Why Developed Countries Should Lead the Carbon Tax

By Bonnie Liu

This week, climate change is enjoying renewed and deserved attention. Following the release of an alarming UN report on global warming’s dire genocidal effects as well as the announcement of William Nordhaus as the recipient of the Nobel Prize for Economics for his research and advocacy for carbon pricing, the necessity of carbon taxes is catapulted to the forefront of debate.

Excessive carbon emissions persist due to market distortions: business moguls brazenly discharge waste with impunity, while ecosystems suffer the worst repercussions, and impoverished groups are ill-equipped to cope with weather and health hazards. Government intervention becomes indispensable to ensuring socially optimal outcomes: Pigovian carbon taxes can curtail emissions by correcting distortions and forcing polluting agents to internalize negative externalities. Its imminent necessity cannot be further underscored.

At first sight, the optimal strategy is a simultaneous, universal carbon tax. However, this possibility rapidly becomes illusory as UN Climate Change Conferences rarely come to fruition: The debacle of the Kyoto Protocol due to U.S. withdrawal is succeeded by the failure of unanimous passage of the Copenhagen Accord, testifying to the difficulty of achieving international compromise or consensus. While universal imposition of carbon tax is the ultimate goal, developed countries must lead the implementation, as the stakes of waiting are simply too high.

A mindset adjustment is paramount for developed countries. Instead of angelic altruism, carbon tax is a logical prerequisite for self-interested preservation. Pollution and preservation embody rivalrous intertemporal choices: the more pollution that occurs today, the less the environment can tolerate tomorrow, and the more severe the consequences. Solving climate change with carbon taxes parallels getting healthy by exercising: Referring to other countries’ inaction as a pretext for delaying taxation is as ludicrous as pointing to your neighbor and shrugging, “Because working out is exhausting, you’re happier from not exercising, and so I shouldn’t exercise either.” In both scenarios, long run benefits far outweigh immediate discomfort. Instead of impeding development, levying carbon taxes is performing a favor for the future self.

Although existing literature details the benefits of a carbon tax, persistent dissent impedes progress. Clouded with myopic agendas, some people fear that taxation will contribute to decline of manufacturing in an increasingly service-oriented economy. In reality, it incentivizes manufacturing sectors to innovate energy-efficient technology and upgrade production, which increases intellectual capital and global competitiveness. As Paul Romer’s endogenous growth model suggests, human intellect and technological prowess can be harnessed to drive economic growth within resource constraints. Moreover, as long as profits exist, the market will naturally self-establish equilibrium, even after a hypothetical mass exodus of manufacturers. Additionally, since revenue flow is purely internal-- taxation merely transfers value from corporations to government/people-- countries need not fear an outflow of wealth.

Critics argue that environmental protection resembles a free rider problem. Since climate change is a global phenomenon (or, a nonrivalrous, nonexcludable public “bad”) and effects of pollution exceed national boundaries, all nations suffer the same repercussions regardless of whether they tax carbon emissions or not. Critics fear that non-taxation countries will take advantage of their responsible counterparts, and reap the nonexcludable environmental benefits while enjoying cheap energy. While palatable in theory, this argument fails to recognize that local damages materialize faster than global ones, and that internalities inflict more acute pain than externalities, which incentivizes countries to act responsibly. Cheap energy entails sacrifice: Since carbon emission is often coupled with release of hazardous pollutants, a major repercussion is health hazards. China serves as a prominent example where dire domestic damages occur almost immediately: CO2-enhances biogenic feedbacks and increased concentration of breathable contaminant, PM2.5, to 300 micrograms/cubic meter, far exceeding World Health Organization’s recommendation of 10. Consequently, lung cancer incidence is alarmingly on the rise with 700,000 diagnoses and 600,000 deaths in 2015. Forced by reality to compensate for past inaction, the government has expended exorbitant sums on health care and reforming industries. London’s 1952 fatal acid rain and Los Angeles’s 1950s smog also demonstrate harrowing local harms. To avoid perishing and spending more later to turn the tide, countries must be self-responsible and impose carbon tax.

Opponents fear that carbon taxes will pressure firms to outsource manufacturing and depress employment. In addition to committing the lump of labor fallacy (assuming there is fixed amount of employment), they also falsely assume the existence of “carbon emission havens” by underestimating the difficulty of outsourcing production. They analogize production offshoring to typical base erosion and profit shifting tax evasion, even though the former is more complicated. Typical tax havens like Cayman Islands are likely able and willing to accommodate infinitely many companies, because registered companies pay annual licensing fees, consume minimal local resources, and impose little to no externality. To the contrary, since pollution-heavy factories incur negative externalities, a rational government would never desire to saturate itself with foreign CO2-emitting factories. Thus, “carbon tax havens” will not degrade into “carbon emission havens.” As governments of emerging economies begin to emphasize sustainable growth, the adoption of environmental protection policies will discourage emission relocations and prevent races to the bottom. Since “emission havens” do not exist in reality, the misplaced concern of losing businesses need not hinder carbon taxes.

To eventually strive for global implementation, Nordhaus envisages the global climate club. Under this proposal, a critical mass of countries participate by agreeing to meet an international target carbon price (for instance, 25 dollars or 30 dollars per ton of CO2) and to punish non-compliant countries by imposing carbon tariffs on exported goods. If the cost of refusing membership is sufficiently high, most nations would adopt carbon regulation.

Nordhaus’ proposal provokes debate on inequality; notably, the global tide of carbon curtailment disadvantages developing and underdeveloped countries in two ways. First, subjecting developing countries to the same standards as their wealthier counterparts deprives them of the “opportunity to pollute.” While more established Western countries like the U.S. and UK enjoyed headstarts on economic prosperity stimulated by 19th century Industrial Revolution, developing countries in Asia and South America missed the “entitlement” to licensed pollution free of retaliation. Second, carbon tariffs penalize developing countries for housing foreign subsidiaries even though they were harmed in the first place. For developing countries, pollution offshoring and carbon taxation are a compoundedly unfavorable combination.

In response, fairness can be promoted with two approaches: collecting retroactive emission fees from developed countries to financially compensate developing countries, or allowing developing countries more adjustment time to prepare for carbon tax. Under the former, just as affirmative action rectifies historical discrimination, carbon regulations can punish past pollution, which begs the questions: Should taxation be retributional in addition to redistributional? Should a supranational entity like the UN equalize across borders? If both answers are affirmative, developed countries should finance an International Environmental Fund to aid second/third-world countries in meeting development needs, or subsidize consumers in these regions, as the brunt of taxation is borne by the consumer. The latter scenario eschews conundrums of international redistribution, and simply instructs developed countries to lead the way in carbon taxes, as greater power entails great responsibility.

Critics further target carbon tax as regressive, claiming the poor are affected disproportionately compared to the affluent, because higher production costs increase the prices of necessities. However, since all consumption taxes are imposed at uniform rates regardless of wealth, most taxes not levied on income exhibit regressiveness, rendering the critique non-unique to carbon taxes. Furthermore, the regressive impact can be mitigated by transferring tax revenue to needy households, subsidizing climate adaptation and disaster relief, or adjusting other taxes (e.g. lump-sum tax rebate or payroll tax cut) to offset imbalance and maintain current distribution of tax burden.

On the optimistic side, rewarding low emissions can complement punishing high emissions, together constituting a carrot and stick approach. Governments can extend lower interest rates to and encourage institutional investment in environmentally-friendly businesses with emissions below an industry-specific threshold. Combining incentives with deterrents eases the acceptance of a carbon tax, making its implementation no longer a distant hope.