The future with a serious carbon tax: Pt. 3

This article originally appeared on the Centre for Global Development blog. To see the original, please click here. Comments are welcome and should be sent to LawrenceMacDonald@gmail.com.

It’s 2030 and instead of racing toward the brink of climate catastrophe the world has begun to back away. Annual global emissions of heat-trapping gasses have fallen two-thirds—faster than anybody had dared to hope as recently as a dozen years ago—with continued steep reductions ahead. Although carbon dioxide (CO2) concentrations in the atmosphere breached 450 parts per million (ppm) last year—the level believed to offer a 50 percent chance of holding global warming below 2 degrees Centigrade this century—the rate of increase has slowed dramatically. Atmospheric CO2 was increasing by 3 ppm per year as recently as 2020; today the annual increase has fallen to just 1 ppm, and attention and investment are shifting from the need for steep emissions reductions—a global goal that has largely been attained—to large-scale, low-cost biological methods for extracting carbon from the atmosphere.

Strikingly, all of this has coincided with improved economic performance and continued reductions in global poverty—despite the absence of a binding international treaty. Although the emissions fees imposed in the United States, China, Europe, and elsewhere raised energy prices, they also sparked a technology and job-creation boom. Revenue from carbon pricing has made possible dramatic rollbacks in other taxes—especially taxes on employment and investment—giving economies a further boost. As a result, growth rates have remained robust in the big emerging market economies, making possible rapid reductions in extreme poverty and the emergence of a global middle class. In the United States and Europe, growth has accelerated from the sluggish rates that prevailed until 2018, when revenue-neutral national emissions fees were put in place as part of a grand bargain that included cuts in middle-class income tax rates.

A fantasy? Of course. But perhaps more plausible than the slim hope that UN negotiations will lead to an ambitious, binding international agreement. Read on to discover an alternative path to averting climate catastrophe. (Everything in this future history up to the publication date is real.)

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Washington and Oregon follow British Columbia’s lead

Before long, British Columbia’s success attracted attention south of the border, in the US states of Washington and Oregon, where the large share of voters in favor of climate action had ringside seats to watch the British Columbia experiment with carbon taxes to their north and California’s experiment with cap-and-trade to the south.

In October 2013 the premier of British Columbia, Christy Clark, and the governors of California (Edmund “Gerry” Brown Jr.), Oregon (John Kitzhaber), and Washington (Jay Inslee) signed a Pacific Coast Action Plan on Climate and Energy [30] that declared their intent to “lead on national and international policy on climate change” by, among other actions, “accounting for the costs of carbon pollution in each jurisdiction.” The document pledged that the four jurisdictions would seek to “harmonize 2050 targets for greenhouse gas reductions and develop mid-term targets needed to support long-term reduction goals.”

In the years that followed, a lively debate ensued in Washington and Oregon about which path to follow. California’s cap-and-trade system seemed to be off to a good start, and the idea that reductions in emissions could be obtained at lower cost and without politically difficult “tax” increases appealed to significant numbers of voters and politicians. In Washington state Governor Inslee, a former US congressman who had been an outspoken advocate for national cap-and-trade legislation, issued an executive order [31] in July 2014 establishing a Carbon Emissions Reduction Taskforce to provide recommendations on the design and implementation of a state-level ETS. Oregon, meanwhile, appeared to be leaning toward a carbon tax. [32]

It wasn’t long, however, before California’s cap-and-trade system began to lose its luster. As in the European Union (EU) ETS, it soon emerged that the cap had been set too high as the result of lobbying efforts from covered industries, so the price of emissions permits fell too low to incentivize emissions reductions. In California’s case, initial overallocation of permits was compounded when otherwise welcome technological breakthroughs in smart grids and utility-scale concentrating solar power reduced the demand for permits, knocking the bottom out of the permit market.

Worse for advocates of cap-and-trade, by 2016, as the US presidential election approached and voters in Washington and Oregon prepared to go to the polls to elect state officials, repeated scandals over false reporting and even corruption in monitoring, reporting, and verifying the actual emissions in California’s “covered entities” further tarnished the system’s reputation. Popular distrust of the cap-and-trade approach heightened a year later when SiliconTribune.comand ProPublica revealed in a joint investigative reporting project that ambitious efforts to link California’s cap-and-trade program to the emerging program in China had opened the way for California firms to buy unverifiable Chinese emission reductions certificates. [33]

For these and other reasons, both Washington and Oregon followed British Columbia’s lead and adopted revenue-neutral carbon taxes, while nonetheless leaving the door open for the future development of US and international certified emissions reduction credits (CERCs), which businesses could purchase as a means of offsetting their tax liability. [34] As in British Columbia, revenue was rebated through a combination of cuts in business taxes, personal tax breaks, and low-income tax credits. And, as in Canada, other subnational jurisdictions took notice when the US Pacific Northwest managed to combine increased economic growth and falling emissions with tax reductions.

The experiment was watched especially closely by the nine northeastern and mid-Atlantic states participating in the Regional Greenhouse Gas Initiative (RGGI), the first US market-based cap-and-trade program. RGGI had reduced the number of permits in 2013 in an effort to shore up the price after a sudden surge in natural gas supplies due to hydrologic fracturing (“fracking”) led to a steep drop in demand. At the spring 2014 auction, some 23.5 million permits sold for a clearing price of $4.00 per ton. [35] While the reduction in the number of permits was successful in maintaining a positive price, as with the EU ETS, few citizens understood the opaque and confusing system and there was little popular pressure to cut the number of permits further and thus push for a higher carbon price. At $4 per ton, the RGGI permit price was better than nothing but below even the initial price for the British Columbia, Washington, and Oregon revenue-neutral carbon tax schemes.

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State-level experiments and national legislation

In 2014 President Obama’s decision to use his powers under the Clean Air Act to move forward on climate despite congressional opposition accelerated state-level experiments with carbon taxes. In June that year the US Environmental Protection Agency (EPA) released long-awaited proposed rules to reduce CO ₂ emissions from existing fossil power plants. The EPA’s Clean Power Plan proposed requiring significant reductions in CO₂ emissions from the power sector, while also providing each state the flexibility to determine its preferred way to comply. [36]

Drawing on powers to regulate carbon and other greenhouse gases that the US Supreme Court had confirmed in a landmark 2007 case, [37] the EPA set state-specific goals and invited each state to develop policy approaches to meet the target. This state-by-state approach was familiar—it had been used repeatedly to successfully cut pollution under the Clean Air Act. [38]Significantly, the EPA approach left the door open to more comprehensive efforts, provided that they met the goals for reductions from existing power plants. The EPA also left room for groups of states to join together in common efforts. This unleashed a range of experiments with fee-and-rebate approaches, several of which were getting under way before the 2016 election. In 2018, RGGI shifted to a revenue-neutral carbon tax approach, joining the upper midwestern trio of Michigan, Wisconsin, and Minnesota and a southwestern regional grouping that included Arizona, Colorado, and New Mexico.

Meanwhile, a series of Deliberative Polls on climate change and carbon pricing had provided a further impetus to a nationwide, revenue-neutral carbon tax. Based on an ancient Athenian approach that combined random samples of citizens with opportunities for learning and small-group discussions, a modernized form of Deliberative Polling developed by political scientist James Fishkin at the Center for Deliberative Democracy [39] at Stanford University had proven successful in helping to drive policy change on complex, contentious issues. For example, a series of Deliberative Polls in Texas—a famously oil-and-gas-friendly state—had led to the implementation of renewable energy portfolio standards that resulted in a rapid expansion of wind power, bringing Texas from last to first among the 50 states in the amount of power from wind. [40]

Starting in 2015 the World Resources Institute, [41] working with partners including MacNeil/Lehrer Productions, [42] producer of the PBS NewsHour and other award-winning public affairs programs, organized a series of Deliberative Polls on policy responses to climate change, with a particular focus on revenue-neutral carbon taxes. One early poll, in the low-lying Tidewater region of southeastern Virginia, included information on the anticipated impacts of sea-level rise, a phenomenon that (unlike storms, heatwaves, and droughts) is indisputably caused by global warming. As participants in the two-day deliberation—a random sample of Tidewater residents that reflected the area’s diverse political mix—learned more about the issue and possible policy responses, opinions shifted strongly in favor of state and national policies to cut emissions by pricing carbon. Similar polls in other parts of the country, culminating in a national deliberative poll on climate change and emissions pricing in Washington, DC, early in 2016, produced similar results.

Climate advocates, including organizations such as the Citizens’ Climate Lobby, 350.org, the Sierra Club, and Greenpeace, used these poll results—particularly answers to questions about what factors led participants to change their opinions—to improve their messaging. Perhaps more important, political advisers to candidates for local, state, and national office also took notice, crafting policy positions that took into account the new evidence on what US citizens would think about climate change and carbon pricing when they were given an opportunity to learn about the issue and discuss it with others.

Information from the Deliberative Polls proved especially helpful to Republican politicians who were increasingly eager to escape from an anti-science, climate denial box. During the 2012 Republican primaries, only Jon Huntsman, [43] a former governor of Utah and one-time White House aide to President Ronald Reagan, dared to address the issue, tweeting, “To be clear. I believe in evolution and trust scientists on global warming. Call me crazy.” [44] The tweet put him in direct conflict with vocal elements in the conservative base and a newly minted presidential candidate, Texas governor Rick Perry, who days before had said that climate scientists “have manipulated data so that they will have dollars rolling into their projects.” [45]Huntsman failed to gain traction in the primaries, and the eventual nominee, Mitt Romney, sought to avoid the question while pouring cold water on proposals for action. [46]

By 2016 things had changed. The question was no longer whether candidates believed that human-caused climate change was real but rather what to do about it. The shift came about not only among moderate Republicans but more surprisingly among elements of the activist Republican base, notably evangelicals and libertarians, who frequently were at odds with the party’s pro-big-business moderates. All three groups included a growing number of people who were uncomfortable with the anti-science stance of climate skeptics and deniers, but who were strongly opposed to big-government regulatory solutions. Revenue-neutral carbon taxes gave them a way to accept climate science while arguing for a solution that was in line with their values and ideology.

Thus the 2016 national election became the first in which what to do about climate change was a significant issue addressed by all major candidates. Many proposals were floated, with Democrats predictably favoring a mix that included carbon pricing, strengthened regulations, government investment in renewables, and direct transfers to households while Republicans pushed for carbon pricing with various combinations of offsetting tax cuts. By 2018, just two years after the election, national legislation for a revenue-neutral carbon tax was well on the way to passage in both houses of Congress. [47] Much of the debate and attention shifted to complex questions involving the harmonization—and revenue sharing—of existing state programs and the national program slated for implementation in 2020.

The national legislation also left open the possibility, here following the lead of the Pacific Northwest, of a future CERCs program of up to 20 percent of the carbon tax liability. The provision was pushed by a coalition of antipoverty and environmental groups drawing on a legislative blueprint set out in a working group report from CGD. As we shall see, that provision proved to be a key element in providing finance for emissions reductions in the developing world, including so-called “cash-on-delivery” or “pay-for-performance” approaches to protecting the last remaining stands of tropical forests.

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In China, pollution and revenue needs drive action

As in the United States and everywhere else, in China politics was inevitably at the heart of decisions about how to respond to climate change. Compared with most other countries, however, in China even more of the politics took place behind closed doors. Less is therefore known about the process, though it seems clear that at least one of the key elements was a bureaucratic tug-of-war between competing ministries, with the powerful National Development and Reform Commission (NDRC) favoring cap-and-trade while the Ministry of Finance preferred carbon taxes. In addition, as in the United States, there was fierce resistance from wealthy, well-connected firms and individuals who had profited immensely from the coal-intensive status quo.

Several factors came together to accelerate China’s development of a hybrid system that combined carbon taxes and cap-and-trade. As in the United States, the primary drivers were domestic—in China’s case rising concern about the health and economic effects of extreme air pollution the need for a more sustainable source of government revenue top the list. An additional complexity in China, and a powerful driver for change, was the revenue needs of sub-national governmental units—provinces, major cities, and even sub-provincial jurisdictions. But China’s leadership also had an eye toward the country’s global reputation and a desire to gain leverage that would cause other major emitters, especially the United States, to accelerate their own efforts, because Chinese leaders recognized that the country’s huge population made it highly vulnerable to extreme weather events and rising sea levels driven by climate change.

China’s early efforts to reduce carbon emissions and the associated conventional pollution through traditional command-and-control techniques proved less than satisfactory at addressing the tension between the growth imperative and sustainability. For example, although the 10th Five-Year Plan (2001–2005) stressed the need for energy efficiency and set ambitious pollution reduction targets, few were achieved. In the 11th Five-Year Plan, targets to reduce energy intensity of the economy by 20 percent and to reduce sulfur emissions and other air pollution were made mandatory and attainment was linked to the promotion prospects of local officials. These tougher enforcement mechanisms achieved an economy-wide energy intensity reduction of more than 19 percent.

But in some places the targets were achieved at high costs. As the end of the plan period approached in 2010, local governments resorted to deliberate power outages to meet their targets for reduced energy intensity. Not only did that approach have substantial economic costs, it also ran counter to the intended purpose of the targets, as firms shifted to diesel to generate their own power. This in turn led to a diesel shortage and long lines of cars waiting at the gas stations with “sold out” signs in many cities.

In response to these experiences, Chinese officials began to assemble the policy building blocks for a more market-oriented approach. In November 2013 the central government released the much-anticipated communiqué of the Third Plenum of the 18th Central Committee of the Communist Party, the first policy blueprint unveiled by the new leadership under President Xi Jinping and Premier Li Keqiang. [48] Extending the market-oriented reform process begun by Deng Xiaoping in 1978, the communiqué changed the description of the role of market economy from “basic” to “decisive.” The communiqué also specifically addressed ecological concerns with a four-point agenda for an “ecological society”:

• establish a systematic and integral ecological societal system;
• improve the natural resource property rights system and usage management system;
• implement the compensated use of natural resources system; and
• reform the ecological and environmental protection and management system.

Although such commitments were compatible with any system for pricing carbon, the references to market pricing were clearly more in line with a cap-and-trade approach, already then being piloted in China, than with carbon taxes. Nonetheless, the policy framework was in place for some form of carbon pricing. This would prove important to the subsequent rise of carbon taxes in China and the eventual emergence of a hybrid system that included both carbon taxes and emissions trading.

Among Chinese technocrats debating the relative merits of the two approaches, the success of the British Columbia experiment and similar programs in Washington and Oregon and the problems with low permit prices encountered in the EU ETS, RGGI, and later in California likely played an important role. Europe had long been a leader in climate action policies and the EU ETS was the first and largest ETS in the world. But the initial distribution of emissions rights—given free to the largest polluters—resulted in an extensive oversupply of permits and a subsequent tumbling of permit prices. Efforts to reduce the number of permits, thereby raising the price and incentivizing investments in renewable energy, proved to be bureaucratically and politically cumbersome.

Before these lessons had become apparent, China had invested heavily in an ETS modeled largely on the EU ETS. In 2009, the State Council announced that China would reduce the intensity of CO₂ emissions per unit of GDP in 2020 by 40 to 45 percent compared with the level of 2005. In August 2010, the NDRC launched a low-carbon pilot, opening the way for the inclusion of an ETS in the national development strategy. In November 2010, the Chinese government announced its 12th Five-Year Plan, which highlighted the carbon intensity reduction target and encouraged the development of an ETS. At the UN Climate Summit in 2014, Vice Premier Zhang Gaoli told the world that China had implemented a national climate change program to ensure that the country would meet its target of cutting carbon intensity by 40 to 45 percent by 2020 from the 2005 levels. [49]

In 2011 the NDRC General Office had designated seven cities and provinces (Beijing, Chongqing, Shanghai, Tianjin, Guangdong, Hubei, and Shenzhen) for ETS pilots. By December that year the State Council had published the “12^th Five-Year Plan Work Program to Control GHG Emissions,” following which the seven pilot governments issued their own plans and each proceeded to put in place an ETS. By 2014 pilots were underway in all seven jurisdictions.

But the markets were not linked, and a careful assessment of their progress published in early 2014 that compared each with the EU ETS showed broad diversity in how they were being implemented. [50] Nonetheless, in August that year a senior climate official with the NDRC told a conference in Beijing that a proposal to launch a national cap-and-trade system in 2016 would be sent to the State Council for approval by the end of the year. [51] Speaking at a press conference in September 2014 following the release of a national plan on climate change, Xie Zhenhua, Vice chairman of NDRC, said China was considering extending the trading regime for the whole nation after the pilot stage [52]

In the years that followed, China’s ETS pilots and the fledgling national scheme encountered many of the same problems seen in Europe, the US Northeast, and California: excessive initial allocations, difficulty in sticking to auction plans in the face of industry pressure for free allocations, and cumbersome procedures for reducing the number of permits sufficiently quickly to keep prices high enough to incentivize innovation. In particular, with more government regulation and intervention than in the West, markets were even thinner, limiting the emissions reductions that could be achieved. Perhaps most important, as in other jurisdictions, China’s ETS failed to generate popular demand for higher carbon prices, leaving well-intentioned government officials vastly outgunned when faced with the lobbying of powerful firms and industrial federations. Perhaps inevitably, corruption came into play in the initial allocation of permits.

Against this background, the Ministry of Finance’s plea for carbon taxes to shore up China’s fiscal position and to provide meaningful incentives for reductions in carbon and health-harming conventional pollutants became increasingly persuasive—especially when combined with the examples of success in British Columbia and the US Pacific Northwest.

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Air pollution cleanup

Though the extreme air pollution that marred China’s early industrialization is now something that Chinese children learn about from their grandparents and in school, not so long ago it was a major social and even political problem. Growing public concern about the health effects and economic costs of air pollution was a major driver in the push to tax carbon pollution. Though carbon itself has no direct ill effects on health, most of the carbon emissions in China were the result of burning coal to generate power and heat, so pricing carbon proved to be a highly effective means of reducing so-called conventional pollution, mono-nitrogen oxides, sulfur dioxide, and particulate matter (PM), especially the superfine particle pollution PM2.5 that was a major threat to human health and was suppressing the productivity of Chinese agriculture.

As recently as 2007, the Chinese government had been unwilling to acknowledge the health costs of the heavy pollution burden. That year Chinese censors removed from a joint World Bank–Chinese report the fact that pollution caused an estimated 350,000 to 400,000 premature deaths per year. By 2014 things had changed, and it was possible for the country’s recently retired health minister to publish an article in The Lancet with co-authors from the Ministry of Environmental Protection putting the annual estimated death toll from air pollution at between 350,000 and half a million. [53]

Senior Chinese officials presumably knew already that even that heavy toll was likely an underestimate: the “Global Burden of Disease Study 2010,” also published in The Lancethad estimated that airborne particles smaller than 2.5 microns in diameter (PM2.5)—small enough to lodge deep in the lungs and enter the bloodstream, causing respiratory infections, asthma, lung cancer, and cerebrovascular disease—caused 1.2 million premature deaths in China in 2010 alone. [54] Another study published in the US journal Proceedings of the National Academy of Sciences found that 500 million people in northern China lost a staggering 5.5 years of life compared with people in southern China due to air pollution from coal. [55]

Public awareness of the problem was also on the rise, with feelings of resigned helplessness shifting to fear, anger, and societywide pressure to change the status quo. One study found that mentions of the term PM2.5 on China’s microblog site Sina Weibo surged from just 200 in January 2011 to more than 3 million per month in January 2013. [56] That year smog enveloped hundreds of millions of people with pollution levels up to 40 times higher than the World Health Organization deemed safe. Public anger was widely reported in the state-controlled media, and by mid-2015 there were 100 million mentions of PM2.5 per month on Sina Weibo.

Concern was also rising about the impact of pollution on food safety and even agricultural productivity. A 2013 study by China’s Ministry of Environmental Protection estimated that one-sixth of China’s arable land, nearly 50 million acres, was affected by soil pollution, primarily contamination by heavy metals, much of which was associated with coal mining and the disposal of coal ash. A 2013 study, Clearer Skies Over China, estimated that air pollution, primarily ozone generated through coal burning, had reduced the output of rice and wheat. [57]

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Revenue needs clinch the deal

Pollution concerns alone might not have been sufficient to overcome resistance to carbon pricing and, in particular, to high and rising taxes per ton of emissions. An additional and more urgent factor was China’s fiscal situation and the unmet needs of the central government and provincial and local governments for additional revenue. Taxing carbon emissions offered a major new revenue source that was easy to collect and had minimal impact on economic growth.

As in the United States, Chinese economists and planners had worried that taxing carbon emissions—and thus raising energy prices—would slow economic growth and hinder job creation. Two studies, one conducted by the Ministry of Finance and one by the Harvard China Project and Tsinghua University, found little basis for these concerns. Both studies reached similar conclusions, recommending that China begin with a modest carbon tax to increase substantially over time. These findings were to prove highly influential in the policy debate.

Check back tomorrow for part four of this five-part series.

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