equal to $23 per ton of CO2 pollution produced. They do some calculations and find they are better off using thinner steel. They save $13, and a ton of CO2 pollution is eliminated by the party who can most afford to do it.
If it had cost everyone in the present day more that $23/ton to reduce CO2 emissions, then nobody would have. That still means the burden falls on the one most able to afford it – our progeny of 2060, for whom the broken window only costs the equivalent of $23 2011 dollars.
Ok, you might say, that works fine for just a few people. What about in a real economy, where there are millions of players, each responding in different ways to the prices of thousands of items? The answer is, the maths gets more complicated in ways, but ironically, easier to solve. Instead of worrying about individual fence makers, the averages smooth out individual passions and emotions, and make us all look like people making mostly sensible decisions about what’s worth spending money on. Then, over a whole economy, and in the medium to long term, the Carbon tax has the following effects.
- It makes the burden of climate change fall on whoever can most easily afford it.
- Each ton of CO2 reduction is accomplished as cheaply as possible.
- Each ton of CO2 emitted is emitted because it produced at least $23 of benefit to somebody. Therefore it outweighs the estimated cost imposed on future generations.
And that’s how a price on Carbon works.
