The Government has been asking people to submit ideas for what kind of carbon pricing we should put in place when we leave the European Union.

At the moment we are part of the European Union’s Emissions Trading System (EU ETS) and we also have our own carbon tax, the Carbon Price Floor (CPF), that comes into play when the fluctuating EU ETS price drops below £18 per tonne.

We could remain in the EU ETS after Brexit. You don’t have to be in the EU to be in the EU ETS. Non-EU members such as Norway and Switzerland are in it, but it is run by the EU so we would be subjecting ourselves to EU control of a Brexited UK were we to decide to remain part of it.

Brexit means Brexit

So this gets into the question of how you define Brexit. Does it mean leaving all EU institutions or is it just leaving the EU itself? According to the Government, if we leave the EU with no deal then that would result in us leaving the EU ETS.

There’s also the question of whether the EU ETS is worth remaining a part of. For most of its history its carbon price has been too low to have much effect. That’s why, in 2013, George Osborne introduced the Carbon Price Floor, and it’s that which has contributed to the demise of coal in this country, though unfortunately it hasn’t been increased the way it was supposed to when it was brought in. Had it done so, we would likely be closer to net zero than we currently are.

Carbon Dividends

One reason why the Chancellor a few years ago decided to freeze the Carbon Price Floor was the impact this would have on the JAMs (just about managings). Energy prices would rise and more people would be pushed into energy poverty.

A solution for that is to make the tax revenue neutral, paying the money collected back to citizens in the form of equal dividends. That way, the poorest among us, whose emissions are relatively low, will get back more in dividend than they pay out in tax. They’ll be better off, even after they’ve paid out their increased gas and electricity bills and everything else.

Another reason the CPF was frozen was down to the lobbying from high energy using industries such as the chemicals industry. Higher energy prices would make them less competitive in relation to those companies operating in regions with a lower carbon price or no carbon price at all. The solution to that is border adjustments, aka carbon tariffs, but tariffs are a tricky issue.

Producing zero-carbon steel could add 20% to total production costs, and producing zero-carbon cement might double cement prices. So any individual steel or cement company that committed to zero-carbon emissions, or was forced to do so by regulation or carbon pricing, could be driven out of business if its competitors did not face equivalent constraints.

Adair Turner

Carbon Tariffs

Could a Brexited UK operating under WTO rules impose carbon tariffs on imports, and rebate the carbon tax paid on exports?

President Macron and BusinessEurope, Europe’s largest business lobby group, have been considering EU carbon tariffs for a similar reason, though they view tariffs as a last resort, but that last resort has drawn closer since the US announced its withdrawal from the Paris Agreement. Part of their resistance to tariffs is fear of retaliation, though as a large trading block they have some clout. The UK trying to go it alone might be more vulnerable, particularly if we’re in a situation where we’re trying to secure trading deals around the world.

If the EU were to impose carbon tariffs at its borders, could a Brexited UK be part of that? Could we be considered within EU borders and thus benefit from its carbon tariffs, and what would the implications of that be? Would we have two pay the EU, or subject ourselves to EU regulations?

The International Monetary Fund and others have suggested carbon clubs, where trading partners agree to harmonise their carbon prices, meaning their businesses are competing on a level playing field. But that may sound too much like the club we’re leaving. Could we be part of a European carbon club whilst still outside the EU? That depends on how clean you want your Brexit to be.

WTO Rules

If the EU were to impose carbon tariffs, would they just apply them to the US or would that be regarded by the WTO as discriminatory? If they apply carbon tariffs would they have to be applied to all imports, including those from a Brexited UK?

Under the WTO agreements, countries cannot normally discriminate between their trading partners. Grant someone a special favour (such as a lower customs duty rate for one of their products) and you have to do the same for all other WTO members.

WTO

If those carbon tariffs take into account any local carbon taxes that have already been applied, then it would be in our interests to ensure our carbon price is at least as high as the EU’s in order to avoid their carbon tariffs, and if our carbon price is higher we might want to put similar carbon tariffs in place.

What about China?

The EU, understandably, is reticent about imposing tariffs as they’re seen as a hostile act, but you have people saying “what about China?” whenever some policy to tackle emissions is mentioned, suggesting what’s it matter what we do if others aren’t making a similar effort? These concerns need to be addressed. You can argue 1) the fact that others aren’t doing the right thing doesn’t mean that we shouldn’t, and 2) countries have differing responsibilities and the UK, as the country that started the whole fossil fuel burning craze in the first place and has gotten rich off pumping far more than its fair share of greenhouse gases into the atmosphere, has a very special responsibility. Whilst both of those points are valid, they’re not going to be enough for everyone. We know the world is not doing enough to cut its emissions, and the UK, whether it’s inside or outside the EU, is a powerful player whose actions can have a far greater global impact than most.

We could be world leaders in tackling climate change, and in some ways we have been: our climate change act, our carbon tax and now, our net zero commitment. Brexit gives us the opportunity of pushing forward as a leading nation without being held back by the climate laggards of Europe such as coal burning Poland, resistant to a higher carbon price (though Poland is now indicating they may support the EU’s net zero by 2050 goal). We could pull out of the EU ETS and raise our carbon price to the level necessary for us to hit net zero by 2050, we could give the revenue to the people and we could impose carbon tariffs at our borders that would encourage other countries to price carbon at a similar rate to us.

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The climate laggards can’t be allowed to play us for mugs. Increasing our carbon price is going to have an effect on business. We can’t bring it in straight away at the level it’ll need to rise to. Like the fuel tax escalator, it’ll need to rise year on year to give businesses time to adjust. If the carbon tax is low, most businesses will be able to absorb the costs without a significant impact on their competitiveness with foreign companies.

Both the dividend (or some other form of revenue neutrality) and carbon tariffs allow the carbon price to rise to the level it needs to be, and the level it needs to be to get emissions to decline at the required rate may not be as high as the social cost, that is where the price you’re putting on carbon is equal to the cost of the damage that burning it does, though the longer we leave it the sharper that decline will need to be.

What that social cost is depends on the discount rate you use, that is the rate at which the well-being of future generations matters less than our own well-being. Or, more bluntly, how much do we care about our children or our grandchildren? If the answer to that question is not that much, actually, then you will end up with a pretty low carbon tax, though still significantly higher than the one we currently have.

In a hostile WTO world, where we’ve already got tariffs being imposed on us by the EU, the idea that we’re just going to sit there and refuse to impose our own carbon tariffs may start to feel a bit naive. We’ve been protected by the EU but now we’re on our own out in the ocean and we’ve got to toughen up or we will sink. If they’re going to put tariffs on us, the gloves are off. A Brexited UK will have to confront this issue. We’ll have to put up our own tariffs, and carbon tariffs could be good for the UK and also good for the world.

Global political agreement on carbon pricing has proven to be elusive. A carbon tariff could unleash a sequence of independent national decisions that drive a beneficial “race to the top” in which roughly equal carbon prices spread around the world.

Adair Turner

The problem with the Paris Agreement is that it’s not binding. Countries say what they’re going to do but they’re not making equal commitments and there’s no penalty for the laggards. If the US voluntarily withdraws from this voluntary agreement as Trump has said they will, they have every right to do so, but should the rest of the world just to let them get away with that? A Brexited UK may need the US on our side more than ever, so could be far less keen on putting tariffs on the US than is the EU.

What is a citizen?

Another thing to consider in a fee and dividend Brexited UK scenario is what we’d regard as a citizen – who would be eligible to get the dividend? A British person living abroad wouldn’t be paying the carbon tax so it’s hard to justify giving them the dividend, and a foreign person living in the UK would be paying the carbon tax so it would be hard to justify not giving them the dividend. So the dividend would go to residents and could potentially be linked to the council tax register.

The idea of the dividend is a bit like the basic income idea, replacing means tested benefits with a flat rate payment to everyone. It has the advantage of being very clear and transparent, and when you look at our current system of taxes and benefits it’s almost as if it was designed not to be understood.

Policies have to be clear. They also have to have some reasoning behind them, and the reasoning behind carbon dividends is usually given as the need to protect the poorest from the effects of a rising carbon tax, but there is another reason for it, a more fundamental reason.

As we’re often told, climate change is our fault. We’re the ones turning on the lights, driving cars, cooking food. We’re the perpetrators, but we’re also the victims. People have died in France. Climate change is going to affect most of us, and more so the younger we are. In what sense is an 18-year-old responsible for climate change? They’ve only just reached adulthood. They were born at a time when the adults running the world new exactly what burning fossil fuels was doing to our planet and yet they did virtually nothing about it. That 18-year-old has been born into a world in which their atmosphere has already been polluted and they deserve some compensation. That’s what the dividend is. It’s society’s way of saying to that teen, sorry we fucked up your atmosphere.

The dividend is a radical idea though. It’s not something that’s been tried here. Every adult living in the country will be entitled to dividend payments, however rich they might be. That prompts some to question why we want to be handing out money to people who don’t need it, but the alternative is to bring in means testing, which is intrusive and bureaucratic. It’s so much easier to just give the dividend to everyone. The rich will most likely be paying out more in tax than they get back in dividend anyway.

You might want to give the money back in other ways, like tax reductions and benefits increases, though that’s going to be less fair (a 1% income tax cut will be worth more to a high earner then to a low owner) and much less transparent. Governments might prefer that kind of approach as it gives them more control.

Whether they go for a tax shift or a dividend, there is still the option of cutting corporation tax or giving certain tax breaks to businesses in the absence of carbon tariffs to help them remain competitive.

Whether we Brexit or not, fee and dividend is a good way of getting and maintaining public support for a robust price on carbon that’s going to do the job we need it to and help us get us to net zero within three decades. As that price increases, and if it goes significantly above the carbon price in force in other countries, then we will need to seriously consider carbon tariffs.

Climate change is global

The UK led the world in industrialising. We have been burning fossil fuels for longer than any other country. We therefore have a very special responsibility. We should not only be looking at policies that will get our own emissions down, but also at policies that will encourage others to do the same.

The suspicion many have that action to tackle climate change is a mug’s game since there will always be some free riders who fail to do their bit is not unfounded. Carbon tariffs ensure that our businesses aren’t harmed by our carbon price, and if we put in place carbon tariffs we may find that others do the same.

Consider trade with some hypothetical country that has no price on carbon and minimal environmental regulations. Their businesses will have lower costs than ours, but if we put a tariff on their imports, based on the embedded emissions of the products being imported, with those emissions priced at the same rate as we price our own, and we rebate the carbon tax to exporters using the same criteria, then we have a level playing field.

The leader of this hypothetical country might then think to himself, hey, if we had our own carbon price we could avoid those tariffs our companies are having to pay to the UK Government and keep that money in our own economy.

If they were to set a carbon price equal to ours then that’s exactly what would happen.

This is how you get a global carbon price. It’s not likely to be imposed from above. The UN doesn’t have that kind of power, and there would be a severe backlash if they tried something like that. Once carbon tariffs are a reality, economic self-interest will push countries to adopt their own carbon prices and to raise them to a level that allows their businesses to compete tariff-free.

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The mugs would now be those countries that fail to price carbon. Rather than carbon leakage, you’d see revenue leakage, where businesses in countries without a price on carbon would have pay tariffs to export to countries that do price carbon.

Someone needs to make the first move when it comes to carbon tariffs. It seems appropriate that it should be the country that made the first move when it comes to burning fossil fuels.

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