Pricing carbon emissions

We all know that the long-term survival of our civilisation, if not of our species, depends on sharply reducing our use of fossil fuels. The UK government has committed to reduce greenhouse gas emissions by 80% by 2050. The single most important tool must be to charge companies and individuals for their emissions of greenhouse gases (GHG) and this may be done by imposing a tax or by requiring permits (which have to be paid for). But what should the price be? And how should it be set?

Last summer Friends of the Earth ran a seminar to discuss the options. The 26 participants were drawn from a mixture of academic, consulting and campaigning backgrounds. Perhaps surprisingly, for an FoE event, the seminar did not come to a simple conclusion but did look at four approaches:

1. Social cost, ie the cost to society.
2. Marginal cost of abatement, ie the cost of reducing emissions.
3. Market cost
4. “Precaution and pragmatism”

None of these approaches produces a clearly correct result (estimates of the costs vary wildly) and each is open to several criticisms. In particular, in each case the number you get depends on the assumptions you make about both the physics of climate change and the policies that governments will follow over several decades. For instance, the more effective we suppose future policies to be:

• the lower the calculated social cost per ton and likely market price but,
• the greater, probably, will be the marginal cost of abatement.

In addition:

• The social cost depends on the values we assign to human life and convenience, ecosystem services and various kinds of damage to life and the environment.
• The current market price, e24/ton, is based on a badly flawed trading scheme and is absurdly low.

The meeting was unable to decide which approach would be best. I, however, am less cautious.

The reason for setting a price is to enable market mechanisms and organisations’ own decision-making processes to make the decisions that will reduce GHG emissions. We ought to accept the logic of this and set the price so that it produces, in the short-term, the change we need. If, for instance, we need to reduce emissions by 3% pa then we set a price that we expect to do this. If, after a year, we are wrong we adjust the price. We should also, obviously, not make or permit investments that encourage additional emissions.

This, in fact, is the “Precaution and pragmatism” approach. It has five important advantages:

1. If pursued seriously, it’s almost certain to produce the required reduction
2. It defines the issue as political and does not seek to hide political choices behind a technocratic smokescreen.
3. The accountability for setting the price is explicit
4. The accountable body, the government, is subject to democratic recall.
5. The link between goal and price is simple and explicit.

On this approach the key decision is just how fast to reduce GHG emissions. My own preference is for 4% pa – which would reduce emission levels by 35% by 2020 and by 80% by 2050. This isn’t very different from the budgets set by the UK Climate Change Committee.

There are, obviously, several disadvantages. First the carbon price may fluctuate wildly in the early years since we don’t really know how business and consumers will respond to price signals. Second, government has to review, and possibly revise, the price every year. This provides many opportunities for bad decisions, especially in difficult economic times.

Despite this “Precaution and pragmatism” is the best choice precisely because it is so straightforward.