Richard Tol on a Global Carbon Tax

Richard Tol, one of the World’s leading economists on climate, has just had published The Structure of the Climate Debate, a paper that makes some very good comments on the gulf between optimal policy and the reality of ineffective policy backed by a great army of bureaucrats, rent-seeking politicians and environmentalists who exaggerate the issues. It is this optimal policy  – a global carbon tax to constrain warming to 2C – that I take issue with. Both economic theory and the empirical evidence contradict this.  The following is a comment posted at cliscep

Richard Tol states in his paper

Only a modest carbon tax is needed to keep atmospheric concentrations below a high target but the required tax rapidly increases with the stringency of the target. If concentrations are to be kept below 450 ppm CO2eq, the global carbon tax should reach some $210/tCO2 in 2020 or so (Tol 2013).

The 450 ppm CO2eq, would produce 2C of warming from pre-industrial levels if a doubling of CO2 on its own produces 3C of warming. The UNFCCC produced a graph for COP21 to illustrate the global emissions pathway needed to ensure 2C limit :-

Whereas even with the all the vague policy proposals fully implemented global emissions will be about 10% higher in 2030 than in 2010, the 2C pathway has emissions 10-30% lower. That means a carbon tax of $210/tCO2 (now £170) would have to turn around the global relentless rise in emissions and have them falling rapidly. I am deeply sceptical that such a global policy would achieve anything like the that difference would be achieved even with an omnipotent, omniscient, and omnipresent planner to impose the tax. The reasons for that scepticism can be found by applying the tax to real world examples.
First let us apply a £170/tCO2 carbon tax to petrol, which produces 2.30kg of CO2 per litre. With 20% VAT applied is equivalent to 47p a litre added to the retail price. (Current excise duties with VAT are equivalent to £300/tCO2, the diesel £250/tCO2). For a car doing 15000 miles at 39mpg, this would generate an additional cost to the owner of £820 per year. Maybe a 15-30% increase in the full costs of running a small car in the UK. There is plenty of empirical visence of the effect of the oil price movements in the last couple of decades (especially in the period 2004-2008 when the price increased) to show that costs increases will have a much smaller effect on demand, whereas for the carbon tax to be effective it would need to have a much greater impact than the percentage cost increase.
Second, let us apply a $210/tCO2 carbon tax to coal-fired power stations. They produce about 400kg of CO2 per megawatt, so the cost would rise by $84MWH. In China, coal-fired electricity will retail at less than $30 MwH. China would rapidly switch to nuclear power. Even so, its power generation emissions might not start falling for at least a decade. Alternatively it might switch to gas, where the carbon tax would be half that of coal.
However, there is another lesson from oil prices, this time over the last three years. A small fall in demand leads to large falls in price, in the short term. That is the market responds by offsetting the cost of the global carbon tax. To use terms of basic economics the demand for fossil fuels is highly inelastic with respect to changes in price, and the supply of fossil fuels in the short term is highly inelastic to changes in demand.  Emissions reductions policies have not just turned out to be pretty useless in practice, they are pretty useless in theory (with real world political constraints removed) as well.

Kevin Marshall

 

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2 Comments

  1. Roland

     /  31/10/2016

    Some clear thinking here. I’ve worked in public policy in Australia, and oil production in Canada. Your theory is in line with what I have observed. A carbon tax will easily be negated by changes in production levels. I believe more radical policy is needed. Accordingly the risks to us all from baboons authoring that policy is increased. Do you have any posts on policy suggestions?

    Reply
  1. Update on a Global Carbon Tax | ManicBeancounter

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