Helge Tveit, EV Private Equity

The bounce-back of CO2 emissions from 2020’s low-point at the onset of the pandemic has been swifter and stronger than most have anticipated. The notion that the world would “build-back-better” is a laudable ambition, but those that expect these initiatives to yield quick results will be disappointed.

Bloomberg New Energy Finance (BNEF) estimates average investment requirements to be between $3.1 trillion and $5.8 trillion per year until 2050 to get to net zero. Until we get close to those levels of investment, it is not reasonable to assume there will be significant progress in curbing CO2 emissions. At the same time, the recent spike in energy prices in Europe has revealed that consumers have limited patience for the “greenflation” of energy prices that squeeze already tight family budgets.

Replacing our current energy system will likely take decades and require patience. So, what can be done now to impact CO2 emissions at the lowest possible cost? Many prominent economists, including William Nordhaus, 2018 Nobel Memorial Prize winner in Economic Sciences, have advocated for a CO2 tax.

There are many responses sceptics have to CO2 taxes;

  • it is just another tax levied by the authorities to increase revenue;
  • it will hurt GDP by creating a “deadweight-loss”;
  • it will distort competitiveness between nations if some countries are introducing a tax and others not.

Let us deal with these counterarguments one by one.

Firstly, it is perfectly doable for a government to reduce other taxes to make a CO2 tax revenue neutral. If appropriately implemented, consumers will not be unduly burdened (on average), which will also be valid for businesses.

To the second counterargument: introducing a CO2 tax will result in a tax deadweight loss in situations where all else is equal. However, if the other taxes are reduced, they should correspondingly reduce the overall tax deadweight loss.

And finally, regarding the distortion of competitiveness, it is indeed true that a CO2 tax can distort competitiveness. Economists suggest dealing with this by introducing a “carbon border adjustment mechanism” (CBAM). If an exporting nation does not have a CO2 tax, then a tax would be levied on the imported products in a country that has implemented a CO2 tax. Many nations have already introduced a similar system for VAT. Through a reverse VAT charge, foreign services and products will have no tax advantage.

But what evidence exists that show this scheme would work? A fascinating case study is provided by Sweden, which introduced the highest CO2 tax in the world in 1990. In a paper authored by the Swedish economist Julius Andersson, he demonstrates that the introduction of the CO2 tax has led to a substantial reduction in emissions while having a negligible effect on reducing GDP growth.

Another feature of the CO2 tax, which is often overlooked, is that it is not just an incentive to change our spending; it’s a source of information about which behaviour we most urgently need to change to minimise CO2 emissions and reduce the rate of global warming.

Economic incentives work: let’s take advantage of them to act against global warming.