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What a carbon tax achieves

  • Published at 12:33 am September 23rd, 2018
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Correct in theory BIGSTOCK

We already have sufficient tax upon petrol and diesel

The World Bank tells us that Bangladesh can and should institute a carbon tax. The World Bank here is correct, although rather less than they themselves think. For a carbon tax obeys two of our most basic rules about taxation, whether or not we think that climate change is an issue to worry about or not. 

However, given that the government already taxes petrol and diesel, there’s not all that much room to tax it further, a small little problem with the idea.

The idea of a carbon tax is that it’s the solution to climate change. And properly instituted, it is. Our problem is that people make carbon emissions. If it were as simple as just banning people from doing that then we’d have no problem at all. However, it isn’t, because the things we do which produce emissions also produce other things that humans like -- transport, heat, cooling, cooking, food itself, all have emissions associated with their production. We’re thus in a rather more subtle position.

Our overall aim is to produce the greatest human utility we can. Within whatever constraints the physical world imposes upon us to have all humans gaining as much as they can get of what they want -- for us all to be as rich as possible. Rich, what people want, these are used in the economists’ wide meaning, community, self-worth, a baby’s smile, these are all things of worth and value.

This is where our climate change problem actually is. The things which produce emissions, and thus the change, also produce things people desire. But people aren’t paying for that damage they do to the environment as they gain or make the things they desire. The solution here is to tax them for the damage they do. 

No, not to then have money to spend on beating climate change, but simply to change the prices people pay for this, then, changes their behaviour. Such a “Pigou tax” as it’s called, means that people will now only do those things where what is gained from the activity is worth more than the damages done to the climate by that same activity.

We also know, from the Stern Review, what that amount is -- some Tk11 or Tk12 per litre of petrol, equating to some $80 per tonne of CO2.

So, good climate change work -- have a tax on petrol of Tk12 per litre.

This also accords with our two basic rules about taxation. The first being that we don’t want to -- even though we have to -- tax good things like incomes, profits, consumption. We would much prefer to be running the government only by taxing bad things -- crime, pollution, and so on. CO2 is pollution, we’re taxing that, great, that’s in accord.

The second is that we want to tax things with inelastic demand. A lightly difficult concept in detail but more generally, well, how much less do people do or buy that thing as a result of an increase in price. In the short to medium term, the demand for petrol (and diesel) doesn’t change very much with price -- it is, in the jargon, inelastic. This means we can tax it without too many people not using it, or using it a great deal less. 

That means we actually get some tax revenue. If something were the opposite, perfectly elastic, then we’d get no tax money as the price change would mean everyone stopped doing it. Of course, in the medium to long term, everything is elastic as people change habits, new technologies are invented, which is the very point of our taxing CO2 anyway.

The World Bank is right, therefore, that we’d like to have a carbon tax. It taxes something bad, pollution, and it taxes something inelastic, so we actually get some tax cash coming in. Over time, it also changes behaviour, so we’ll head off climate change itself.

The WB is also correct that we’d like the government to have some more tax revenue. At the moment, only some 10% of GDP arrives in the tax treasury, and that’s really not enough for the things that government really must do. 

It’s not true that we’ve got to get to 40% and 45% of GDP like Sweden or France, but we do need more than 10%. 15% to 20% is probably the minimum we can run a proper government upon. A carbon tax might raise 1% or so of GDP, which would be a useful step on that path.

Except, except, we have a problem here. The government already taxes petrol and diesel. Quite rightly too, we’ve got to pay for the roads and all that somehow. But this is a problem that near everyone misses when talking about such Pigou taxes upon pollution and carbon. 

There’s a correct level of such tax -- those damages being done. Climate change doesn’t mean that we should have an extra Tk12 tax on petrol, it means we should have Tk12 tax on petrol.

For example, in my native Britain, a proper carbon tax would mean a reduction in the taxation of petrol, for the government already taxes much more heavily than the 11 pence per litre, which would be the correct carbon tax. The climate change argument is for a certain level of tax, not for an extra level of it, for it works by changing prices.

Translating this into the Bangladeshi experience, we already have sufficient tax upon petrol and diesel to gain that correct market price, one adjusted for the costs of climate change. Thus, there isn’t much more money to be raised -- we’re already doing it.

Thus, the World Bank is entirely correct in theory -- carbon taxes are a good idea and all that. It’s just that in actual practice, in our situation, there’s not much use to it, for we’re already charging that sort of level of tax anyway.

Tim Worstall is a Senior Fellow at the Adam Smith Institute in London.