Episode 61: Carbon Pricing with Dr. Marc Hafstead (Resources for the Future)

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Episode Intro Notes

What We Will Cover

• What is carbon pricing?

• When did carbon pricing start and who came up with it?

• Where does carbon pricing exist today?

• What are the positives and negatives of carbon pricing and is there an alternative?

• How are the most effective carbon pricing systems structured?

• Who are the leading people and groups advocating for a price on carbon?

• Marc Hafstead, Resources for the Future

what is carbon pricing?

• The World Bank defines carbon pricing as an instrument that captures the external costs of greenhouse gas (GHG) emissions and ties those costs to their sources, usually in the form of a price on the carbon dioxide (CO2) emitted. The “external costs” from GHG emissions include damage to crops, health care costs from heat waves and droughts, and loss of property from flooding and sea level rise.

  • To put it simply, putting a price on carbon makes entities incorporate the cost of their impact on the climate.

• A price on carbon helps address the fact that climate impacts are often endured by people who were neither the producer nor the consumer of something that exacerbated climate change. Consider someone who lives on the coast impacted by rising sea levels from carbon emissions, many of which came from power plants that produced power in a location and for people far away from our hypothetical person on the coastline.

  • This issue of someone not involved in a transaction facing a negative impact from the transaction is referred to in economics as “negative externalities.”

• Ok, let’s stay with the basics and explore how carbon pricing works.

  • To set a price on carbon, the government must first determine what to charge per ton of greenhouse gas emissions.

    • This gets tricky as economists, scientists, and government officials must all agree on this cost and what assumptions to use.

    • For example, one study we found said that warming could be limited to two degrees if a carbon price of $30 per ton is set and rises to $107 per ton in 2050. In contrast, the U.N. recommended a carbon tax of between $135 and $5,500 per ton by 2030 to keep overall global warming below 1.5 degrees Celsius.

      • At this time, carbon prices currently in place aren’t set high enough to have a significant impact on climate change. A recent report from the Organization for Economic Cooperation and Development estimated that in 2018 the carbon pricing gap, which contrasts actual carbon prices and real climate costs, was 76.5%.

        • That gap is closing but not at a fast rate. With the current pace of decline in the carbon pricing gap, real costs won’t be met until 2095.

          • In efforts to close the carbon price gap, French Finance Minister Bruno Le Maire called for a global minimum price for carbon emissions in a July 2021 meeting of the G20.

  • There are also two main types of carbon pricing: emissions trading systems (also known as ETS) and carbon taxes

    • ETS introduces a cap-and-trade system, which caps the total level of greenhouse gas emissions.

      • The cap comes from the government issuing a limited number of permits called emissions allowances, each of which grants the holder the right to emit one ton of CO₂. So if the cap is 10,000 tons of carbon, there could be 10,000 one ton allowances made available and those that emit carbon would need an allowance for those carbon emissions.

      • In this system, there is certainty as to how much carbon will be emitted but not certainty on how much it costs. The market sets the price because once the permits are given out by auction or by allowance from the government, they typically can be traded, and the market determines what the ability to emit a ton of CO2 is worth.

    • The second type of carbon pricing is carbon taxes, which sets a fixed price that must be paid for every ton of CO2 emitted into the atmosphere. So in this approach, there is certainty on the price, but it’s unclear how much carbon emissions will occur.

when did carbon pricing start and who came up with it?

• Carbon pricing efforts are relatively new in the green movement, but have had quite the rocky road when it comes to passing legislation.

• The idea of needing a price on carbon can be traced back to 1920 when an economist named Arther Pigou (Pig-oo) introduced the idea of putting a price on negative externalities.

  • Remember negative externalities and our example of the person on the remote island experiencing sea level rise? If not, we get it, this is kind of a dense episode! But stick with us :) To refresh the memory, a negative externality occurs when an economic activity exerts a negative effect on a third party that was independent of the economic activity.

• Globally, Finland was the world’s first country to introduce a carbon tax in 1990. Since then, 16 countries have followed.

• The world’s first carbon cap and trade system was the European Union Emission Trading System (EU ETS), which was launched in 2005. Today, it’s the world’s largest carbon market.

• In the US, the first proposal for a price on carbon was in 1990 in the U.S. House of Representatives by Rep. Pete Stark, a liberal Democrat from California.

  • Since then, in the U.S. over 50 nationwide carbon pricing bills have been introduced and none have passed.

  • However, there has been success at the state level. Twelve states have active cap-and-trade programs and collectively they account for a third of the U.S. GDP.

    • 11 eastern states make up the Regional Greenhouse Gas Initiative (RGGI). 

    • California has its own cap-and-trade program and it is associated with the programs in the Canadian provinces of Quebec and Nova Scotia via the Western Climate Initiative, Inc.

    • And in the spring of 2021, Washington State enacted into law a “cap and invest” program that will use the revenue from the carbon credits to increase sustainable transportation and climate change resilience. 

  • Additionally, nearly half of the largest 500 companies in the world by market value already have an internal carbon price or intend to adopt one in the coming two years.

    • We link in the intro notes to a Yale University report on internal carbon pricing that has case studies on organizations that have an internal price on carbon including Yale University, Microsoft, and Delta Airlines.

    • Also, in our sustainable beer episode, internal pricing comes up in our original and updated conversations with Katie Wallace of New Belgium Brewing.

where does carbon pricing exist today?

• As of May 2021, there are 64 carbon pricing policies in operation, which represent 61 countries and 22% of global emissions.

  • Of all the world’s developed economies, only Australia and the U.S. have no form of nationwide carbon pricing in place. 

  • Alternatively, if you look at the 20 largest economies, the only other holdouts are India and a few Persian Gulf oil states.

what are the positives and negatives of carbon pricing and is there an alternative?

• While carbon pricing is a legitimate tool we can utilize to reduce our global emissions, we must address the positives and negatives of carbon pricing.

• Positives:

  • 1) Carbon pricing motivates companies to switch to clean energy by increasing the cost of carbon-based fuels.

  • 2) It is possible for the economy to grow while a price on carbon is in place. For example, Sweden has had a carbon tax since 1991. And one study that looked at the carbon tax through 2017, found that in those year its emission were reduced by 26% while its GDP grew by 78%.

  • 3) A price on carbon raises substantial revenue that can be used for a variety of purposes.

    • Those purposes include reimbursing government agencies administering the carbon pricing scheme, providing dividends to consumers to help with any price increases that may come from the carbon price (we’ll touch more on “cap-and-dividend” later), and funding research for innovations that can help in the fight against climate change.

    • We’re talking significant dough. The Congressional Budget Office estimated in 2011 that a carbon tax starting at $20 per ton and increasing to $34.40 per ton in 10 years would raise $1.2 trillion during its first decade. And these days we’re often talking about larger costs per ton.

• Negatives:

  • 1) To state the obvious, with a carbon pricing system, the utilization and reliance on carbon will still exist. And as the utilization of carbon continues, fossil fuel-fired power plants may continue to operate and emit air and water pollutants in neighborhoods already burdened by pollution.

  • 2) By making fossil fuels more expensive, it potentially imposes a harsher burden on those with low incomes. 

    • Potential price spikes on public transportation and consumer goods would have a disproportionate impact on low-income consumers.

  • 3) It can be difficult to measure how much carbon is produced, and therefore difficult to know what is the appropriate/effective price to set for carbon.

  • 4) It could shift manufacturing production to nations without a price on carbon. If that were to occur, not much would have been accomplished in the fight on carbon since a ton of carbon emitted has the same effect no matter where it is emitted on Earth.

    • One tool being used to address this is a carbon border adjustment tax. Carbon border adjustment taxes are taxes on imports and rebates on exports that account for variance in carbon pricing policies across different countries. It’s meant to protect domestic manufacturers facing higher costs from a price on carbon policy and ensure progress in the fight against climate change.

      • The EU is including a carbon border adjustment tax in its "Fit for 55," which is a massive package of 12 laws to help the EU reduce its carbon emissions by about 55% over the next decade.

      • Also, in July 2021, democrats in the U.S. Congress proposed a carbon border adjustment tax as a way to raise revenue in their $3.5 trillion budget plan.

• In terms of whether there is an alternative to cap-and-trade and carbon tax, there isn’t one that has garnered a lot of attention.

  • One alternative that was pushed in a 2020 journal article is something called “Sustainability Transition Policy” (STP). The authors argue that carbon pricing has five major issues, including (1) it places particular weight on efficiency as opposed to effectiveness, and (2) it tends to stimulate the optimization of existing systems rather than transformation. In short, STP argues for a “policy mix that promotes innovation and decline [of carbon emissions], accounts for political dynamics, varies between sectors and over time, and aims at profound system change.”

how are the most effective carbon pricing systems structured?

• Different governmental officials, economists, and scientists all may disagree on what constitutes an “effective” carbon pricing system.

  • An economist may argue that a carbon pricing policy that reduces the overall financial burden on everyday citizens is most efficient.

  • And on the other hand, a scientist may push for a carbon pricing policy that results in the biggest reduction in emissions.

• When designing an effective carbon pricing system, there are three different design factors that Resources for the Future has highlighted that can influence the overall effectiveness of introducing a carbon pricing policy. These include policy stringency, coverage, and revenue use.

  • Policy stringency dictates how a carbon tax or emissions cap will change over time. For example, higher taxes (or lower emissions caps) will result in more substantial emissions reductions but will increase the overall cost. 

  • Coverage controls which sectors must follow the carbon pricing system and which emission types are covered by the carbon price. 

  • Revenue use that is strategic can make carbon pricing policies more progressive, minimizing negative impacts on low-income households—or even benefiting them by redistributing the revenue in areas of need.

• Let’s apply these three design factors to the forthcoming Washington state “cap and invest” program we mentioned earlier.

  • Policy stringency. 

    • The law has emission targets for 2030 (50 million metric tons), 2040 (27 million metric tons), and 2050 (5 million metric tons).

  • Coverage

    • Washington’s bill covers the state’s 100 largest emitters, which is about 75 percent of the state’s total greenhouse gas emissions. It omits certain so-called “nonpoint sources,” like those from agriculture.

  • Revenue use.

    • The bill is forecast to raise at least $460 million in the fiscal year that starts July 1, 2023, and at least $580 million annually by 2040. The money would be invested in a broad range of activities that include restoration of marine and fresh waters, forest health, renewable energy and public transportation.

      • The bill stipulates that at least 35 percent of the program’s investments be made in vulnerable communities, with an additional 10 percent for tribal lands. It also incorporates input from an environmental justice council.

who are the leading groups and people advocating for a price on carbon?

• The Carbon Pricing Leadership Coalition brings together leaders from government, private sector, academia, and civil society to expand the use of carbon pricing policies.

  • The CPLC Secretariat (i.e., its administrative leadership) comes from The World Bank.

  • In 2021, it released its fifth Carbon Pricing Leadership Report. It highlights examples of leadership in the field of carbon pricing in 2020 and 2021. The intention is to inspire governments, business leaders, and other relevant stakeholders from around the world to use carbon pricing as a tool for effective climate action in support of sustainable development.

• The Climate Leadership Council (CLC) was founded by Tad Holsted. He joined forces with former Secretaries of State James Baker and George Schultz to publish in 2017 the Conservative Case for Climate Dividends. The CLC is focused on continuing the momentum toward a solution where there is a gradually rising carbon fee, a carbon dividend for all Americans, simple regulations, and a border adjustment tax.

  • Recent research by Marc Hafstead (who we are interviewing in this episode!) projects that a carbon pricing plan from the CLC would reduce US energy-related carbon emissions by more than 50% by 2035, relative to 2005 levels.

• Since 2009, Citizens Climate Lobby (CCL) has been advocating for the policy “Carbon Fee and Dividend.” One such bill that would establish a carbon fee and dividend that it supports is the Energy Innovation and Carbon Dividend Act (EICDA).

  • According to CCL’s website tracking support for the EICDA, there are 1,193 companies, 150 local governments, 298 nonprofits, and 1 Don Cheadle supporting the EICDA.

about our expert guest

• Our interviewee, Marc Hafstead, is certainly one of the leading people on carbon pricing. He is a Fellow at Resources for the Future (RFF) and Director of their Carbon Pricing Initiative. 

  • RFF is a non-profit, independent research institution in Washington, DC that seeks to improve environmental, energy, and natural resource decisions through impartial economic research and policy engagement.

• With Stanford Professor and RFF University Fellow Lawrence H. Goulder, he wrote Confronting the Climate Challenge: US Policy Options to evaluate the environmental and economic impacts of carbon taxes, cap-and-trade programs, clean energy standards, and gasoline taxes.

• His research also analyzes the distributional and employment impacts of carbon pricing.