Establishing the goal to stabilize the global temperature increase well below 2°C, the Paris Agreement was a major milestone for climate diplomacy in 2015. Three years later, the 24th Conference of the Parties to the UNFCCC (COP) in Katowice, Poland, has aimed to spell out rules how to put this goal into practice.
While scientist, politicians and policymakers were discussing in Katowice, the city of Paris became again the center of global attention. The plans of the French government to raise fuel prices due to increasing domestic carbon taxes have initiated massive protests by the “Yellow Vests” movement. Arguably, the protests are not solely motivated by higher fuel prices, but reflect deep structural issues in the French political system. The subtle signals from the protests in Paris towards governments around the world however were loudly and clearly heard in Katowice: Leave your hands off price instruments to tackle climate change! Yet, taking the economically most efficient measure to reduce carbon emissions off the table would likely put an end to the Paris Agreement’s climate targets.
Public protests following environmental taxation policies are not unique to France. In 2012, Nigeria has seen massive protests after cutting on subsidies on oil products. Indonesia made similar experiences. The list of failed attempts to reform is long. In a 2013 study, the International Monetary Fund lists 16 examples of at least partly unsuccessful reforms, often due to public opposition. They all seem to confirm a common notion that implementing environmental taxes, be it on transportation fuels or carbon, or removing subsidies, which has the same economic effect, would over-proportionally hurt the poor and hence increase inequality over time. However, this notion cannot be backed by science, which reveals a more complex picture.
Taxing carbon and compensate can help close the gap between rich and poor
Given the rich, but ambiguous literature on the topic, MCC has recently led two synthesizing studies. After systematically collecting data for a broad set of developing and emerging countries, we can show that in most low- and medium income countries carbon pricing would proportionally be more costly for the rich. That is, in most countries it could contribute to closing the gap between rich and poor.
The effect can mainly be explained by the way the poorer parts of the population use energy. In countries that are still relatively poor, proportionally to their income, (carbon-intensive) energy plays a smaller role in poor households’ consumption baskets. This changes with countries becoming richer and also poorer households spending more on energy. However, in those richer countries our second study finds that fuel taxation in particular is more likely to be progressive than other measures – i.e. it impacts the richer parts of the population more.
However, regardless of environmental taxes' relative distributional effects, even relatively small losses in absolute terms can harm poor households. For them, higher taxes could mean reducing consumption of basic goods and services, such as food, transport, health care, etc. Some, like those on the streets in France these days, perceive the (additional) tax burden as unacceptably high irrespective of whether it would reduce inequality in the long run.
This is where the recycling of the revenues generated by environmental and carbon taxes comes into play. Revenues can be transferred to households to buffer financial losses in a way that would convey substantial net benefits for poor households. Such a recycling scheme could even be front-loaded to yield tangible benefits for recipients before the tax burden kicks in. Some countries and other jurisdictions already use revenue recycling to increase support for carbon taxes. The Canadian province of British Columbia, for example, returns about 40 percent of carbon tax revenues to citizens by means of income tax cuts and transfers to particularly vulnerable households. In Switzerland each citizen received approximately USD 100 in 2018 as a revenue from the carbon levy on heating fuels. Revenues could also be invested in infrastructure. In many developing countries, for example, taxing carbon at levels that would be in line with the Paris climate targets would provide sufficient revenues to finance most of the (non-climate) Sustainable Development Goals, including universal access to electricity, clean water or decent health care.
Nothing would be as wrong and fatal than shying away from reform
The distributional implications of all of those measures are different from country to country and can – and should – be discussed by the respective societies, the media, and in parliaments. For their success, timing and communication of tax reforms matter a lot. This has been true for fossil fuel subsidies in the past. It can also be observed in the current debates. While in France increases of fuel prices more or less entered into force over night and on top of other tax reforms that were in particular harmful for the more rural and poorer parts of the population, a different way forward can currently be observed in Canada. Here, a national carbon tax of 30 Canadian dollars will be introduced in 2019, which will be increased in steps of 10 dollars per year until it reaches 50 dollars in 2022. To accompany this move, the Canadian government has been careful to clearly communicate how the revenues will be recycled and how much households will gain from it.
If governments are serious about protecting their citizens from catastrophic climate impacts, they should seriously investigate how to put carbon prices into practice. This will need to include the broad public, as well as the entire cabinet – including the finance ministers. Nothing would be as wrong and fatal than shying away from discussing and communicating those solutions that make climate policy work. Rather, a well-designed carbon tax could mitigate climate change and at the same time reduce inequality, a major challenge for social cohesion on par with the challenges posed by climate change. Adding some optimism, it could even bring back some confidence in the government’s capability to solve the big problems that – looking beyond Paris – so often seems to be lacking these days.