A dramatic increase in low carbon investment is needed to avoid irreversible climate change – of the order of US$500bn per year according to some estimates - and the UN expects that over 85% of this will come from the private sector. But the uncertainty and recent low prices seen in the carbon market are major barriers to gearing up investment. A hybrid carbon tax and trading scheme would provide the certainty of a minimum carbon price as well as a safety valve to limit overall costs, according to new analysis by PricewaterhouseCoopers LLP.
‘Carbon taxes vs carbon trading: pros, cons and the case for a hybrid model’, a white paper by PwC, argues that a modified trading scheme would bring some of the advantages of price certainty provided by a carbon tax while also capturing both the potential political attractions of carbon trading schemes and the virtues of allowing some price flexibility in response to evolving economic and technological conditions.
John Hawksworth, head of macroeconomics, PricewaterhouseCoopers LLP, said:
“Much of the debate on whether climate change should be tackled with a tax or through carbon trading is unduly black and white. Our evaluation of the arguments suggests that neither carbon taxes nor carbon trading are clearly superior to one another: both approaches have pros and cons.
“A hybrid trading scheme with price ceilings and floors offers a potentially attractive balance of price flexibility and predictability that we think merits serious consideration by governments as a potential alternative to either pure trading or pure tax solutions.”
Richard Gledhill, global climate change leader, PricewaterhouseCoopers, said:
"Carbon markets ought to play a key role in delivering low carbon investment, but the recent volatility and low carbon prices in the EU Emissions Trading Scheme and the Clean Development Mechanism market are undermining the business case for long term investment in emissions reductions. Business needs clear, long term price signals if major shifts in private sector investment are to be made."
The kind of hybrid scheme considered in the paper could be readily applied in Europe through relatively minor modifications to the existing EU Emissions Trading Scheme and this could then be linked to congruent schemes in the US and other major developed economies. In the longer term, such a scheme could also be rolled out to China, India, Brazil and other major emerging economies. This would, however, require international agreement on the levels of price caps and floors among participating countries, including arrangements for co-ordinated government action to buy or sell emission allowances in order to keep carbon prices within these limits.
The report notes that countries favouring a carbon tax could achieve approximate consistency with such a hybrid scheme through setting their tax rates within the carbon price trading bands (see diagram attached). These price bands could rise gradually over time to give enhanced incentives for emission reductions as abatement technology advances.
Mark Schofield, global sustainability and climate change tax leader, PricewaterhouseCoopers, said:
“There has been a lot of debate recently about the role of carbon taxes, as business underlines the need for more certainty and stability in policy to tackle climate change and as pressure mounts on public finances.
“While climate change is a global issue, tax systems remain local – operating on a country-by-country basis. Coordination between nations on such a strategic issue presents a significant challenge. However Copenhagen provides the context for a step change in policy and this hybrid model, which provides a practical policy framework that would strengthen investment incentives, should form part of the debate.”
1. Key advantages of a carbon tax identified in the paper include:
- It avoids high carbon price volatility seen in other emissions trading schemes (e.g. spikes in SO2 and NO2 prices in the US and the sharp drop in EU ETS carbon prices seen both in 2007 and again more recently);
- It can build on existing tax collecting mechanisms and authorities, so it should be simpler and less costly to run; and
- It raises more revenues for governments unless tradable permits are fully auctioned (and even then a tax is a more predictable revenue source).
2. Key advantages of carbon trading include:
- It is more politically acceptable since it does not involve an explicit tax and it may be easier to get international agreement on a globally-linked trading scheme than a global carbon tax;
- Trading schemes give certainty around achieving quantitative emissions targets;
- Auctioning can be phased in once a scheme is well established; and
- Some degree of price flexibility may be appropriate under conditions of economic and technological uncertainty and can be kept to manageable levels through banking or borrowing.
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