Carbon Pricing and Just Transition

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Carbon Pricing and Global GHG Emissions

Economically, carbon pricing is regarded as the most efficient climate change mitigation policy, as it provides the flexibility to reduce greenhouse gas emissions at the lowest cost. New carbon pricing schemes, such as  carbon taxes or emission trading, are emerging around the world. To date, there are 64 carbon pricing initiatives covering more than 20% of global emissions, albeit with prices much lower than those needed to achieve the targets of the Paris Agreement.

The social cost of Carbon Pricing

A key question is whether carbon pricing yields socially equitable outcomes. As placing a price on carbon raises the price of fossil fuels, it affects social groups differently. For instance, in high-income countries, poorer people tend to spend a higher share of their income on carbon-intensive goods. Therefore, carbon pricing would have a regressive outcome, i.e. impose higher costs on poorer people relative to disposable income. Moreover, people in rural areas and commuters could be more adversely affected than others. The scope of carbon pricing also matters for distributional outcomes. As poorer people are less likely to own a car and tend to drive shorter distances, pricing schemes that include the transport sector are, on average, more likely to be progressive than schemes focusing on the electricity sector only.

A recent study by IPPI and the Heinrich Böll Foundation found that carbon pricing would affect the poorest 10% of Israeli households twice as much as the richest 10% – relative to their disposable income. Independently of income, the Arab population would be more heavily affected than people of other ethnicities or religious backgrounds. Such unbalanced outcomes may provoke social unrest and undermine public support for climate policies. Therefore, carbon pricing has to be designed to enable a just energy transition.

What strategies to support Carbon Pricing and a Just transition?

There are various conceivable strategies for recycling revenues from carbon pricing back to citizens. The revenues can be handed out directly – either on an equal per capita basis or by targeting low-income households. This would make poor households net beneficiaries, as they would receive transfer payments that exceed their additional spending due to higher energy prices. Alternatively, other taxes, such as payroll taxes or value added taxes, can be reduced. Carbon pricing revenues can also be put back into expanding social security benefits, such as unemployment insurance and pensions, or into education. Finally, the additional public funds can be invested in infrastructure that would help people adjust to higher fossil fuel prices – for instance, by expanding clean mobility options such as public transportation or charging stations for electric mobility.

Yet a just transition strategy should not focus exclusively on consumers. It must also take into account economic futures and employment in the region. This is particularly important for fossil fuel extraction and energy-intensive industries, which could experience substantial declines in market shares if the prices of their products rise due to higher energy costs.

Some regions in which emission-intensive activities, such as production of steel, aluminum, chemicals, glass or pulp and paper are concentrated, will inevitably suffer adverse impacts from carbon pricing. These regions can be supported with predictable long-term transition strategies devised with all relevant stakeholders, such as industry associations, unions and civil society organizations. Some regions, such as Pittsburgh in the US, have successfully addressed the decline of their coal industry by building up higher education institutions. This has facilitated new avenues of business in the form of start-ups emerging from university research. Investing in transportation or telecommunication infrastructure can attract entrepreneurs, thereby protecting vulnerable regions from economic hardship.

Companies affected by higher energy costs can be compensated by selectively lowering corporate income taxes. This would help prevent adverse effects on employment and competitiveness, without diminishing the incentive for clean energy production provided by carbon pricing. Alternately, the productivity of firms could be increased, for instance by supporting energy-efficient measures.

Some countries, most importantly the EU, are currently considering carbon border adjustment mechanisms (CBAM) to prevent the relocation of energy-intensive industries to regions with less ambitious climate policies. CBAMs would be implemented by estimating the carbon content of imports and requiring importers to pay a levy proportional to the EU carbon price. This could further incentivize countries whose economies are closely integrated with the EU to adopt carbon pricing. With a domestic carbon price, Israeli firms would still be affected by higher energy costs (instead of the EU CBAM). Nevertheless, the revenues would accrue in the public budget of the Israeli government (instead of the EU) and could be spent on just transition measures.

Smart use of revenues can make carbon pricing key to a just energy transition. However, every shekel can only be spent once. Policymakers will need to navigate tough political trade-offs between various revenue uses, and withstand the influence of well-organized actors with vested interests who may aim to appropriate those revenues. Otherwise, carbon pricing could be perceived as a ploy to take money out of people’s pockets in favor of powerful lobbies, thereby undermining public support for climate change mitigation policies.

The opinions expressed in this text are solely that of the author/s and do not necessarily reflect the views of IPPI and/or its partners.

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