Tom Burke’s political commentary: Trying to square the carbon price circle

Published in ENDS Report, issue 446, March 2012.

Economists like things to be simple. All the world is a market and the men and women merely rational agents. If each plays his part pursuing self-interest then all will be well with the world. This core belief has taken a bit of a battering of late as the world has hit back against the phony certainty created by the mathematics economists use to describe markets.

Markets have turned out to be only part of a world in which men and women behave in complex, unpredictable and very possibly un-computable, ways. Very little that has happened to the economy in recent years has turned out quite the way we were told. This has left our political masters clinging on for dear life to whatever piece of theoretical wreckage they could find to keep themselves afloat in a turbulent ocean of uncertainty.

One of the currently most useful of these life-rafts is the idea of putting a price on carbon. The theoretical basis for this idea is elegant. Companies which emit carbon impose costs on other companies and on the economy as a whole. If there is no charge for those emissions, there is no incentive for companies to reduce them.

This is unfair on other companies and bad for society. Actually, given that those emissions have us on course for a world that will be four degrees warmer shortly after the middle of the century, they are pretty bad for civilisation too.

Economists call these emissions an externality – that is a cost to society not borne by the emitter. This is the justification for governments to intervene by imposing a carbon price. This, so the theory goes, internalises the externality and provides an incentive to reduce the emissions.

So far, so elegant. What is more, this works in economic models. Impose a high enough carbon price and, at least in a model, the carbon emissions disappear. The business community has enthusiastically bought into the idea. It is difficult to find a corporate statement on climate change anywhere that does not lead with the importance of pricing carbon.

The real world, sadly, is much more complicated. For a start, businesses prefer the theory of carbon pricing to the practise. Few governments have yet managed to create one without generating howls of rage from one part of the business community or another.

Nor are governments themselves immune from inconsistency. Britain is not the only country in which the government is trying simultaneously to drive energy prices down in order to address fuel poverty and competitiveness concerns, while driving them up by imposing a carbon price in order to tackle climate change.

There may be some clever way to square this circle but so far the best brains in Whitehall have not discovered it. This recently led Tim Yeo, chairman of the Energy and Climate Committee, to call on the Chancellor to scrap what he called ‘faux environmental taxes’ that would have a ‘devastating effect on UK industry’.

He is more right than he thinks. The so-called Carbon Floor Price is a very long way form being a green tax. Yeo is right to claim that it will do nothing to cut greenhouse gas emissions. First, because the theory has always been wrong, and second, because that is not why the Treasury is imposing it.

Dealing with climate change requires transformational change in our energy system. And it must be achieved in forty years. That is within the lifetime of the high capital, long life investments that underpin our energy system. To drive those decisions today would require a carbon price signal that totally overwhelmed the far more significant costs of capital and labour.

A carbon price certainly helps with change at the margin. But no politically deliverable carbon price will drive the necessary transformational change in our energy system that is required whatever it can accomplish in a model. So why is the Treasury so keen on a floor price?

Well, it is not a floor price for a start. There is no connection between the market for carbon emission permits and this policy instrument. It is simply a carbon tax disguised by Treasury officials’ skill with the elasticity of the English language.

The technical papers describing it are honest enough. They call it a carbon support price which is what it is. Simply an old fashioned tax intervention to stabilise a commodity price of the kind that Conservatives like Mr Yeo have opposed for years. Hence the subterfuge of spinning it as a floor price.

There is another layer to the Treasury cover story about this policy. A rising carbon price is also part of the subsidy package being put together to induce EDF and the French Government to pay for new nuclear power stations the market will not finance. But even this is not the real reason why Treasury officials are so keen.

The one unarguable effect of this tax is that it will raise revenue. A lot of revenue. Very reliably. And that is what the Treasury really cares about. And it will go on raising revenues this way as long as environmentalists and businesses allow it to get away with it.

We should not be surprised, or even upset, by Treasury dishonesty in tax matters. No-one likes taxes and we do what we can to resist or avoid them as much as possible. The temptation to paint taxes green to lower the political pain of imposing them is too strong to resist. We must expect it to continue.

There is only one way to keep politicians honest about green taxes and that is to recycle the revenues they raise into dealing with environmental problems. If we do not, there is a real danger that the Treasury will become addicted to them, as it already is to alcohol, petrol and tobacco taxes.

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